Company History and Business Strategy

Company History:

Super Duper Electronics (SDE Inc.), a retail company that specializes in electronics, has 43 stores that generate sales in excess of $350 million. Today, the company’s outstanding stock has a market value of $660 million. “In the early part of the 1900s, sales in the consumer electronics retail industry grew significantly. As the public’s demand for electronics grew [SDE’s CEO] converted his SDE stores into electronic supermarkets” (pg. 1). In 2005, SDE decided to go public to raise capital to finance the company’s expansion; however, the company was delayed in issuing IPOs for one year due to the discovery of disarrayed financial records. Among other problems, there were extensive related-party transactions, speculative investments unrelated to the company’s principal line of business, interest-free loans to employees, and all of the company’s key executives were related to the CEO. SDE did go public after cleaning up its accounting records and financial affairs. “The sale of SDE’s stock to the public was a great success. Because the IPO was oversubscribed, the company’s underwriter obtained permission from the SEC to sell 200,000 more shares than originally planned” (pg. 3). Even if these problems occurred many years ago, our audit firm should be concerned that SDE is still not continuing in any unethical financial practices. This is important, because if we take SDE as a client and discover that the company is involved in unethical practices, our audit firm’s reputation could be damaged. In this situation, our audit firm should consult with auditing standards # 7 to determine if our audit firm should accept SDE as a client (PCAOB website).

SDE’s Business Strategy:

There are a few ways in which SDE generates revenue. In 2011, SDE featured a couple of product lines. Figure 1A shows the types of products that were offered and their percentage contributions to overall sales for 2011. Aside from a diverse product line, SDE’s CEO encourages the company’s salespeople to generate more revenue by having them pressure consumers to buy product warranties. In the electronics industry, selling warranties is a great way for companies to earn extra revenue. These companies hire people with statistical and accounting knowledge to figure out the percentage of products that will fail within a given time and to determine a warranty price that will more than cover the cost of replacing failed products. Examining other electronic retail companies’ revenue accounts can serve as a benchmark in seeing how SDE is competing against its competitors in generating sales. Another way in which SDE has been able to generate more profits is by acting as an electronic wholesaler. The company “began extracting large price concessions from suppliers and began what is essentially a wholesale operation. The ability to purchase electronics in large quantities with significant discounts enables the company to become a ‘trans-shipper,’ or secondary supplier, of these goods to smaller electronic retailer in the So. California area. Sales testing in 2010 showed that transshipping accounted for 4.8% of sales revenue” (pg. 2). Our audit firm needs to pay close attention to fluctuations in revenue (if revenue has been increasing or decreasing over the years). If there is a sudden fluctuation in revenue, there could be a major material misstatement in SDE’s financial reports. SDE’s main marketing strategy involves heavy advertising.  These advertisements involve radio and television commercials. In addition, SDE hired Doctor TJ, a radio personality, to be the spokesperson for SDE. Doctor TJ has brought the company national awareness.

Figure 1A

Televisions sets					33%
Cell phones and accessories					20%
Radios					15%
Stereo and sound reproducing equipment					10%
Video electronics equipment					6%
Accessories and supplies					3%
Ebook readers and accessories					3%
Miscellaneous					10%
Total					100%

References

“Client Acceptance Department Step 2: Additional ARPs.”

Assignment #2 Outline. Pg. 1-3.

PCAOB website. “Auditing Standards #7.” www.pcaob.org

2010 & 2011 Unaudited Cash Flow Statements and Assumptions

		Super Duper Electronics
		Cash Flow Statement
		For year end 2010
Cash flows from operating activities
Net Income							13,244
Adjustments to reconcile net income
to net cash provided by operating activities:
Decrease in accounts receivable (net)					-494
Increase in accounts payable					28,645
Facilities depreciation expense					12,405
Increase in inventory					-33,321
Increase in accrued expense					8,393
Increase in short-term debt					1,831
Increase in pre-paid expenses					-1,718
Unearned revenue*					2,523		18,264
Net cash provided by operating activities							31,508
Cash flows from investing activities
Purchase of property, plant, & equipment					-20,980
Increase in other assets					-4,141
Purchase of short term investments					-26,840
Net cash provided by investing activities							-51,961
Cash flows from financing activities
Issuance of common stock including paid in capital					5516
Convertible subordinate debentures					0
Increase in long-term debt					76
Unearned Revenue**					1,194
Net cash provided by financing activities							6,786
Net decrease in cash							-12,779
Cash at beginning of year							29,331
Cash at end of year							16,652

		Super Duper Electronics
		Cash Flow Statement
		For year end 2011 (Unaudited)
Cash flows from operating activities
Net Income							10,596
Adjustments to reconcile net income
to net cash provided by operating activities:
Increase in accounts receivable (net)					-8,600
Decrease in accounts payable					-1,701
Facilities depreciation expense					16,568
Increase in inventory					-49,208
Decrease in accrued expense					-11,533
Increase in short-term debt					47,317
Increase in pre-paid expenses					-8,276
Unearned revenue*					-55		-15,488
Net cash provided by operating activities							-4,892
Cash flows from investing activities
Purchase of property, plant, & equipment (net)					-29,544
Increase in other assets					-1,036
Purchase of short term investments					-95,117
Net cash provided by investing activities							-125,697
Cash flows from financing activities
Issuance of common stock including paid in capital					40043
Convertible subordinate debentures					80,975
Increase in long-term debt					758
Unearned Revenue**					1,508
Net cash provided by financing activities							123,284
Net decrease in cash							-7,305
Cash at beginning of year							16,652
Cash at end of year							9,347

Assumptions: There are a few assumptions as auditors that we would have to make when preparing Super Duper Electronics, Inc. cash flow statement. One assumption that we would make is the other assets account. As auditors, we would find out more about this account and we assume that the company’s other assets account does not consist of any property, plant, and equipment. We need to ask the client about what kind of assets are in this account, because different kinds of assets are either considered assets for operating, investing, or financing activities. As auditors, we assume that other assets are for the company’s operational activities. Another assumption that we would make is unearned revenue* (current estimate of warranty liability). Since the company is currently involved in selling warranties, we ended up placing the unearned revenue* account in the operational activities of the company’s cash flow statement. We included convertible subordinate debentures in the financing activities of the cash flow statement section, because convertible subordinate debentures are exchangeable debt that allows debt to be exchanged for equity of the company. The advantage for convertible subordinate debentures for the company is that if convertible debt changes to equity, the debt vanishes. As equity increases, the client’s earnings per share dilutes.

            There are a few red flags in the company’s unaudited cash flow statement that we need to take into account. One is the increase in accounts receivable (net). This was a red flag, because over the past two years, the client was experiencing a downward trend in accounts receivable (net). In 2011, this account had an increase (from $2,246 to $10,846). Also, there was a dramatic increase for 2010 to 2011 in the inventory account (from $59,864 to $109,072). By examining these figures in the financial reports, we can see that there was a big fluctuation in the inventory account. Lastly, accrued expenses had a sudden change in trend from increasing expenses to decreasing expenses. Errors in these accounts could have occurred from an employee accidentally typing in the wrong numbers in the computer or the company may have experienced software issues.


Christine & Lindsay

Linear Regression Projection

Using linear regression in determining our audit expectations for select accounts. For X axis, we use the 4 year financial data of each account. For Y axis we use the amount for each account. We use both Income statement and Balance sheet (For comparative and common size I/S and B/S) data in our regression calculation to find the projected 2011 value of the four accounts (sales, cost of goods sold, gross margin, and current assets). They are as follows:

Graph: Sales, CoGS, Gross Profit, Current Assets projection in linear regression

• Net Sales : $337,843
• COGS : $257,282
• Gross Margin : $80,561
• Current Assets : $225,700
  
  
  Note: An example on how to use linear regression in SAS 99 audit brainstorming.
  
  
  Andreas

Ratio Analysis

• Current Ratio:

Current Ratio is a measure on how well a company can pay its short term debt. We see a sharp increase in current ratio, from 1.443 in 2010, to 2.406 in 2011. This is caused by a sharp increase in short term investment, with a 350% increase. However, compared with Industry Ratio, SDE is still in the lower quartile from 2008-2010.

• Liabilities to Inventory Ratio (L/I ratio):

L/I ratio is a measure a company's reliance on inventories to pay off its debts. This Ratio keeps decreasing every year; which means that Super Duper Electronics lessen their reliance on available inventory to pay off debts. Compared with industry ratio, SDE did slightly better than industry median quartile. This is an improvement over 2008-2010, when SDE started at the lower quartile. However, the sharp decrease in this ratio can be attributed to a sharp increase in inventories.

• Inventory Turnover Ratio (IT ratio):

Inventory turnover ratio is a measure on how much a company replaces its inventory periodically. A high IT ratio means that a company's sales is strong, and vice versa. Although SDE IT ratio increases every year, it is still far below industry's lower quartiles. This means that SDE have poorer sales than industry's bottom 25%.

• Assets to Sales Ratio (A/S ratio):

Assets to sales ratio is used to measure how well a company is managing its assets to generate revenue. High assets to sales ratio means that a company requires less investment to manage, and vice versa. Although SDE A/S Ratio is increasing every year, it is still far below industry's lower quartiles. This means that SDE require a lot of investments to generate revenue. Which is why we see a $80,975 subordinate convertible debentures as a capital injection to the company.

• Return On Assets Ratio (ROA):

ROA is a profitability measure of how well a company is in generating revenue from its assets. This ratio decreases significantly in 2011, in otherwise a stable 8-10% over the years. This means that Super Duper Electronics did not manage its assets effectively to generate revenue. However, SDE ROAs were better than the upper quartiles of the industry from 2008-2010.

• Return On Sales Ratio (ROS):

ROS is a profitability measure of how much income being generated per dollar of sales. ROS is also called “operating gross margin”. After increasing from 2008-2010 and leading the industry, SDE ROS slide in 2011. However, SDE also lead the industry because their ROSs were better than the upper quartiles of the industry from 2008-2010.


Ref: PCAOB AU329 Ratio Analytics

Andreas

Demo presentation

For our blog demo on tuesday feb. 21, i am thinking to make a backup cloud audit documentation using either Microsoft azure or skydrive or Amazon cloud, whichever is free. And for future presentations, i think it is time we move from powerpoint to prezi (http://prezi.com/). suggestions & comments?

Andreas

Tomb raiders group blog new users

Hello team,
This is Andreas. I created this new blog for this specific assignment. Since i am new to blogging, i need time to figure this stuff out. Have fun Blogging~!
Andreas