Financial Statement Fraud Exercise #1 In your Fraud Examination Casebook with Documents textbook, read Case 1: Fraudulent Financial Statements (pp. 5-19). Perform Exercise 1 - Fraudulent Financial Sta
1-3 EXERCISES—FRAUDULENT FINANCIAL STATEMENTS (LARSEN CONVENIENCE STORE)
Exercise 1: Individual Assignment
Input the IRS Schedules C from the 2013–2015 income tax returns into a spreadsheet.
Add percent columns to the right of dollar column for each year.
Calculate common‐sized percentages in the percent columns [divide each number for that year (e.g., 2013) by gross receipts for that year (e.g., 2013)].
Review the dollars horizontally across the three years and vertically down each year and identify any material irregularities.
Review the percentages horizontally across the three years and vertically down each year and identify any material irregularities.
Are there any material trends or material single‐year changes (e.g., material increases or decreases)?
Input the other metrics from the individual tax returns (e.g., income from wages and salaries, interest earned, and estimated tax payments).
Review the dollars horizontally across the three years and vertically down each year and identify any material irregularities.
Compare estimated tax payments with total taxes for the year (vertically during the same year).
Are there any material trends or material single‐year changes (e.g., material increases or decreases)?
Because you did not observe the inventory, which was destroyed in the fire, estimate ending inventory using the 2013 and 2014 dollars and percentages (Method #1: Cost of goods sold to gross receipts ratio).
Because you did not observe the inventory, estimate the ending inventory for 2015 by:
Averaging the 2013 and 2014 cost of goods sold and 2013 and 2014 gross receipts, and then dividing the average cost of goods sold by the average gross receipts. You cannot use an average of an average (e.g., Cost of goods sold/Gross receipts ratios for 2013 and 2014), which can distort the average. You must calculate the average for each and then the Cost of goods sold/Gross receipts ratio.
Multiply the resultant percentage from 3.a.i. by the 2015 gross receipts to get an estimated 2015 cost of goods sold total in dollars.
How does the estimated ending inventory impact the individual income tax return ending inventory, cost of goods sold, net profit, and net income? Find out by adding an additional column for 2015 and recalculate cost of goods sold using the estimates calculated above. Every number in that column is identical to the recorded 2015 column except estimated inventory, cost of goods sold, gross profit, and net profit.
Compare your recalculated ending inventory to that given to Sharptop Bank and to Southern Appalachian Insurance. Is either estimated ending inventory materially different from that reported on the 2015 IRS Schedule C?
OPTIONAL (extra credit points determined by professor) Because you did not observe the inventory, which was destroyed in the fire, estimate ending inventory by rolling the October 31, 2015, physical inventory totals forward (method #2).
Starting with the October 31, 2015, physical inventory, roll the inventory forward at cost by adding the purchases from November 1, 2015, through December 31, 2015 (according to the various wholesaler purchase records), to the December 31, 2015, physical inventory totals. This results in the inventory available for sale during 2015.
Then, reduce the inventory available for sale by the sales from November and December 2015 Georgia Sales and Use Tax Returns. Note: These sales are at retail price and must be reduced to wholesale cost. Use the Cost of goods sold/Gross receipts ratio determined in 3.a.i.
OPTIONAL (extra credit points determined by professor) Go to a business library or university librarian and locate RMA Annual Financial Statement Studies or a similar publication and locate convenience stores and comparable ratios (e.g., cost of goods sold to total revenues). How does the cost of goods sold to total receipts ratio in that publication compare to the ratios on the 2015 IRS Schedule C?