Crazy Eddie Inc.

Case 1.7- Crazy Eddie, Inc.

September 27, 2011

1. The current ratio and working capital were used on Crazy Eddie's financial statements to help determine the financial health of the company. The current ratio (CA/CL), is a measure of a company's ability to pay short-term obligations should they become due immediately. The ratio was .7612 in 1984, which suggests that the company would be unable to pay off its obligations if they came due at that point. From 1985-1987, it is greater than one, but an analysis of the cash account shows a $21 million increase from 1984-1985. It was red flag to me because the increase in cash is not supported by a substantial increase in net sales. for the same time period. Working capital (CA-CL), is a measure of both a company's efficiency and short-term health. In 1984, working capital was a -$2.136 million. A negative working capital means that a company currently is unable to meet its short-term liabilities with its current assets. In 1985, working capital was $18.794 million. That is a drastic $20.89 million dollar increase, which once again is not supported a substantial increase in net sales. On March 1, 1987, working capital was $153.034 million. This was a red flag because in 1984 working capital was negative, but in a three year span it increased by over $155 million. After seeing this drastic increase, an auditor should closely examine the current asset accounts and gather the supporting evidence needed to prove the validity of the account balances. In 1984 and 1985 Crazy Eddie had no short-term investments on the books, but in 1987 there was $121.957 million dollars in the short-term investment account. Another account that posed a problem was the merchandise inventory account. From 1984-1987, the merchandise inventory account increased by $85.729 million. With sudden spikes over a three year period in short-term investments and merchandise inventory, appropriate evidence should have been gathered to test the validity and existence of these accounts. The large variance in the accounts was a red flag to me the Crazy Eddie posed a higher than normal audit risk.

2. The specific audit procedures that might have led to the detection of the shady accounting by Crazy Eddie's are provided in the following list:

a. The falsification of inventory count sheets: Examine, Compute, and Vouch

b. The bogus debt memos for accounts payable: Scan, Trace, Compare, and Inquire

c. The recording of transshipping transactions as retail sales: Examine, Foot, Trace, and Vouch

d The inclusion of consignment merchandise in year-end inventory: Count, Examine, and Foot

3. In the mid 1980s, there was a large growth in the technological