The following scenario and analytical information describe a company. Three sets of facts are presented about this company. At the end of each set, perform a brainstorming analysis identifying all the factors that will affect the planning and conduct of the audit.

a. Company Background. Brandon Apparel group is a manufacturer and wholesaler of apparel. The company was purchased five years ago by two young entrepreneurs and is heavily leveraged. The owners put up $400,000 of their own money and borrowed approximately $6 million to acquire the company from the previous owner. The owners tried to sell the company, but a due diligence review by the potential buyer indicated that some of the assets acquired in previous years did not exist. The company’s debt is now over $10 million and Equity is about $1.2 million (unaudited).The Company has approximately $1.8 million in short-term payables. The company is relatively small with total sales last year of $13 million. Many of its customers are large, e.g., J.C. Penney, Sport Mart, MC Sporting Goods, and Kohl’s. The industry is competitive. The loan covenants require a debt-to-equity ratio not exceeding 3.5 to 1.0 and a tangible net worth above $1.5 million. Management fired the previous auditor and has asked you in to perform the audit because you are local and know the city better. During the year, the company moved to licensing more of its goods rather than manufacturing them.

b. Industry and Analytical Analysis. There is sketchy industry information available. The following reflects Brandon vs. the industry:

Other Financial Information:
Although the company has shown revenue and profit growth, cash flow from operations has been negative for the past three years.
c. Management Information and Controls. Management has determined that they need to outsource most of the manufacturing to other companies under a licensing agreement. However, for this year, they will continue to record the total amount outsourced as sales until the conversion to all licensing income is completed. Most of the large customers do not confirm accounts receivable. The company is implementing a more automated bar-coded inventory system at the end of the year. The new system is more accurate. The company will move the inventory to the new location after the end of the year where it will be counted on January 8 as it is unloaded and scanned into the new inventory system. Management has sued the former owners of the company for the $1 million note that is still due to them. The suit alleges that assets that were originally sold to the owners five years ago did not exist and according to the contract, the owners have the right to offset the discovery of the non-existent assets against the notes payable. Accordingly, the company has set up a contra liability account to show the offset with a corresponding increase in retained earnings.

Required
a. Perform a brainstorming exercise within your group to determine the following:
i. Motivations to conduct a fraud
ii. Potential problems with existing accounting principles within the company
iii. How a financial fraud might be conducted
iv. The likely ways in which a fraud might take place
v. Expected effects of the fraud on the financial statements
b. Prioritize the hypotheses as to how a fraud might occur.
c. For the three highest rated hypotheses as to how a fraud might occur, identify the audit procedures that should be implemented to address the possibility of afraud.

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Brandon Industry Revenue increase % Returns as % of revenue Gross margin % Inventory-% of assets Accounts receivable--% of assets Cash-% of assets Intangibles--% of assets 12% 3.4% 28.5% 58.4% 22.8% 00% 9.4% 5% 2.8% 43.2% 32.7% 18.2% 4.3% 7.4%