Case 1.

5 The Leslie Fay Companies

Vahida Yacub Ana Lopez Luminita Tanase

Accounting 6355 Seminar in Auditing Standards and Application Professor: Dr. Yonghong Jia September 12, 2012

customers. Its major competitor. After John Pomerantz had taken over the company.5) Synopsis The Leslie Fay Companies. knowledge of the company’s creditors. and investigators determined that Leslie Fay’s earnings were overstated by $80 million from 1990 – 1992.Written Case Aalysis Leslie Fay Companies (1. The company is based out of New York. knowledge of industry. Leslie Fay reported impressive sales and earnings. and extent of further audit procedures”. The company was named after his daughter. However. and to design the nature. whose revenue faced slowing sales from its major product lines. Pomerantz focused Leslie Fay on one key segment of the industry. Despite the economic trend towards casual clothing affecting the women’s apparel industry. a large accounting fraud was revealed. in addition. suppliers. Analyzing the financial statements can be seen there is a huge constant increase of net income from 1987–1991. According to PCAOB Audit Standard No. In late 1980s and early 1990s. including its internal control. Liz Claiborne. the auditor needs to have knowledge of the company which includes being knowledgeable of what industry the company is in. The Standards of Field Work under GAAS. the economy decline. statement #2 requires auditors to have knowledge about the company’s environment. by developed a moderated priced and a conservative style dresses for women aged 30 through 35. and the recession caused many consumers to limit their discretionary expenditures. 12. was eventually forced to take large inventory write-downs. profits started climb sharply even though the market for women’s apparel was going downhill due to the recession from the 1980’s through the 1990’s. In early 1993. . including buying new clothes. and Fred Pomerantz made the company public in 1952. From the beginning. Fred Pomerantz ended up taking the company back to a private entity for a few years in the 1980’s due to a buy out from his son John Pomerantz. to assess the risk of material misstatement of the financial statements whether due to error or fraud. was founded by Fred Pomerantz. The Leslie Fay Companies became public again in 1986. which is a manufacturer of women’s apparel. timing. “The auditor must obtain a sufficient understanding of the entity and its environment.

the auditors has to examine the internal control and accuracy of such transactions as one of the audit risk. 3. During recession when the competitors were forced to take large inventory write-offs. sent letters to the customers to verify the sales. the company failed to recognize write-offs. The auditors should have examined the internal control. in this case the period end inventory has been inflated from 83 million in 1987 to 126. as in Accounting standard no.Auditors should always be aware of industrial situations pertaining to the company they are auditing (AS#9).8 million in 1991. ignored discount on receivables.6 million in 1991 and their cost of sales account increased only from 403.(AS # 8) .6 million when the rest of the industry competitors were struggling to make profit indicates that the sales account has to be substantially tested and verified for material misstatement. which can be an inherent risk for such companies where the accounting system was maintained in old fashioned way of recording the entries manually. 2. 13 3. When Leslie Fay reported net sales of 836. 4.Inventory.When Leslie Fay reported an increase in sales from 582 million in 1987 to 836. which can be easily manipulated by one person.Orders received from customers were recorded as sales. in retail business has always been analyzed as a potential threat for misrepresentation.1 million in 1987 to 583. makes the account susceptible of material misstatement. this company had none. which has been overlooked by the auditors.1 million in 1991 which is proportionately less. which is a red flag and has to be further examined by the auditors.Key Issues Related to Auditing 1.

Plant and Equipment Goodwill Deferred Charges and Other Assets T la ota ssets L IL IE ANDS OC H D R ' E IAB IT S T K OL E S QUIT Y Current Liabilities: Notes payable Current Maturities of Long-termDebt Accounts Payable Accrued Interest Payable Accrued compensation Accrued Expenses & Other Income Taxes Payable T l Current L bilities ota ia Long Term Debt Deferred Credits & Other Noncurrent Liabilities Total Shareholders' Equity T lL ota iabilitiesa S reholders' E nd ha quity 19 90 18 99 18 98 18 97 1% 30% 32% 5% 68% 10% 21% 1% 100% 1% 32% 34% 5% 72% 7% 20% 1% 100% 1% 30% 31% 5% 68% 7% 24% 1% 100% 2% 30% 29% 5% 66% 7% 26% 1% 100% 1% 27% 27% 5% 61% 8% 30% 2% 100% 9% 0% 8% 1% 4% 1% 0% 23% 21% 1% 55% 100% 11% 0% 10% 1% 3% 1% 1% 27% 30% 1% 43% 100% 6% 0% 10% 1% 5% 1% 1% 25% 33% 1% 41% 100% 8% 0% 13% 1% 5% 2% 2% 30% 32% 1% 37% 100% 5% 0% 10% 1% 3% 2% 1% 24% 38% 2% 39% 100% . Given these data. compute for Leslie Fay the ratios shown in Exhibit 2. For that same period. C m s eB om on iz alance S heet The L lie F C panies es ay om 19 91 AS E S ST Current Assets: Cash Receivable(net) Inventories Prepaid Expenses & Other Current Assets Total Current Assets Property.Responses to case Questions 1. which financial statement items do you believe should have been of particular interest to BDO Seidman during that firm’s 1991 audit of Leslie Fay? Explain. Prepare common-size financial statements for Leslie Fay for the period 1987-1991.

2 0.42 0.96 31.8 0. .51% 2.60 55.92 52.06% 3.45 3.21 0.27% 15.58 1.53 4.Sales has been growing steadily except the slight drop in 1991.73 days 2.45 3.95% 17.03 31.83 6.81 62.99 days 1.C m s e Incom S om on iz e tatem The Les F C panies ent lie ay om 19 91 100% 70% 30% 22% 23% 7% 2% 5% 2% 4% 19 90 100% 69% 31% 23% 24% 8% 2% 6% 2% 3% 18 99 100% 68% 32% 23% 24% 8% 2% 6% 2% 3% 18 98 100% 68% 32% 23% 23% 8% 3% 6% 2% 3% 18 97 100% 69% 31% 23% 23% 7% 3% 5% 2% 3% Net Sales Cost of Sales G ross Proft Operating Expenses: Selling.67% 16. General and Administrative Total Operating Expenses Operating Income Interest Expense Income Before Taxes on Income Income Taxes Net Income Industry L iquidity Current Ratio Quick Ratio S olvency: Debt to Assets Times Interest Earned Long-termDebt to Equity Activity: Inventory Turnover Age of Inventory Accounts Receivable Turnover Age of Accounts Receivable Total Asset Turnover Profitability: Gross Margin Profit Margin on Sales Return on Total assets Return on Equity 1. there some of the financial statement item that should have been of particular interest to BDO Seidman: .67% 2.43 6.1 30.7 days 2.38 57.9 0.37% 3.7 53.20% 6.57 days 1. which is contrary to the industry recession.49 56.02 51.61% After reviewing the common size financial statements and the key ratios of Leslie Fay.63 3.57 3.5 days 3.13 1.60 1.01 52.3 days 6 60.8% 13.28% 16.08 51.50% 2.29% 16.73 7. Warehouse.21days 7.38% 13.75 1.91 30.54days 1.91 1.88 31.14 6.1 31.00% 14% 2.28 0.85 days 6.27 1.33 0.35 5.71 6.61 1.62% T L he eslie F Com nies ay pa 2.69 54.7 days 8 45.21 days 6.70% 3.74% 3.73% 3.21 0.38% 15.39% 15.16% 2.64 1.20 1.05 days 7.63 2.06 0.51% 15.

Inventory. Auditors need to understand the relation that Leslie Fay company had with is customers.” According with PCAOB -AS 3. statement # 3. 2. source. “The auditor must obtain sufficient appropriate1 audit evidence by performing audit procedures to afford a reasonable basis for an opinion regarding the financial statements under audit. which gives auditor an overall opinion about the company’s expected growth and its profit margin level pertaining to the industry standards. As the current and quick ratio of Leslie Fay show. . Since the industry suffered of the downhill sales.” Also. and the conclusions reached. All other major competitors had to writeoff while LESLIE Fay announced a record sales for the same period. the audit documentation should “be prepared in sufficient detail to provide a clear understanding of its purpose. -Any documentation with its customer regarding its orders. the auditors should analize company’s policy of write-off. according to PCAOB AS 15. In addition to the data shown in Exhibit 1 and Exhibit 2. .Liability accounts.paragraphs 7-17. such as financial reporting practices that pertain to the industry. but it hasn't been reflected in the inventory account. as a result there should be inventory write-off issue in the apparel industry. 9 “an auditor should establish overall audit strategy for developing an audit plan which includes planned responses to the risk of material misstatement. . auditors should “plan and perform the audit to obtain appropriate audit evidence that is sufficient to support the opinion expressed in the auditor's report. economic conditions that affects the overall performance of the industry.Other assets account. Fictios customers can be created and inflate the sale and that will result in an increase in the accounts receivable. Leslie Fay has been known for not catching up the fashion. and to understand the company policy and procedures with regard of sales. Accounts Payable and debt could be understated. List nonfinancial variables or factors regarding the industry that auditors should consider when planning an audit and its audit implications: As mentioned in AS No.Any credit and bad debt write-off policy. The other financial information about the company falls under the Standards of Field Work under GAAS.” 3. what other financial information would you have obtained if you had been responsible for planning the 1991 Leslie Fay audit? Other financial info that the auditor might have obtained: .All contracts or agreements of Leslie Fay and department stores to verify the Accounts Receivable and liabilities.” The auditor should consider the matters affecting the industry in which the company operates. The auditor should be aware of laws and regulations that has to be followed and the one that has been changed has to be considered in audit planning and noncompliance with . these ratios are significantly higher than the industry norm. .Accounts Receivables are always in a question because of its nature of hiding fraud. According to PCAOB – AS 12.. auditors should obtain an understanding of the company and its environment .

Explain why the SEC ruled that BDO Seidman’s independence was jeopardized by the lawsuits that named the accounting firm. and top executives of Leslie Fay as codefendants. control deficiencies that has been previously communicated has to be considered in the planning stage.regulations may have an impact of dollar value or legal issues which the auditor should consider. According to the company insider who read the report. which forced the firm to resign as Leslie Fay’s auditor in early May 1993. . implausible relationship between key financial statement items and unreasonably generous bonuses paid to the top executives. The auditor should consider the public information about the company and evaluate the possibility of material misstatement and the companys internal control over fianancial reporting. Matters relating to company’s business. Leslie Fay stockholders filed several large lawsuits naming the company’s management team and BDO Seidman as defendants. Auditor’s consideration when planning an audit: Company’s independent auditors should establish an overall strategy and communicate the objective and also set forth the nature of communications required from the company’s personnel as per PCAOB standards. Leslie Fay. The resulting 600-page report was reviewed by members of Leslie Fay’s board and then submitted to the SEC and federal prosecutors. The most startling feature of the fraud was its pervasive nature. 4. BDO Seidman officials contacted the Securities and Exchange Commission (SEC). which can affect the company’s performance and thus resulting in misrepresentation of accounts. Company management immediately appointed Arthur Anderson as Leslie Fay new auditor. Leslie Fay’s audit committee completed its eight-month investigation of the accounting fraud. BDO Seidman withdrew its audit opinions on the company’s 1990 and 1991 financial statements. Following Pomerantz’s disclosure of the fraud. Technological changes have to be considered in audit planning stage. recent changes in its operation. BDO Seidman had served as Leslie Fay’s audit firm since the –1970s and issued unqualified opinions each year on the company’s financial statements. BDO Seidman was reckless in auditing company’s periodic financial statements and did not evaluate the red flags such as implausible trend lines in the company’s financial data . Although the report was not released publicly. capital structure. several of its key findings were leaked to the press. The auditor’s preliminary judgment about materiality and factors relating to material weakness and effectiveness of internal control should be considered in the planning stage. The SEC informed BDO Seidman that its independence was jeopardized by those lawsuits. 5. its operating characteristics. In April 1993. In September 1993. “there wasn’t an error entry on the cost side of the company’s ledgers for those years that wasn’t subject to some type of rejiggering”. In the ensuing weeks. and inquired regarding to the status of their firm’s independence from Leslie Fay given the pending lawsuits.

Sign up to vote on this title
UsefulNot useful