4/22/2020 Assignment 3

Forensic audit

Submitted to
Mr. Bilal Naeem
Submitted by
Muhammad Abdullah Jan
S2017314005
 CRAZY EDDIE FRAUD
QUESTION 1:
Based on the errors made by the external auditors during their stock check of stores and
otherwise, comment on the points that external auditors should be specifically careful
about when conducting stock check

ANSWER:
Based on the errors made by external auditors of Crazy Eddie auditors should have kept
following points in view while conducting stock check:

 Professional competence
First thing that was influenced by Sam was the competence of the auditor. An
inexperienced auditor was sent to do the audit which was contradicting with the concepts
of professional competence. If a more competent auditor was sent, he would have
avoided the errors.

 Professional skepticism
Second thing compromised and exploited by Crazy Eddie was the professional
skepticism of the auditors. When auditor arrived he was welcomed by a good looking
female employee who also helped him with all the stock check. She was advised by her
employers to get acquainted with the auditor and gain his trust. This way the auditor
trusted her and in turn Crazy Eddie and his skepticism was compromised and he trusted
their stock count.
He not only trusted them with stock count but his trust also enabled them to gain access
to his confidential audit plan documents which helped Crazy Eddie to prepare for future
audit.

 Verification of count
Another thing that auditor could have done was to verify the count himself with physical
stock and records instead of totally trusting Crazy Eddie employee with that.

QUESTION 2:
Explain the fraud indicators which you feel should have been picked up by the external
auditors or the regulators especially at the time of listing of Crazy Eddie?

ANSWER:
Following are the red flags that auditors and regulators should have picked to stop the fraud at its
early stages more specifically before Crazy Eddie going public:

 Sudden increase in sales

As Crazy Eddie was going public and its sales were not very high at that time and a
detailed financial analysis was to be done so, Crazy Eddie added its own money from
foreign accounts that it gathered by skimming in past through a money laundering
channel into its business as revenue from sales to increase its sales by almost $2 million
and a sales of this volume to a single customer in such a short time was definitely a red
flag. Moreover that single customer was also fictitious which could have been caught if
audit was done properly.

 Inflated inventory
Second red flag was the increase in inflated inventories during 1985-87. These increased
inflated inventories showed that Crazy Eddie was taking longer periods to turnover its
inventory. Moreover, AP to inventory ratio also decreased in 1987 as Crazy Eddie
showed fictitious purchase discounts and trade allowances. The decreased AP to
inventory ratio accompanied by consistently increasing Days’ sales in inventory ratio was
very clear red flag that something was wrong.

 Cash balances
In the year 1985, the cash balance of Crazy Eddie increased sky high but it was followed
by sudden decrease in next two years which suggested that most of the company’s money
was invested and it had very low money at hand to pay its expenses but company was
acting normally and this could also have been a red flag for the auditors and regulators.