You are a fraud investigator who has been hired to detect

Question

Case Study 1

You are a fraud investigator who has been hired to detect financial statement fraud for the Chipmunk Company. You have been provided with the financial statements on the following pages and are now begin- ning your analysis of those financial statements.

CASE STUDY 1
	CHIPMUNK COMPANY BALANCE SHEET DECEMBER 31, 2010 AND 2009
Assets 2010 2009 Current assets Cash $ 1,320,096 $ 1,089,978 Accounts receivable: net (Notes 2 and 5) 1,646,046 1,285,593 Inventories [Notes 1(a), 3, and 5] 13,524,349 12,356,400 Prepaid expenses 17,720 15,826 Deposits 7,916 5,484 Total current assets $16,516,127 $14,753,281 Property, plant, and equipment [Notes 1(b) and 4] 596,517 612,480 at cost, less accumulated depreciation Total Assets $17,112,644 $15,365,761 Liabilities Current liabilities Notes payable-Bank (Note 5) $5,100,000 $ 4,250,000 Accounts payable 1,750,831 1,403,247 Accrued liabilities 257,800 217,003 Federal income taxes payable 35,284 45,990 Current portion of long-term debt (Note 6) 5,642 5,642 Total current liabilities $ 7,149,557 $ 5,921,882 Long-term liabilities Long-term debt (Note 6) 409,824 415,466 Total Liabilities $ 7,559,381 $ 6,337,348 Stockholders' Equity Common stock (Note 7) $10,000 $10,000 Additional paid-in capital 2,500,000 2,500,000 Retained earnings 7,043,263 6,518,413 Total stockholders' equity $ 9,553,263 $ 9,028,413 Total Liabilities and Stockholders' Equity $17,112,644 $15,365,761

CASE STUDY 1

CHIPMUNK COMPANY

STATEMENT OF INCOME AND RETAINED EARNINGS FOR THE YEARS ENDED DECEMBER 31, 2010 AND 2009

	2010	2009
Sales	$26,456,647	$22,889,060
Sales returns and allowances	37,557	27,740
Net sales	$26,419,090	$22,861,320
Cost of sales	19,133,299	16,530,114
Gross profit	$7,285,791	$6,331,206
Expenses
Accounting	$ 48,253	$ 46,750
Advertising	28,624	27,947
Depreciation	46,415	46,578
Bad debts	148,252	162,344
Business publications	1,231	872
Cleaning services	15,817	12,809
Fuel	64,161	53,566
Garbage collection	4,870	4,674
Insurance	16,415	16,303
Interest	427,362	364,312
Legal	69,752	29,914
Licensing and certification fees	33,580	27,142
Linen service	3,044	1,939
Medical benefits	4,178	4,624
Miscellaneous	47,739	16,631
Office supplies	26,390	23,289
Payroll benefits	569,110	461,214
Pension expense	40,770	37,263
Postage and courier	8,623	20,962
Property taxes	3,978	27,947
Rent	158,526	120,000
Repairs and maintenance	51,316	26,439
Salaries and wages	4,310,281	3,970,092
Security	96,980	100,098
Telephone	5,707	7,092
Travel and entertainment	21,633	16,303
Utilities	63,329	41,919
Total expenses	$ 6,316,336	$ 5,669,023
Net income before income tax	$ 969,455	$ 662,183
Income tax expense	344,605	239,406
Net Income	$ 624,850	$ 422,777
Retained earnings at beginning of year	6,518,413	6,195,636
Less: Dividends	100,000	100,000
Retained earnings at end of year	$ 7,043,263	$ 6,518,413

Note: Inventories balance on January 1, 2009, was $11,427,937.

Ratio Analysis 12/31/2010
LIQUIDITY RATIOS	12/ 31 /10	12 / 31 /09	CHANGE	PERCENT CHANGE	INDUSTRY AVERAGE
Current ratio					1.21
(current assets/current liabilities)
Quick ratio
[(current assets - inventory - prepaid expenses)/current liabilities]					0.35
Sales/Receivables
[net sales/net ending receivables]					23.42
Number of days sales in A/R
[(net ending receivables/(net sales/365)]					15.58
Inventory turnover
(cost of sales/average inventory)					1.29

1. Calculate the 2010 and 2009 liquidity ratios identi- fied using the Ratio Analysis table above. Also cal- culate the change and the percentage change for the ratios and complete the table. (Formulas are given to shorten the time spent on the assignment.)

2. Analyze the Chipmunk Company's ratios for both years and compare the figures with the given indus- try ratios. Based on the ratios identified, where do you think fraud may have occurred?