CAL TEMP SERVICES, INC. GROUP 3: Sonia Canessa-Gonzalez Maria Fernandez de Castro Andres Suarez

BACKGROUND Cal Temp Services, Inc. (“CTS”) Provides engineering services, temporary personnel and personnel training services for the defense contracting industry. Company was started in 1990 Minimally capitalized (owners savings) Profitable since formation with revenues reaching $5.4MM in 1997

BACKGROUND cont… Initial growth was financed via a bank line against Accounts Receivable. Bank required audited financial statements. December 1993 through 2000 the CPA firm of Miller & Starr (“M&S”) audited their financial statements. Expansion plans with focus on larger engineering projects and other value-added services

BACKGROUND cont…. Additional financing required for expansion. Second Union Bank established an asset-based line of credit for the greater of $1.0MM or 75% of eligible accounts receivable. Conditions: First security interest in all assets as collateral. Only Receivables less than 90 days old would be considered for financing under bank line. Audited financial statements Monthly Collateral report consisting of Aged A/R . Certification from an officer that reports were complete and accurate.

Financial Condition of CTS Gross Revenues declined by 7% Decrease in gross profit margins Increased administrative expenses Resulting pre-tax loss of <$279,931>. Issue: Second Union informs CTS that they will not renew the line unless the company returns to profitability.

Issue at hand for CTS CTS would go out of business if the bank line was discontinued. No source of internal funding. Minimal cash with no liquid investments or other current assets easily convertible to cash. Debt to Equity approx. 3.4x Slow down in revenue generating projects. Reduction in expenses was not sufficient to return CTS to profitability.

Issue at hand for Second Union June 1999, the bank was presented with interim financial statements showing a return to profitability. The bank extended the line of credit for an additional year. FYE 1999 financial statements showed significant improvement over 1998 results Bank increases bank line up to $1.3MM

Issue at hand for Second Union cont… Continued profitable results throughout 2000. In 2001 further analysis of balance sheet shows a deteriorating A/R and frequent overdrafts. Owner of CTS is confronted and he admits that many of the A/R balances were uncollectible.

What pre-cautionary measures could the bank have taken? Audit of the company records. Bank credit line agreements normally afford the bank the right to review company books and records. This is often overlooked due to associated expense. Detailed analysis of cashflow statements and basic analytical techniques (ratios). Review of Earnings. Where they reinvested? Distributed? Additional supporting documentation. (i.e.,Original Copies of signed service agreements. ) Do they have additional sources of funding? (internal/external).

What about the auditors? Sufficient due diligence was not exercised by the auditors. The audit procedures for accounts receivable was not in accordance with GAAS. Fax confirmations are not acceptable since they can be easily modified and there is no way to verify if it was sent by the appropriate party. Review of credit and debit memo logs. Why so many? And why were they concentrated at the beginning of the year? Review of work order logs!! This would have reveals that revenue recognition was not according to their own accounting policies as stated in their audited stmts.

What about the auditors? cont… Analytical review of financial statement results and account balances. (Increased Revenues and profitability but negative operating cash flow? Why?) Too much reliance on management representations rather than physical evidence. Lack of judgment and independence. SAS 99, the auditor should have planned and performed audit to obtain reasonable assurance that material mistatements are detected.

Extent of Fraud As of December 31, 1999, we believe that accounts receivable are overstated by $253,427. Date Customer Adjustment Balance 12/31/1999   1,023,623 12/30/1999 Penns -75,000 948,623 11/29/1999 McDonald Douglas -58,995 889,628 11/30/1999 Nexus -119,432 770,196 Overstatement 253,427

Extent of Fraud As of December 31, 2000, we believe that accounts receivable are overstated by $666,242. Date Customer Adjustment Balance 12/31/2000   1,744,804 Nexus -187,210 1,557,594 CMI -197,697 1,359,897 JLO -77,200 1,282,697 DCS -30,000 1,252,697 Vortext -174,135 1,078,562 Overstatement 666,242

Litigation Consulting Issues Main evidence indicating knowledge of fraud: Credit memos to the A/R accounts. Admittance by owner of A/R uncollectability. Main motives: Loss of market share resulted in decreased cashflow. Keep company running until revenue generating projects were developed and concluded.

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