Crazy Eddie, Inc.

Common Size Balance Sheets

March 1, 1987 March 1, 1986 March 1, 1985 May 31, 1984
Cash 3.17% 10.47% 33.99% 3.76%
Short-term investments 41.36% 21.14% 0.00% 0.00%
Receivables 3.68% 1.77% 4.18% 7.12%
Merchandise inventories 36.99% 47.16% 40.51% 63.83%
Prepaid expenses 3.61% 1.86% 0.98% 1.41%
Total current assets 88.81% 82.40% 79.66% 76.12%

Restricted cash 0.00% 2.64% 10.77% 0.00%
Due from affiliates 0.00% 0.00% 0.00% 15.69%
Property, plant and equipment 8.95% 5.65% 5.64% 5.05%
Construction in process 0.00% 4.93% 1.76% 0.00%
Other assets 2.24% 4.38% 2.17% 3.14%
Total assets 100.00% 100.00% 100.00% 100.00%

Crazy Eddie, Inc.
Common Size Income Statements
Year Ended
March 1, 1987 Year Ended
March 1, 1987 Year Ended
March 1, 1987 Year Ended
March 1, 1987
Net Sales 100.00% 100.00% 100.00% 100.00%
Cost of Goods sold 77.23% 74.11% 75.87% 77.89%
Gross profit 22.77% 25.89% 24.13% 22.11%

Selling, general and admin expense 17.68% 16.39% 15.04% 16.43%
Interest and other income 2.10% 1.22% 0.89% 0.51%
Interest expense 1.48% 0.31% 0.32% 0.38%
Income before taxes 5.70% 10.41% 9.66% 5.81%

Pension contribution 0.14% 0.31% 0.44% 0.00%
Income taxes 2.84% 5.06% 4.94% 3.06%
Net income 2.72% 5.05% 4.28% 2.75%
Net income per share 0.000096% 0.000183% 0.000176% 0.000131%

Crazy Eddie, Inc.
Key Ratios
1987 1986 1985 1984
Liquidity Ratios:
Current Ratio 2.4062 1.3985 1.5626 0.9287
Quick Ratio 1.4044 0.5982 0.7680 0.1499

Solvency Ratios:
Debt to Assets Ratio 0.6837 0.6643 0.6359 0.8298
Times Interest Earned 3.6169 30.3927 28.2877 14.9253
Long-Term Debt to Equity 2.1617 1.9786 1.7462 4.8755

Activity Ratios:
Inventory Turnover 3.2320 4.3811 5.1358 5.8812
Accounts Receivable Turnover 32.5026 116.7711 49.7515 52.7208
Collection of Accounts Receivables in Days 33 117 50 53

Profitability Ratios:
Gross Margin 0.2277 0.2589 0.2413 0.2211
Net Income Margin 3.0058 5.0498 4.2760 2.7483
Return on Total Assets 0.0359 0.1043 0.890 0.0758
Return on Equity 0.1136 0.3107 0.2443 0.6062

Upon analysis of Crazy Eddies ratios and financial statements there were several red flags
that suggested the firm posed a higher-than-normal level of audit risk. Analysis of the
financial statements raises several red flags. The first red flag was the shift in the balance of
the cash and short-term investment accounts. In 1985 cash represented 33.99% of total
assets and in 1986 cash represented only 10.47% of total assets. This shift in the cash
balance is most attributable to the shift in short-term investments which were 0% and 21.14%
respectively. The drop in cash shows that Crazy Eddie was beginning to experience financial
issues and liquidating their cash. Crazy Eddie continued to expand in this toughening market
which furthermore liquidated cash.
Another red flag is the drop in value of the merchandise inventory account. In 1984 the value
of the inventory was 63.83% and in 1987 had dropped to 36.99% which shows that they
were liquidating their inventory and replacing it with short-term investments. The retail
industry is composed largely of merchandise inventory and this downward trend should have
been a huge red flag. These red flags show a company who is losing market share because
of the expansion of the electronics market in the late 1980s.
Analysis of key ratios continues the trend of red flags for an auditor. The first ratio that looks
a bit suspicious to me is the current ratio which increased from .93 in 1984 to 2.41 in 1987. A
current ratio over 1 generally suggest that if all of the current liabilities came due at one then
the company would be able to pay the debt but in this situation for it to increase 150% over a
4 year span. The next red flag concerning ratios is the long-term debt to equity ratio which
decreased from 4.88 to 2.16. The ratio show how aggressive Crazy Eddie was in financing
their debt.
The major red flag that I see with the ratios is the collection of accounts receivables in days
which well below industry average. In 1984 Crazy Eddie was able to collect on account in 53
days and this number skyrockets to 117 in 1986. This show the inability for the company to
collect the debt owed to them which is also reflected in the downward trend of cash.
Extremely high accounts receivable turnover rates are an indicator of credit and collection
policies that are too restrictive.
The fact that the Antar family had absolute control over the operations was a red flag as well.
Eddie Antar knew that if he kept the company controlled by family members that they would
remain loyal. They were able to manipulate all aspects of the company. There were major
self-dealing transactions and related party transactions by family members (Antar, S)
The audit procedures that an auditor is supposed to perform are there to help protect from
fraud that may occur. The falsification of inventory count sheets could have been prevented if
the auditor would have verified the information that was on the sheets. Crazy Eddie
executives were excellent at staying one step ahead of the auditor because they knew in
advance which stores the auditors would visit, then they would ship merchandise to those
specific stores.
The bogus debit memos should have been authenticated by contacted some of the vendors
of Crazy Eddies and asking for supporting documentation. Unfortunately for the CPA, it is
too easy for the client to conceal liabilities (Wells). The auditors should have confirmed the
notes payables with the bank to verify their existence which would have also shown the
inflation of the accounts payable account.
The recording of transshipping transactions as retail sales should have been authenticated
by a review of the total sales at the specific store versus the gross profit and merchandise
levels. The auditors should have followed the paper trail in this situation to see where the
specific merchandise was coming from all the way to the sale of the merchandise. If the
auditors had performed this necessary step they would have seen that sales were inflated
and inventory was overstated with an increase in gross profit from sales. The inclusion of
consigned merchandise in year-end inventory could have easily been detected had the
auditors verified the merchandise records. The auditors should have seen that the
merchandise was to be returned to the suppliers.
An auditor should be very well educated in the trends of the industry for which they are
performing an audit. The industry was booming in the early 1980s and began to slow as the
decade continued. As the 1980s continued, Crazy Eddie continued to show double digit
growth while the other electronic retailers were struggling to break even. If the auditors
involved in the case would have examined the industry then they would have taken a closer
look at Crazy Eddie.
The auditors appeared to have turned a blind eye to Crazy Eddie because of the revenue
that was brought to their company based on non-auditing work from Crazy Eddies. The first
auditors was a small local firm that needed the revenue Crazy Eddie brought to them so they
did as they were asked and in many situations did not ask any questions. The second
auditors Main Hurdman had a nationwide practice with several clients in the consumer
electronics industry and should have known what the trend was in the industry. They too
received only a small portion of the revenue from auditing Crazy Eddie versus the amount
they received from computerizing inventory system.
Lowballing is an unethical practice that is involved in many industries including the auditing
profession. Lowballing is when services are performed below the market price just to keep
the business of an existing client or to attract new clients. In this case, Main Hurdman
lowballed to obtain Crazy Eddie and knew that they could make up for the lost revenue by
selling consulting services.
An audit can be affected because the audit firm may not use the same resources on the
client. The audit firm may be more willing to use interns or less experienced auditors to
perform the audit to make up for the lost revenue. The audit may also be compromised
because the auditors may not perform the accurate inventory checks as well as verifying
other accounts.
Crazy Eddie was clearly trying to impede auditors from performing their job by misplacing
their invoices. A company with a sound financial system would not misplace 10 invoices.
This should have been a huge red flag that Crazy Eddie was being deceptive. Unfortunately
the auditors in the case just turned a blind eye and allow the company to continue to have
material misstatements on their financial statements.
In this situation, the auditor could request invoices from the suppliers to get an accurate
count of the merchandise that was delivered to the company. The next step would be to
perform and inventory count at some of the Crazy Eddie locations without giving advance
notice.
I think that companies should be allowed to hire individuals who formerly served as their
independent auditors. Companies are facing cost issues and are trying to save money
because of our economic situation and training costs will be greatly reduced if the company
can hire an individual that is already familiar with the accounting system. In considering a
cooling-off period, the Independence Standards Board noted that a mandated cooling-off
period for partners and professional staff might create a greater appearance of
independence between the accounting firm and the registrant (U.S. Securities and Exchange
Commission).
The cons of this practice are that the audit firm may encourage this practice in order to keep
the client as a customer which created a disadvantage for the competition. There is also the
increased risk of fraud because the auditor has first-hand knowledge of how the audit will be
performed. The auditor will know how to manipulate the numbers because they will know the
checks that will be performed.
Afterthought
While doing research for the case I became intrigued with how detailed and complex the
fraud became at Crazy Eddies. In the article titled So Thats Why Its Called a Pyramid
Scheme, the author described 5 principle types of financial statement fraud and how Crazy
Eddies was involved in all 5. While doing research on the case I was surprised by how much
information there was on the internet. I also found it interesting that Sam Antar, former CFO
has his own blog site where he details the aspects of the fraud and how it was concealed
from the auditors.
http://www.whitecollarfraud.com/1265851.html. Antar, Sam E. 2010.
http://www.journalofaccountancy.com/Issues/2000/Oct/SoThatSWhyItSCalledAPyramidSche
me.htm. So Thats Why Its Called a Pyramid Scheme. Wells, Joseph T. 2000
http://www.sec.gov/rules/final/33-8183.htm. U.S. Securities and Exchange Commission.
2003