It is the usual accountant's story...a friend of yours (John Dough) has purchased a small business and knows that you are proficient at analyzing financial information. He has asked you to help him with his financial analysis. He informs you of the following background information:

After 20 years of service at his prior job, John was burned out and considering a change. While Christmas shopping, he was talking with a retail owner at a local mall and was informed that most retail stores mark up their prices 200%. John decided to quit his job and purchase and operate a retail toys and hobby shop. So, after finding the right opportunity, in January of year 1, he purchased a small store and inventory of toys / games for $300,000. He financed the purchase through the local bank, which loaned him 80% of the money at 7% for 10 years and required John to personally finance the other 20%. Since he is the owner of a small business, he has been operating it as a sole proprietor and not issued any stock. He is not paid a salary, but draws money out as needed. He has a full-time bookkeeper who handles all his books and accounting functions. There are two full-time sales clerks that work in the store and stock inventory in storage or on the shelves as it is delivered. All three of these employees have worked for him since he opened his business. John started each of them out at about $25,000 per year and has given each of them raises every year (approximately 3% per year). Additionally, if the company has a good year (net income), he rewards the employees by paying each of them a bonus of 3% of the net income amount. The bonuses are paid in the following year (February).

For years 1 and 2, he hired some external accountants for the compilation report. For years 3, 4 and 5 he hired a different set of external accountants for the compilation reports. The compilation reports state that the books are kept on an accrual basis of accounting according to GAAP and that Property & Equipment is capitalized at cost and depreciated using the straight-line method over the useful life of the property (Equipment 3 years, Furniture 5 years and Buildings 15 years).

Required : List 5 accounts that are suspicious relating to possible irregularities and why you believe additional investigative work should focus on them. Hint: to answer this you need to example the relationship between two accounts, ie. if one account increases what do you expect from the other related account. You should list 5 of such relationships.

Year Ended 12/31 1 2 3 4 5 Current Assets: Cash $12,351 $19,553 $42,862 $31,055 $21,908 A/R $17,459 $22,725 $46,826 $57,357 568,606 Investments - CD $20,000 $40,000 $20,000 $5,000 Inventory $83,457 $78,958 $107,763 $67,915 $88,749 Prepaid Insurance $5,922 56,355 56,988 $7,419 $7,988 Total current Assets $119,189 $147,591 $244,439 $183,746 $192,251 Property: Equipment $36,599 $37,596 $37,596 639,458 $44, 187 Furniture & Fixtures $27,495 527,495 $30,509 $30,509 $30,509 Buildings $157,976 $157,976 $157,976 $157,976 $157,976 Total Property, Plant & Equipment $222,070 $223,067 $226,081 $227,943 $232,672 Less Accumulated Depreciation $(18,580) 5(38,050) 5(64,216) 5(84,803 5(103,634) Net Property, Plant & Equipment $203,490 $185,017 $161,865 $143,140 $129,038 Total Assets $322,679 $332,608 $406,304 $326,886 $321,289 Current Liabilities Accounts Payable $12,897 $20,589 $22,477 $25,688 $27, 195 Accrued Wages Payable $1,233 32,241 $1,685 $1,957 52,391 Short term portion of LT debt $18,426 $19,758 $21,186 622,718 624,360 Total Current Liabilities $32,556 $42,588 $45,348 $50,363 $53,946 Long-Term Liabilities Long-Term Note Payable $204,391 $188,135 $171,392 $153,799 $135,762 Total Long-term Liabilities $204,391 $188,135 $171,392 $153,799 $135,762 Total Liabilities $236.947 $230.723 $216,740 $204.162 $189.708Equity John Dough, Equity $85,732 $101,885 $159,564 $122,724 $131,581 Total Equity $85,732 $101,885 $159,564 $122,724 $131,581 Total Liabilities & Equity 6322,679 $332,608 $376,304 $326,886 $321,289 Revenues: Sales $373,492 3452,781 $449,685 $362,755 $399,975 Less Returns & Allowances $(2,895) 5(1,670) 5(8,477) $(9,317) 5(11, 179) Net Sales $370,597 $451, 111 $441,208 $353,438 6388,796 Less Cost of Goods Sold $128,968 $158,987 $176,388 $169,589 $162,832 Gross Profit $241,629 $292, 124 $264,820 $183,849 $225,964 Expenses: Advertising & Promotion $10,725 $4,343 $8,289 $6,131 $5,700 Bad Debt Expense (write offs) 6399 $1,483 $125 $2,349 $1,300 Bank Charges $1,940 $2,177 $1,803 $1,799 $1,998 Depreciation $18,580 $19,470 $26,166 $20,587 $18,831 Insurance $3,948 $4,477 $4,695 $5,143 $5,637 Interest Expense $16,256 $16,743 $17,593 $18,037 $18,397 Legal & Professional $8,697 $6,602 $6,419 58,627 58,885 Miscellaneous $261 $426 6778 $1,875 $2,972 Office Supplies $4,265 $3,871 $4 825 $4,385 $4,000 Payroll Taxes 59,215 $10,982 $14,397 $15,183 $16,831 Repairs & Maintenance $5,042 $10,928 $11,472 $18,035 $15,849 Salaries & Wages $77,587 $79,915 585,619 $90,590 594,715 Telephone $1,840 $2,770 $2,812 $3,871 $3,700 Travel $1,982 $2,279 $1,806 $3,092 $3,240 Utilities $4,788 $5,819 $6,392 $11,471 56,100 Total Expenses $165,525 $172,285 $193, 191 6211, 175 $208, 155 Net Income (Loss) $76,104 $119,839 $71,629 $(27,326) $17,809