Abc Healthcare Equipment Company

ABC Healthcare Equipment Company

Audit Analysis

I. Concerning Issues and "Red Flags"

Numerous issues arise when analyzing ABC HealthCare Equipment Company. These factors stem around the declining MRI industry, which suffered a four-year decline. From this, it is acceptable to say that many companies may commit unethical practices to encourage external investment. As for ABC HealthCare, it lost its largest customers, downsized its staff, acquired an aggressive CEO, and alternated at least two different external auditors with no formal explanation on why they did so. However, they still managed to record earnings. The primary cause of concern here is with the significant audit risk involved with this company.

First, there is the inherent risk surrounding the MRI industry at this time. The business is in a decline in which auditors have no control over how this affects the company. The new CEO managed to persuade new investors when quickly entering into the company. With the support of professional skepticism, it is possible that he convinced investors with false hopes and unrealistic earnings estimates.

Secondly, there may be a strong lack of internal controls, which leads to a high degree of control risk. Since the company is cutting all possible costs, there is probably a much lower emphasis the design and implementation of internal control procedures.

Furthermore, with a fewer personnel, it is most likely that there is less segregation of duties. This can ease the cover up of internal fraud. Finally, since the CEO symbolizes the "tone at the top," he is telling employees to meet forecasts through all means, which further increases the likelihood that management would manipulate their financial statements. This could be a case of fraudulent reporting and may be hard to detect since upper management may have gone through great length to conceal it. The CEO may not be open to external advice, but it is an auditor's responsibility to enforce the proper and necessary auditing procedures to prevent any fraudulent activities to reach outside investors.

There are multiple red flags for possible fraud occurring in ABC HealthCare. The biggest red flag is the excessive pressure from the CEO to meet financial targets. The CEO and his no fail policy intimidate the entire company. He expects the company to meet or exceed financial targets, which proves to be how the "tone from the top" is one of the leading causes of fraud in companies, especially from executives like the CFO.

Another red flag is the rapid growth of ABC HealthCare with the loss of its largest customers while it competitors continue to struggle in the industry. The MRI industry is in a slump, but ABC still manages to meet and exceed earnings for thirteen consecutive quarters. This is a serious red flag that the draws attention to if the company is committing fraud to meet their targets. Since the CEO was able to get such significant new funding from outside investors, it is important to know why these investors continue to fund this company in a decline industry. Furthermore, the firing of the previous auditors is another red flag for fraud. This is especially the case since the previous auditors did not provide a definite reason as to why they left. It is possible to believe that management is trying to influence the auditor.

Finally, since the company is cutting costs as much as possible the internal audit function and internal controls may be taking a hit. Inadequate monitoring of internal controls, ineffective accounting and information systems, and lack of an effective internal audit function are all red flags for possible internal fraud.

II. Financial Statement Analysis

Performing a horizontal analysis on ABC Healthcare's balance sheet, there were significant accounts that required the auditors' attention. For instance, the percentage of change in inventory from 2007 to 2008 seemed to be a substantial increase of 46.67%. In comparison to the previous years, the percentage of change in inventory from 2008 to 2009 had a substantial decrease of -3%. By analyzing the numbers, the increase in inventory should have led to a decrease in the cost of goods sold account from 2007 to 2008, which would then lead to an overstatement of net income and retained earnings. Conversely, the -3% percentage of change in inventory from 2008 to 2009 should have led an increase in the cost of goods sold account, which will then lead to an understatement of net income and retained earnings. As for the income statement, ABC Healthcare showed a change of 101.75% in 2007 to 2008 and 158.52% in 2008 to 2009 in their cost of goods sold account. Overall, ABC Healthcare's cost of goods sold account increased from year to year, which then led to a possibility of an understatement of retained earnings. Lastly, referring back to ABC Healthcare's Balance Sheet. The retained earnings account showed a percentage of change of 156.85% in 2007 to 2008 and 110.99% in 2008 to 2009. Due to our professional skepticism as auditors, we considered this is necessary for further investigation of ABC Healthcare's inventory and retained earnings account due to fraudulent activity that maybe occurring. Thus, this affects the company's financial performance to be knowingly misstated.

Based on the analysis conducted upon the company's financial statements, it is important to analyze various accounts and their relationship to one another. It is easy to detect fraud through the analysis of different accounts in order to prove that the company does truly have the stated amounts on its financial statements.

One of the most important relationships to examine would be the cash and receivables accounts in relation to the sales account. While the company generates sales, it is important to know how the company makes its sales and where most of its sales go. If the company has most of its funds in its receivables account, it is important to determine if those receivables are from real customers or from an internal fraudulent activity.

The second most important relationship would be the inventory and cost of goods sold accounts