There are five practical problems. Please submit all of your work for these in one word or excel file. Practical Problem 1 The Regina Company, Inc. The Regina Company, Inc. (Regina) was engaged in the manufacture and marketing of various household equipment, such as vacuum cleaners and whirlpools. Regina's financial information follows these questions (pages 1-3, double click on Regina's financials to open them in Excel) - use these financial statements to answer the following questions: 1) Perform a vertical analysis on the financial statements. 2) Based on the results of the vertical analysis, what relationships appear to be out of alignment? 3) Is the relationship between sales and cost of goods sold linear? 4) Should the relationship between sales and cost of goods sold be linear? Why or why not? 5) Can you identify the potential fraud? If so, how did you determine there was a potential fraud? If not, what other information will help you determine whether there was a potential fraud? The Regina Company, Inc. STATEMENT OF INCOME (In Thousands) 12/31/1986 12/31/1987 (Audited) 12/31/1988 (Audited) (Audited) Net Sales 76,144 128,234 181,123 Cost of Goods Sold 46,213 70,756 94,934 Gross Margin 29,931 57,478 86,189 General Expenses 20,105 42,600 64,285 Operating Income 9,826 14,878 21,904 Interest Expense 1,930 1,584 3,189 Income Taxes 3,807 6,189 7,761 Net Income 4,089 7,105 10,954 Earnings Per Share 0.46 0.78 1.21 BALANCE SHEET (In Thousands) The Regina Company, Inc. 12/31/1986 12/31/1987 12/31/1988 (Audited) (Audited) (Audited) ASSETS Cash 63 514 885 Accounts Receivable 14,402 27,801 51,076 Inventories 9,762 19,577 39,135 Other Current Assets 708 1,449 3,015 Total Current Assets 24,935 49,341 94,111 Fixed Assets 19,523 19,736 27,884 Accumulated Depreciation (3,140) (4,948) (6,336) Other Assets 1,884 1,112 2,481 TOTAL ASSETS 43,202 65,241 118,140 LIABILITIES AND EQUITY Lines of Credit 2,707 Current Portion L/T Debt - 900 Accounts Payable 7,344 15,072 1,250 13,288 Accrued Liabilities 3,127 5,468 4,710 Income Taxes Payable 1,554 2,619 3,782 Total Current Liabilities 14,732 24,059 23,030 Bonds Payable 14,800 13,900 14,625 Bank Debt 5,941 47,432 Deferred Income Taxes 685 1,254 1,881 TOTAL LIABILITIES 30,217 45,154 86,968 Common Stock 1 1 1 Add'l Paid in Capital 8,010 8,018 8,023 Retained Earnings 5,210 12,315 23,269 Currency Adjustments 126 Treasury Stock (236) TOTAL LIABILITIES and 43,202 (247) 65,241 (247) 118,140 EQUITY BALANCE SHEET RATIOS Current Ratio 12/31/1986 12/31/1987 12/31/1988 1.693 2.051 4.086 Quick Ratio 0.982 1.177 2.256 Collection Ratio 69.037 79.132 102.929 Asset Turnover 2.365 1.975 Days sales in inventory 77.102 75.674 112.867 Debt-to-Equity Ratio 2.327 2.248 2.79 OPERATIONS RATIOS Receivables turnover 5.287 4.613 3.546 Inventory turnover 4.734 4.823 3.234 Times interest earned 2.119 4.485 3.435 COGS/Sales 60.69% 55.18% 52.41% Gross Margin % 39.31% 44.82% 47.59% Return on equity 31.49% 35.37% 35.14% The following practical problems involve the use of financial ratio comparisons to detect fraud. Practical Problem 2 Assume the following information for Company A: Current Assets Current Liabilities Year 1 Year 2 $640,000 $230,000 $720,000 $482,000 1) Define ratio analysis and describe how it can be used to detect financial statement fraud. 2) Calculate the current ratio for Company A for years 1 and 2. 3) What is the possible fraud implication of Company A's current ratio for year 2 compared to year 1? 4) What additional procedures should you always follow before reaching any tentative conclusions concerning possible fraud as a result of comparisons of ratio calculations? Practical Problem 3 The following information is given for Company B: Year 1 Year 2 Total cash, securities, and receivables $250,000 $300,000 Total current liabilities $122,000 $315,000 1) Calculate the quick ratio for Company B for years 1 and 2. 2) What is the possible fraud implication of Company B's quick ratio? Practical Problem 4 The following information is determined from Company C's accounts: Net sales on account Average net receivables Year 1 Year 2 $65,000 $250,000 $37,000 $180,000 1) Calculate the accounts receivable turnover for Company C for years 1 and 2. 2) The accounts receivable turnover ratio measures the number of times the accounts receivable balance is turned over, or collected, during the accounting period. It indicates the possibility of fictitious sales revenue. Describe fictitious or fabricated revenue. 3) Calculate the collection ratio for Company C for years 1 and 2. 4) What is measured by the collection ratio? 5) What are the fraud implications of Company C's collection ratio? Practical Problem 5 The following information is given for Company D: Cost of goods sold Average inventory Year 1 Year 2 $600,000 $350,000 $1,250,000 $525,000 1) Determine the inventory turnover for Company D for years 1 and 2. 2) What is measured by the inventory turnover ratio and what are the fraud implications? 3) Calculate the average number of days that inventory is in stock for years 1 and 2. 4) What are some of the important aspects of the average-days-inventory-in-stock calculation? 5) How might fraud examiners use the ratio and what is its significance