Assignment
Instructions
Questions
1) Wearever Appliances, a mid-sized manufacturer of small appliances, agreed to guarantee a loan for BioGenics, a startup pharmaceutical firm that has developed a bioengineered drug that would treat certain types of hard-to-treat cancers. The amount of the loan would be 50% of BioGenic's total assets and 10% of Wearever's.Because Wearever is an established, profitable firm with strong market position, bank approved the loan to BioGenics at a favorable interest rate. Wearever also is publicly traded and meets SEC guidelines concerning the makeup of its Board of Directors and Audit Committee
The pharmaceutical industry is consider highly risky because firms can invest millions in developing a drug only to have it fail clinical trials and, therefore, fail to receive FDA approval. Recent studies show that only one in ten drugs like BioGenics produces even make it to the second round of FDA approval.
Currently, BioGenics has little capital and only the one drug ready to submit for FDA approval. Thus, it has no other sources of revenue should the FDA deny approval and would probably have to go out of business without a significant infusion of new capital from lenders or new stockholders.
You work in the Director of Internal Audit department of Wearever and are reviewing the draft financial statements for the current year, which includes the loan guarantee for BioGenics. The CFO has not disclosed the loan guarantee in any way in the draft financial statements, to include not including it as a liability of the firm.
The text's coverage of contingent liability rules under GAAP is incomplete in that a contingent liability not only needs to be probably, but the amount also needs to be estimable before GAAP requires that it be recorded as a liability. Here is a diagram of the contingent liability decision rules under GAAP.
a) What should the accounting treatment for the loan guarantee be on Wearever's financial statements and why?
b) Do you see factors in this case that would suggest fraud? What are they and why might they indicate fraud?
c) Assuming that you, as the Director of Internal Audit, do suspect fraud. What would your next steps be and why?
2) Using the financial statement data provided for ABC Inc. provided below, calculate ratios that would help you determine whether they are underreporting accounts payable. I have provided these data in the "Supporting Case Data Week 9" spreadsheet file attached to this assignment. Show your ratios either in this Word document or attached a copy of your spreadsheet file if you used it to calculate the ratios.
If you spot possible evidence of underreporting of accounts payable, explain the evidence and how it might indicate fraud.
3) The text briefly discusses setting up "cookie jar" reserves.
a) Describe what a "cookie jar" reserve is and how management can create them.
b) The year in which management sets up "cookie jar" reserves the financial statements will show lower income and either lower assets or higher liabilities than they would show without the reserves. Why would management want to manipulate financial statements so that they have less income and less assets or more liabilities?
c) In my conversations with auditors, they describe the establishment of "cookie jar reserves" as a significant audit issue. However, the text states that they very rarely are involved in frauds. Speculate on what this difference in emphasis occurs. This is a thought provoking question, which is why I used the term "speculate." I just want to see what you can reason out and will not grade this part of the question "tightly."
Attachment:- Supporting-Case-Data.rar