Crazy Eddie, Inc. Common Size Balance Sheets March 1, 1987 March 1, 1986 March 1, 1985 May 31, 1984 Cash 3.17% 10.47% 33.99% 3.76% Short-term investments 41.36% 21.14% 0.00% 0.00% Receivables 3.68% 1.77% 4.18% 7.12% Merchandise inventories 36.99% 47.16% 40.51% 63.83% Prepaid expenses 3.61% 1.86% 0.98% 1.41% Total current assets 88.81% 82.40% 79.66% 76.12%

Restricted cash 0.00% 2.64% 10.77% 0.00% Due from affiliates 0.00% 0.00% 0.00% 15.69% Property, plant and equipment 8.95% 5.65% 5.64% 5.05% Construction in process 0.00% 4.93% 1.76% 0.00% Other assets 2.24% 4.38% 2.17% 3.14% Total assets 100.00% 100.00% 100.00% 100.00%

Crazy Eddie, Inc. Common Size Income Statements Year Ended March 1, 1987 Year Ended March 1, 1987 Year Ended March 1, 1987 Year Ended March 1, 1987 Net Sales 100.00% 100.00% 100.00% 100.00% Cost of Goods sold 77.23% 74.11% 75.87% 77.89% Gross profit 22.77% 25.89% 24.13% 22.11%

Selling, general and admin expense 17.68% 16.39% 15.04% 16.43% Interest and other income 2.10% 1.22% 0.89% 0.51% Interest expense 1.48% 0.31% 0.32% 0.38% Income before taxes 5.70% 10.41% 9.66% 5.81%

Pension contribution 0.14% 0.31% 0.44% 0.00% Income taxes 2.84% 5.06% 4.94% 3.06% Net income 2.72% 5.05% 4.28% 2.75% Net income per share 0.000096% 0.000183% 0.000176% 0.000131%

Crazy Eddie, Inc. Key Ratios 1987 1986 1985 1984 Liquidity Ratios: Current Ratio 2.4062 1.3985 1.5626 0.9287 Quick Ratio 1.4044 0.5982 0.7680 0.1499

Solvency Ratios: Debt to Assets Ratio 0.6837 0.6643 0.6359 0.8298 Times Interest Earned 3.6169 30.3927 28.2877 14.9253 Long-Term Debt to Equity 2.1617 1.9786 1.7462 4.8755

Activity Ratios: Inventory Turnover 3.2320 4.3811 5.1358 5.8812 Accounts Receivable Turnover 32.5026 116.7711 49.7515 52.7208 Collection of Accounts Receivables in Days 33 117 50 53

Profitability Ratios: Gross Margin 0.2277 0.2589 0.2413 0.2211 Net Income Margin 3.0058 5.0498 4.2760 2.7483 Return on Total Assets 0.0359 0.1043 0.890 0.0758 Return on Equity 0.1136 0.3107 0.2443 0.6062

Upon analysis of Crazy Eddies ratios and financial statements there were several red flags that suggested the firm posed a higher-than-normal level of audit risk. Analysis of the financial statements raises several red flags. The first red flag was the shift in the balance of the cash and short-term investment accounts. In 1985 cash represented 33.99% of total assets and in 1986 cash represented only 10.47% of total assets. This shift in the cash balance is most attributable to the shift in short-term investments which were 0% and 21.14% respectively. The drop in cash shows that Crazy Eddie was beginning to experience financial issues and liquidating their cash. Crazy Eddie continued to expand in this toughening market which furthermore liquidated cash. Another red flag is the drop in value of the merchandise inventory account. In 1984 the value of the inventory was 63.83% and in 1987 had dropped to 36.99% which shows that they were liquidating their inventory and replacing it with short-term investments. The retail industry is composed largely of merchandise inventory and this downward trend should have been a huge red flag. These red flags show a company who is losing market share because of the expansion of the electronics market in the late 1980s. Analysis of key ratios continues the trend of red flags for an auditor. The first ratio that looks a bit suspicious to me is the current ratio which increased from .93 in 1984 to 2.41 in 1987. A current ratio over 1 generally suggest that if all of the current liabilities came due at one then the company would be able to pay the debt but in this situation for it to increase 150% over a 4 year span. The next red flag concerning ratios is the long-term debt to equity ratio which decreased from 4.88 to 2.16. The ratio show how aggressive Crazy Eddie was in financing their debt. The major red flag that I see with the ratios is the collection of accounts receivables in days which well below industry average. In 1984 Crazy Eddie was able to collect on account in 53 days and this number skyrockets to 117 in 1986. This show the inability for the company to collect the debt owed to them which is also reflected in the downward trend of cash. Extremely high accounts receivable turnover rates are an indicator of credit and collection policies that are too restrictive. The fact that the Antar family had absolute control over the operations was a red flag as well. Eddie Antar knew that if he kept the company controlled by family members that they would remain loyal. They were able to manipulate all aspects of the company. There were major self-dealing transactions and related party transactions by family members (Antar, S) The audit procedures that an auditor is supposed to perform are there to help protect from fraud that may occur. The falsification of inventory count sheets could have been prevented if the auditor would have verified the information that was on the sheets. Crazy Eddie executives were excellent at staying one step ahead of the auditor because they knew in advance which stores the auditors would visit, then they would ship merchandise to those specific stores. The bogus debit memos should have been authenticated by contacted some of the vendors of Crazy Eddies and asking for supporting documentation. Unfortunately for the CPA, it is too easy for the client to conceal liabilities (Wells). The auditors should have confirmed the notes payables with the bank to verify their existence which would have also shown the inflation of the accounts payable account. The recording of transshipping transactions as retail sales should have been authenticated by a review of the total sales at the specific store versus the gross profit and merchandise levels. The auditors should have followed the paper trail in this situation to see where the specific merchandise was coming from all the way to the sale of the merchandise. If the auditors had performed this necessary step they would have seen that sales were inflated and inventory was overstated with an increase in gross profit from sales. The inclusion of consigned merchandise in year-end inventory could have easily been detected had the auditors verified the merchandise records. The auditors should have seen that the merchandise was to be returned to the suppliers. An auditor should be very well educated in the trends of the industry for which they are performing an audit. The industry was booming in the early 1980s and began to slow as the decade continued. As the 1980s continued, Crazy Eddie continued to show double digit growth while the other electronic retailers were struggling to break even. If the auditors involved in the case would have examined the industry then they would have taken a closer look at Crazy Eddie. The auditors appeared to have turned a blind eye to Crazy Eddie because of the revenue that was brought to their company based on non-auditing work from Crazy Eddies. The first auditors was a small local firm that needed the revenue Crazy Eddie brought to them so they did as they were asked and in many situations did not ask any questions. The second auditors Main Hurdman had a nationwide practice with several clients in the consumer electronics industry and should have known what the trend was in the industry. They too received only a small portion of the revenue from auditing Crazy Eddie versus the amount they received from computerizing inventory system. Lowballing is an unethical practice that is involved in many industries including the auditing profession. Lowballing is when services are performed below the market price just to keep the business of an existing client or to attract new clients. In this case, Main Hurdman lowballed to obtain Crazy Eddie and knew that they could make up for the lost revenue by selling consulting services. An audit can be affected because the audit firm may not use the same resources on the client. The audit firm may be more willing to use interns or less experienced auditors to perform the audit to make up for the lost revenue. The audit may also be compromised because the auditors may not perform the accurate inventory checks as well as verifying other accounts. Crazy Eddie was clearly trying to impede auditors from performing their job by misplacing their invoices. A company with a sound financial system would not misplace 10 invoices. This should have been a huge red flag that Crazy Eddie was being deceptive. Unfortunately the auditors in the case just turned a blind eye and allow the company to continue to have material misstatements on their financial statements. In this situation, the auditor could request invoices from the suppliers to get an accurate count of the merchandise that was delivered to the company. The next step would be to perform and inventory count at some of the Crazy Eddie locations without giving advance notice. I think that companies should be allowed to hire individuals who formerly served as their independent auditors. Companies are facing cost issues and are trying to save money because of our economic situation and training costs will be greatly reduced if the company can hire an individual that is already familiar with the accounting system. In considering a cooling-off period, the Independence Standards Board noted that a mandated cooling-off period for partners and professional staff might create a greater appearance of independence between the accounting firm and the registrant (U.S. Securities and Exchange Commission). The cons of this practice are that the audit firm may encourage this practice in order to keep the client as a customer which created a disadvantage for the competition. There is also the increased risk of fraud because the auditor has first-hand knowledge of how the audit will be performed. The auditor will know how to manipulate the numbers because they will know the checks that will be performed. Afterthought While doing research for the case I became intrigued with how detailed and complex the fraud became at Crazy Eddies. In the article titled So Thats Why Its Called a Pyramid Scheme, the author described 5 principle types of financial statement fraud and how Crazy Eddies was involved in all 5. While doing research on the case I was surprised by how much information there was on the internet. I also found it interesting that Sam Antar, former CFO has his own blog site where he details the aspects of the fraud and how it was concealed from the auditors. http://www.whitecollarfraud.com/1265851.html. Antar, Sam E. 2010. http://www.journalofaccountancy.com/Issues/2000/Oct/SoThatSWhyItSCalledAPyramidScheme.htm. So Thats Why Its Called a Pyramid Scheme. Wells, Joseph T. 2000 http://www.sec.gov/rules/final/33-8183.htm. U.S. Securities and Exchange Commission. 2003