Fraud Identify Potential Financial Statement Fraud Schemes

Fraud

Identify potential financial statement fraud schemes at Apollo

In many instances the quantitative figures of companies can be misleading. The nature of generally accepted accounting principles (here forth referred to as GAAP), are such that they provide flexibility in determining appropriate financial figures. On occasion, management or executives may misrepresent these figures to make the company seem more or even less attractive during certain periods. For example, a company may take more losses in the current period, in order to seem more profitable in subsequent periods that follow. Likewise, companies may also seem to be more profitable than they are in an effort to hide substantial losses that have occurred in the business operations. Complicating the financial issue further is the fact many transactions don't appear within the financial statements at all. These transactions, called "Off-balance sheet transactions" can have a profound impact on the value placed on various companies including Apollo. This adroit financial engineering is often a result of a misalignment with company objectives with those of management, and can be very costly in regards to valuation of a business. As such, individuals must be aware of these miscalculations in financials and adjust financial statements accordingly based on reasonable expectations.

Describe the types of evidence that would determine if fraud is taking place

In regards to Apollo, we will discuss three aspects of the business in detail -Accounts receivable, Inventory, and Fixed Assets.

Accounts Receivable- First, an alarming figure within the income statement is that of bad debt expense. Here is where fraudulent activity occurs. To begin, the bad debt expense is the amount of receivables that Apollo deems uncollectable within a given period. As of 2010, that amount was $1,622,000. As a percentage of sales, which were $240,755,000 this amount was approximately .6%. This statistic alone is very favorable as it depicts Apollo's ability to manage credit well. However, in 2011, sales increased to $245,213,452.88 or approximately a 1.85%. During this period however, bad debt expense was 0. A 100% decline in bad debt expense within one year is alarming considering that also during that period, accounts receivable increased to approximately $49,000.000. This was up from $16,000,000 the year before. In essence, the accounts receivable have nearly tripled while the bad debt expense has plummeted. The fact that the accounts receivables increased so rapidly might also suggest that Apollo is easing credit terms in order to generate sales. As such, the earnings of the company may not be legitimate as the company has nearly tripled the receivables it has on account. This results in fraudulent activity as earnings are overstated and costs understated.

Additionally, the company has not taken the necessary precautions to guard against a sudden default on the part of it customers. An increase in receivables as rapid as that mentioned above, such be accompanied by a corresponding amount of doubtful account allowance. This allowance for doubtful accounts is money set aside in the event that a customer may not pay. The annual report states that in 2010 and 2009, 15% and 11% of all revenue was generated from a single customer, respectively. Not only are receivables increasing but the customers receiving the favorable terms are becoming more concentrated. As a result we should expect the allowance for doubtful account to reflect this. It does not however. In 2010 accounts receivable was $16,410,903. The allowance for doubtful account was $1,262,819. As a percentage of total receivables the allowance for doubtful accounts was 7.6%. Again this is not a bad number. In essence, $7.60 out of every $100 is allocated toward accounts that may not be collectable. However, when juxtaposed against 2011, an alarming picture arises. As mentioned earlier, receivables nearly tripled over this period to $49,780,259. However the allowance actually decreased over the same period to $1,254,010! As a percentage, the allowance is only 2.5%. Only $2.50 out of every $100 in receivables is allocated towards uncollectable payments which are unreasonable given the step increase in the overall receivables account. This should be signal to fraudulent activities as the company simply can not sustain this kind of behavior and be profitable. Likewise, the nature of the shoe and apparel business is cyclical in nature. An adverse economic downtown, such as the one in 2008, could be a huge detriment to Apollo's business operations. By not allocated effectively, the company is putting itself at risk. Also by having too many receivables concentrated on too few customers, the company also is exposed to counterparty risk, which again hurts the business. As such, fraudulent activities are likely to occur in this area of the financial statements.

Inventory- Inventory within the apparel business is of huge concern. For Apollo, large inventories can be a detriment to business as the company is forced to mark down merchandise or extend favorable credit terms. As I mentioned above, the company is indeed extending favorable credit terms as its accounts receivable have tripled within one year without any increase in bad debt expense or allowance for doubtful accounts. In regards to inventory fraudulent activity can occur on both a quantitative and qualitative basis. On the qualitative side, one concern regarding fraud is the actual quality of the shoes themselves. In many instances, consumers taste and desire change. Are the shoes that Apollo's manufacture in style? Are they relevant to the consumer? The answer to this question would be no, as I will mention the proof in subsequent sections below. In addition, what is the composition of Apollo's inventory? Is it merely shoes that are too large for the general population to wear in terms of size? Are they broken, worn down, and obsolete? Is their better technology or merchandise available at a similar price point? Have fair values of assets declined below book value? All these questions affect the value of the inventory on hand. If the answer to the above questions are "Yes" then the value of Apollo's inventory is overstated which again opens the door for fraudulent activity as the value is misleading.

Now in regards to the quantitative component, an alarming picture again arises within the context of fraud. In 2010, inventory was valued at $18,825,205 with a reserve for obsolescence of approximately $3,000,000. The percentage is roughly 15%. Now is 2011

(The year of excessive receivables remember? This will be important later on) inventory was an astounding $67,424,527 with a reserve of only $867,000. The percentage is roughly 1.2%, again, very unrealistic. Additionally there is a discrepancy between audited and unaudited inventory levels. For example, the unaudited balance is $67,424,527.50 while audited balance is $18,825,205.24.

Describe the substantive procedures used to analyze the potential fraud schemes