Case 1.8 Essay

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1. Compute common-size balance sheet and income statements and key ratios and other financial measures for Crazy Eddie during the period 1984-1987. Identify and briefly explain the red flags in Crazy Eddie’s financial statements that suggested the firm posed a higherthan-normal level of audit risk. Identify specific accounts/areas that the auditor should spend more time on based upon this analysis. There are some red flags in Crazy Eddie’s financial statements that indicate a higher-thannormal level of audit risk and we list them as follows: cash dropped from 34 percent in 1985 to 3.2 percent in 1987. Short-term investments increased from zero in 1984 and 1985 to 41.4 percent in 1987. Merchandise inventories decreased from 63.8 percent in 1984 to 37 percent in 1987. Accounts payable decreased from 55 percent in 1984 to 17 percent in 1987. Shortterm debt increased from 0.3 percent in 1984 to 16.8 percent in 1987. Accrued expenses went from 16.6 percent in 1984 to 1.9 percent in 1987. In addition, the inventory turnover decreased from 4.6 in 1984 to 3.2 in 1987 while the age of inventory increased from 79.7 days in 1984 to 113.2 days in 1987. This is a miserable sign because the electronics innovate day by day but Crazy Eddie needed more time to sell the products. The accounts receivable turnover decreased from 135.4 in 1984 to 53.9 in 1987 while the age of accounts receivable increased from 2.7 days in 1984 to 6.8 days in 1987 indicate that Crazy Eddie had some problems on realizing accounts receivable. In terms of cash and short-term investments, the cash and restricted cash account for 44.8 percent in 1985 and 3.2 percent in 1987. This change was related to the short-term investments, a drastically increase occurred from zero to 41.4 percent in 1987. This might resulted from the big explosion of opening branches. The convertible subordinated debentures increased

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