EARNINGS MANAGEMENT AND FRAUD PROJECT ACCT 312: Spring 2020 You have just been hired as the controller for Wholesale Corp. The last controller left suddenly. The day after you started work, the president of the corporation called you into the office to discuss a preliminary draft of the December 31, 2019 financial statements. The statements reported a net operating loss of S21,000. The president was quite upset and wanted to know what you could do to "make them look better." The president was planning to go to the bank to discuss obtaining a new line of credit and was afraid that the request would be turned down because of the loss. You responded that you would check things out and see what you could do. (Hint: Things might get much worse) In the course of your account analysis, you became aware of several issues. Please complete the following project for the year ended December 31, 2019. (Do not prepare any descriptions or journal entries that should be made for January 2020) 1. Part 1: Prepare any necessary adjusting journal entries and determine the effect of cach entry on net income (record in the format noted below). The income (loss) per the trial balance and the effect of the adjusting journal entries should be totaled after the last entry. This project must be typed. I strongly suggest that you show me your journal entries and the related effects on income before handing in the project. Note: The company uses the periodic inventory method. 2. Part 2: For each transaction, briefly (maximum of a couple of sentences) discuss the problem identified and how it should be handled (problem, solution/correction effect on income). The descriptions should be written in the form of a memo, numbered, and be understandable by the president (do not discuss in terms of debits and credits) Only address the effect of the problems regarding the year ended December 31, 2019. (Ex: Sales of $X and the related COGS of $Y were recorded too early. The adjustment reduced income by $Z.) Page 1 As noted in the syllabus, do not request (or send) electronic or paper copies of a partially or completed project from (or to) others. Do not email your project to someone else to let them "compare answers" or for any other reason. Doing so enables others to change a few items and submit the project as their own work. It can also result in the project solution being circulated throughout the class. Students are allowed to discuss the journal entries with each other. However, each student must type all of their own journal entries and the memo. Both must be in their own words and in the required format. Do not "divide up" the project or cut and paste anyone else's work. If two or more students are found to have substantially the same projects, all involved will EARNINGS MANAGEMENT AND FRAUD PROJECT-Spring 2020 1. Upon reviewing the bank reconciliation, you realized that the general ledger had not been adjusted for $200 worth of NSF checks received for cash sales. The amounts of the individual checks were too small to make it worthwhile to turn them over to an attorney for collection. While testing the inventory counts, the auditors noticed that several high dollar items had counts on the inventory listing which were materially higher than the actual counts. The difference between the actual and recorded inventory value was $47,000. While comparing the current and prior year inventory schedules you noted that several products had approximately the same quantities. Upon further investigation you determined that the items had very little or no activity during the year. The inventory in question had a recorded value of $52,000. Upon discussions with sales and warehouse personnel, you learned that the items were prior versions of products, and were no longer offered for sale in the product catalog. You were also told that they will probably be thrown out rather than be sold through alternative distribution channels. While reviewing the inventory listing you noticed that certain items were counted by the unit, but priced per the case. The difference between the actual and recorded inventory value was $78,000. While testing items in the December sales journal, you noted that shipping documents indicated that $70,000 in sales (cost of $48,000) were not actually shipped until January of the new year. The related inventory was counted and listed on the year-end inventory summary. As part of performing the year-end sales cut-off procedures you identified a large sales return that was recorded early in the new year. Upon further investigation, you determined that the sales manager had asked a favorite customer to accept the delivery before year-end and had told the customer to "Just return them later, and I will take them off your bill". The products were invoiced for $400,000 and cost $240,000 to manufacture. You also learned that the sales manager was afraid of being fired because Page 2 sales for the year were well below the forecasted amount. The company uses the direct method to record sales returns. While reviewing the accounts receivable aging you noticed several large 180 day outstanding balances for accounts that were otherwise current. Upon questioning the accounts receivable supervisor you were told that there had been a problem with the orders. The systems shipped were defective and had been returned. The production manager said "New systems would be shipped out so don't worry about adjusting the books. Unfortunately, the customers canceled the orders and bought similar systems from a competitor. You also learned that the defective systems could not be economically repaired but were still counted and included in the ending inventory. The original sales were recorded at $70,000. The inventory was valued at $42,000. The company uses the periodic inventory system. While reviewing the accounting procedures for sales made on the company's website, you determined that when the order is placed, the customer's credit card is charged and the sale is immediately recorded. Goods sold through the website are typically shipped once a week. While reviewing the general ledger, you noted that there was no balance in the unearned revenue account. Upon further investigation, you determined that sales of $40,000 (cost $24,000) were made on the website during the last week of the 2019 and shipped on January 7, 2020. 9. During discussions with the marketing department, you discovered that they had recently rolled out a new campaign and made shipments to several major retailers under terms that they could take, display, and sell the products for three months. Any products that were not sold in the three-month "trial period" could be returned. Payment for the products sold (or that they wanted to keep an hand) would need to be paid for during the fourth month of the special promotion. The shipments were made on December 1. Sales were recorded in the amount of $300,000. The cost to manufacture the products was $180,000. 10. While working in your office, you received a call from an irate customer. The customer complained that she was still being billed for products that had been previously returned. After speaking with the warehouse supervisor you determined that the systems were returned during the week before year-end. The sales manager had told the warehouse manager not to worry about preparing a return slip until the new year. The warehouse manager also asked you whether it was OK to prepare the return slip now. You further determined that the products were counted during the year-end inventory and valued at $24,000. The original sale was recorded at $40,000. 11. While examining the allowance for doubtful accounts, you noticed that the only activity was a beginning balance, and some specific accounts receivable write-offs. Considering 1. While examining the allowance for doubtful accounts, you noticed that the only activity was a beginning balance, and some specific accounts receivable write-offs. Considering the accounts receivable aging, and subsequent collections, you estimated that the most likely scenario was problem accounts of $320,000 (independent of other adjustments). The allowance for doubtful accounts per the preliminary financial statements had a CR balance of $180,000. Page 3 12. While reviewing the maintenance & repairs account, you noticed that the bookkeeper expensed the engine overhaul on one of the delivery trucks. The new engine cost $40,000 and is expected to be good for another 100,000 miles. You also discovered that the $33,000 cost of repainting the factory was capitalized as a building improvement. 13. While reviewing the trial balance you noted a "Gain on sale of land" in the amount of $150,000. Upon further investigation you determined that the land sold had been acquired 2 years ago at a cost of $50,000. The closing statement indicated a sale price of $200,000. No cash or notes receivable were received. The company did receive another parcel of land that management felt was worth $200,000. You further determined that the other hastama 13. While reviewing the trial balance you noted a "Gain on sale of land" in the amount of $150,000. Upon further investigation you determined that the land sold had been acquired 2 years ago at a cost of $50,000. The closing statement indicated a sale price of $200,000. No cash or notes receivable were received. The company did receive another parcel of land that management felt was worth $200,000. You further determined that the other party to the transaction was a company solely owned by the principal shareholder of your company and that the transaction lacked commercial substance After updating the depreciation schedules, you determined that depreciation expense for the year was $180,000. When looking in the general ledger, you noticed that a standard journal entry in the amount of $11,000, had been posted each month during the year. 15. While reviewing the prepaid insurance and insurance expense accounts, you noted that the balance of the prepaid insurante account was $165,000 per the books, and that there were no entries made to insurance expense. Per your calculations, the prepaid insurance account should have had a balance of $15,000. 16. While analyzing the "other income" account you noticed a $271,000 CR posted from the general journal. On closer review you determined that it represented the sale of accounts receivable, without recourse, that are still on the books in the amount of $300,000. You also determined that there was a related allowance for doubtful accounts in the amount of $12,000. 17. While analyzing the sales account you noticed a $100,000 CR from the general journal (instead of the sales journal). Upon further investigation, you determined that it represented loan proceeds. You also determined that $1,000 of related interest expense had been incurred through year-end, but had not been recorded. 18. While reviewing the accounts payable cutoff, you were informed that all invoices received in January 2020 were recorded as January purchases. After spot checking the large invoices you determined that purchases in the amount of $28,000 were delivered in December, but were recorded as January payables. 19. While reviewing large direct distributions in the January 2020 cash disbursements journal, you noted purchases in the amount of $19,000 that were actually made in the December 2019. 20. While inquiring if any vendor invoices received were being held, a nervous employee mentioned that you might want to look in the former controller's file cabinet. When you investigated you found a thick folder containing invoices for that never been given to the accounts payable clerk. The invoices were for purchases, totaled $61,000 and were all for the period under audit. Page 4 21. While reviewing the January 2020 payroll journal you noticed that Payroll of $45,000, for the week ending December 31, 2019, was actually paid and expensed on January 7, 2020. There was no other unpaid payroll. On December 31, 2019, there was a $15,000 CR balance in the payroll payable account. EARNINGS MANAGEMENT AND FRAUD PROJECT ACCT 312: Spring 2020 You have just been hired as the controller for Wholesale Corp. The last controller left suddenly. The day after you started work, the president of the corporation called you into the office to discuss a preliminary draft of the December 31, 2019 financial statements. The statements reported a net operating loss of S21,000. The president was quite upset and wanted to know what you could do to "make them look better." The president was planning to go to the bank to discuss obtaining a new line of credit and was afraid that the request would be turned down because of the loss. You responded that you would check things out and see what you could do. (Hint: Things might get much worse) In the course of your account analysis, you became aware of several issues. Please complete the following project for the year ended December 31, 2019. (Do not prepare any descriptions or journal entries that should be made for January 2020) 1. Part 1: Prepare any necessary adjusting journal entries and determine the effect of cach entry on net income (record in the format noted below). The income (loss) per the trial balance and the effect of the adjusting journal entries should be totaled after the last entry. This project must be typed. I strongly suggest that you show me your journal entries and the related effects on income before handing in the project. Note: The company uses the periodic inventory method. 2. Part 2: For each transaction, briefly (maximum of a couple of sentences) discuss the problem identified and how it should be handled (problem, solution/correction effect on income). The descriptions should be written in the form of a memo, numbered, and be understandable by the president (do not discuss in terms of debits and credits) Only address the effect of the problems regarding the year ended December 31, 2019. (Ex: Sales of $X and the related COGS of $Y were recorded too early. The adjustment reduced income by $Z.) Page 1 As noted in the syllabus, do not request (or send) electronic or paper copies of a partially or completed project from (or to) others. Do not email your project to someone else to let them "compare answers" or for any other reason. Doing so enables others to change a few items and submit the project as their own work. It can also result in the project solution being circulated throughout the class. Students are allowed to discuss the journal entries with each other. However, each student must type all of their own journal entries and the memo. Both must be in their own words and in the required format. Do not "divide up" the project or cut and paste anyone else's work. If two or more students are found to have substantially the same projects, all involved will EARNINGS MANAGEMENT AND FRAUD PROJECT-Spring 2020 1. Upon reviewing the bank reconciliation, you realized that the general ledger had not been adjusted for $200 worth of NSF checks received for cash sales. The amounts of the individual checks were too small to make it worthwhile to turn them over to an attorney for collection. While testing the inventory counts, the auditors noticed that several high dollar items had counts on the inventory listing which were materially higher than the actual counts. The difference between the actual and recorded inventory value was $47,000. While comparing the current and prior year inventory schedules you noted that several products had approximately the same quantities. Upon further investigation you determined that the items had very little or no activity during the year. The inventory in question had a recorded value of $52,000. Upon discussions with sales and warehouse personnel, you learned that the items were prior versions of products, and were no longer offered for sale in the product catalog. You were also told that they will probably be thrown out rather than be sold through alternative distribution channels. While reviewing the inventory listing you noticed that certain items were counted by the unit, but priced per the case. The difference between the actual and recorded inventory value was $78,000. While testing items in the December sales journal, you noted that shipping documents indicated that $70,000 in sales (cost of $48,000) were not actually shipped until January of the new year. The related inventory was counted and listed on the year-end inventory summary. As part of performing the year-end sales cut-off procedures you identified a large sales return that was recorded early in the new year. Upon further investigation, you determined that the sales manager had asked a favorite customer to accept the delivery before year-end and had told the customer to "Just return them later, and I will take them off your bill". The products were invoiced for $400,000 and cost $240,000 to manufacture. You also learned that the sales manager was afraid of being fired because Page 2 sales for the year were well below the forecasted amount. The company uses the direct method to record sales returns. While reviewing the accounts receivable aging you noticed several large 180 day outstanding balances for accounts that were otherwise current. Upon questioning the accounts receivable supervisor you were told that there had been a problem with the orders. The systems shipped were defective and had been returned. The production manager said "New systems would be shipped out so don't worry about adjusting the books. Unfortunately, the customers canceled the orders and bought similar systems from a competitor. You also learned that the defective systems could not be economically repaired but were still counted and included in the ending inventory. The original sales were recorded at $70,000. The inventory was valued at $42,000. The company uses the periodic inventory system. While reviewing the accounting procedures for sales made on the company's website, you determined that when the order is placed, the customer's credit card is charged and the sale is immediately recorded. Goods sold through the website are typically shipped once a week. While reviewing the general ledger, you noted that there was no balance in the unearned revenue account. Upon further investigation, you determined that sales of $40,000 (cost $24,000) were made on the website during the last week of the 2019 and shipped on January 7, 2020. 9. During discussions with the marketing department, you discovered that they had recently rolled out a new campaign and made shipments to several major retailers under terms that they could take, display, and sell the products for three months. Any products that were not sold in the three-month "trial period" could be returned. Payment for the products sold (or that they wanted to keep an hand) would need to be paid for during the fourth month of the special promotion. The shipments were made on December 1. Sales were recorded in the amount of $300,000. The cost to manufacture the products was $180,000. 10. While working in your office, you received a call from an irate customer. The customer complained that she was still being billed for products that had been previously returned. After speaking with the warehouse supervisor you determined that the systems were returned during the week before year-end. The sales manager had told the warehouse manager not to worry about preparing a return slip until the new year. The warehouse manager also asked you whether it was OK to prepare the return slip now. You further determined that the products were counted during the year-end inventory and valued at $24,000. The original sale was recorded at $40,000. 11. While examining the allowance for doubtful accounts, you noticed that the only activity was a beginning balance, and some specific accounts receivable write-offs. Considering 1. While examining the allowance for doubtful accounts, you noticed that the only activity was a beginning balance, and some specific accounts receivable write-offs. Considering the accounts receivable aging, and subsequent collections, you estimated that the most likely scenario was problem accounts of $320,000 (independent of other adjustments). The allowance for doubtful accounts per the preliminary financial statements had a CR balance of $180,000. Page 3 12. While reviewing the maintenance & repairs account, you noticed that the bookkeeper expensed the engine overhaul on one of the delivery trucks. The new engine cost $40,000 and is expected to be good for another 100,000 miles. You also discovered that the $33,000 cost of repainting the factory was capitalized as a building improvement. 13. While reviewing the trial balance you noted a "Gain on sale of land" in the amount of $150,000. Upon further investigation you determined that the land sold had been acquired 2 years ago at a cost of $50,000. The closing statement indicated a sale price of $200,000. No cash or notes receivable were received. The company did receive another parcel of land that management felt was worth $200,000. You further determined that the other hastama 13. While reviewing the trial balance you noted a "Gain on sale of land" in the amount of $150,000. Upon further investigation you determined that the land sold had been acquired 2 years ago at a cost of $50,000. The closing statement indicated a sale price of $200,000. No cash or notes receivable were received. The company did receive another parcel of land that management felt was worth $200,000. You further determined that the other party to the transaction was a company solely owned by the principal shareholder of your company and that the transaction lacked commercial substance After updating the depreciation schedules, you determined that depreciation expense for the year was $180,000. When looking in the general ledger, you noticed that a standard journal entry in the amount of $11,000, had been posted each month during the year. 15. While reviewing the prepaid insurance and insurance expense accounts, you noted that the balance of the prepaid insurante account was $165,000 per the books, and that there were no entries made to insurance expense. Per your calculations, the prepaid insurance account should have had a balance of $15,000. 16. While analyzing the "other income" account you noticed a $271,000 CR posted from the general journal. On closer review you determined that it represented the sale of accounts receivable, without recourse, that are still on the books in the amount of $300,000. You also determined that there was a related allowance for doubtful accounts in the amount of $12,000. 17. While analyzing the sales account you noticed a $100,000 CR from the general journal (instead of the sales journal). Upon further investigation, you determined that it represented loan proceeds. You also determined that $1,000 of related interest expense had been incurred through year-end, but had not been recorded. 18. While reviewing the accounts payable cutoff, you were informed that all invoices received in January 2020 were recorded as January purchases. After spot checking the large invoices you determined that purchases in the amount of $28,000 were delivered in December, but were recorded as January payables. 19. While reviewing large direct distributions in the January 2020 cash disbursements journal, you noted purchases in the amount of $19,000 that were actually made in the December 2019. 20. While inquiring if any vendor invoices received were being held, a nervous employee mentioned that you might want to look in the former controller's file cabinet. When you investigated you found a thick folder containing invoices for that never been given to the accounts payable clerk. The invoices were for purchases, totaled $61,000 and were all for the period under audit. Page 4 21. While reviewing the January 2020 payroll journal you noticed that Payroll of $45,000, for the week ending December 31, 2019, was actually paid and expensed on January 7, 2020. There was no other unpaid payroll. On December 31, 2019, there was a $15,000 CR balance in the payroll payable account