Auditing Case 2: Crazy Eddie, Inc.
1. An analysis of key ratios during the period of 1984-1987 would have resulted in red flags that indicated that Crazy Eddie had a higher than normal level of audit risk.
The balance sheets for 1984 to 1987 show some huge irregularities in the accounts between the years. For instance, cash fell from 34 in 1985 to 3.2 in 1987. A red flag came up when analyzing the merchandise inventories to total assets ratios which were 63.8 in 1984 to 37 in 1987. Short-term investments had a zero balance until 1986 when it went to 21.1, then up again to 41.4 in 1987. Short-term debt increased from .3 in 1984 to 16.8 in 1987. Accrued expenses went from 16.6 in 1984 to 1.9 in 1987. Cash and restricted cash were 44.8 in 1985, but only 3.2 in 1987. Crazy Eddie's management was trying to rapidly expand the company with these huge investments but they did not have a lot of cash just in case something unforeseen happened. For instance, they did not plan for market saturation and an explosion of competition which led to their inventory being undersold and obsolete.
Other financial measures indicated that there was a problem with inventory also. The age of inventory at Crazy Eddie went from 80 days in 1986 to 111.8 days in 1987. The inventory turnover decreased from 4.5 to 3.22. There is also a problem with accounts receivable, the turnover decreased from 105.2 to 53.9, while the age increased from 3.4 days to 6.7 days. It is important to move electronics in the inventory fast because the technology gets obsolete quickly. Crazy Eddie was facing increased competition and market saturation yet still managed to increase profits. The inventory ratios verified that there was a problem with the accounting at Crazy Eddie.