Apple Blossom Cologne Company

Contingent Liabilities and Subsequent Events

December 31, 2003

Inquiry was made of Mr. Lancaster, President, Mr. Shelton, Controller, and Ms. Stockton,
Treasurer, concerning possible contingent liabilities and events occurring subsequent to
the balance sheet date that may require accrual or disclosure in the financial statement.

The client’s legal counsel, Edwards, Overstreet, and Gilley report in their letter to us
(Schedule (A.L./G-5)) that there is an action, Newman v. Apple Blossom Cologne
Company, against the client involving possible defective products. It is probable that the
action and subsequent litigation will result in a loss. The amount of liability at this time
is not susceptible of reasonable estimation.

I also examined the minutes of the meetings of the Board of Directors, inquired of
management, and reviewed subsequent year’s journals and ledgers, searching for possible
contingent liabilities and subsequent events. Nothing was found to indicate the existence
of any other contingent liabilities or subsequent events.

On the basis of my examination, it is my opinion that the action and subsequent litigation
loss be properly disclosed in the footnotes. No other contingent liabilities exist at 12-31-
03, and no subsequent event have occurred requiring accrual or disclosure.

Audit Senior
February 5, 2004
 ANDERSON, OLDS, & WATERSHED
Certified Public Accountants
615 Big city National Bank Building
Main at Michigan Avenue
Chicago, Illinois 60612
Phone: (312) 555-4452
Fax/; (312) 555-9991
www.aowcpa.com

INDEPENDENT AUDITOR’S REPORT

Board of Directors and Stockholders

The Apple Blossom Cologne Company

We have audited the accompanying balance sheet of Apple Blossom Cologne Company,
Inc. as of December 31, 2003 and 2002, and the related statements of income, changes in
stockholder’ equity, and cash flows for the years than ended. These financial statements
are the responsibility of the Company’s management. Our responsibility is to express an
opinion on these financial statements based on our audits.

We conducted our audits in accordance with generally accepted auditing standards.

Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of materials misstatement. An
audit includes examining, on a test basis, evidence supporting the amounts and disclosure
in the finical statements. An audit also includes assessing the accounting principles used
and significant estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits prided a reasonable basis for our
opinion.

In our opinion, the financial statements referred to above present fairly, n all material
respect, the finical position of Apple Blossom Cologne Company as of December
referred3 and 2002, and the results of its operations and its cash flow for the years than
ended in conformity with generally accepted accounting principles.

Certified Public Accountants

April 19, 2004
 APPLE BLOSSOM COLOGNE COMPANY
Senior’s Audit Memorandum
December 31, 2003

To: Partner-in-charge
Apple Blossom Cologne Company Audit

As senior-in-charge of the audit examination of the financial statements of Apple

Blossom Cologne Company for year ended December 31, 2003, I have prepared all
accompanying working papers in accordance with generally accepted auditing standards
and include all procedures considered necessary in the circumstances. I have preformed
all steps of the audit program. Other that those described in the following paragraphs,
there we no special accounting or auditing problems encountered.

When searching for unrecorded liabilities, it was discovered that the Company had no
error in recording the proper liabilities. I proposed that there is not need to make any
adjustments to the liability accounts, Moreover, the Company had correctly extended
their inventory, for which there is not need for an adjustment.

The company is approximately 76% financed through equity (owner’s equity

$2,493,166/total owner’s equity & liability $3, 275,915). There is a long-term notes
payable of $475,000.

The material level for planning was set at 5% of pretax income, which is approximately
$20,930 ($418,585.05). Any amount greater would be an intolerable misstatement and
further investigation and action will need to be taken.

It is my opinion that the accompanying draft of the client’s financial statements is in

accordance with generally accepted accounting principles with proper disclosure and that
we may issue that unqualified opinion as shown in the accompanying draft of the audit
report.

Audit Senior
April 19, 2004
 ANDERSON, OLDS, & WATERSHED
Certified Public Accountants
615 Big City National Bank Building
Main at Michigan Avenue
Chicago, Illinois 60612
Phone: (312) 555-4452
Fax: (312) 555-9991
Internet: www.aowcpa.com

February 7, 2004
The Board of Directors of Apple Blossom Cologne Company:
In planning and performing our audit of the financial statements of the Apple Blossom Cologne
Company for the year ended December 31, 2003, we considered its internal control structure in
order to determine our auditing procedures for the purpose of expressing our opinion on the
financial statements and not to provide assurance on the internal control structure. However, we
noted certain matters involving the control structure and its operation that we consider being
reportable conditions under standards established by the American Institute of Certified Public
Accountants. Reportable conditions involve matters coming to our attention relating to
significant deficiencies in the design or operation of the internal control structure that, in our
judgment, could adversely affect the organization’s ability to record, process, summarize, and
report financial data consistent with the assertions of management in the financial statements.
We have found the following deficiencies.
• The duty of write-offs of bad debts is not separated from credit manager.

• The duty of approving credit memos is not separated from sales manager.

• The duty of billing customers is not separated from journal entries clerk.

• The duty of cashier is not separated from A/R clerk.

• The duty of receiving cash/check is not separated from the treasurer who makes deposit
and reconciles bank statement.

• Cash receipts are not deposited intact daily.

• The duty of check signers is not separated from who approve cash disbursements.

• The duty of check signers is not separated from whom post to the general ledger.

• The checks are left unlocked.

• The duty of bank accounts reconciled is not separated from who has other cash
responsibilities.

• The duty of inventory counts is not separated from inventory clerk.

• The duty of purchasing is not separated from receiving and accounting.

 • The duty of maintaining inventory master records is not separated from inventory clerk.

• Not all purchases of merchandise and services are recorded in the voucher register before
disbursement.

• Vendors’ monthly statements are not reconciled to the accounts payable subsidiary
ledger.

• The company does not ensure that claims for damaged merchandise are processed
promptly.

• The unmatched invoices, receiving reports, and purchase orders are not reviewed
periodically.

• The duty of preparing check and mailing check are not separated from A/R clerk after
signed.

• Access to customer checks, A/R application, cash, and make deposit are not limited to
authorized personnel.
Any of the foregoing deficiencies could lead to defalcations. Additionally, no specific
authorization procedures exist for the sales credit, write-offs of bad debts, and receiving and
depositing cash. The Board of Directors should individually authorize transactions of these
types.
This report is intended solely for the use of the Board of Directors, management, and others
within the organization. If you would like to discuss any of these matters, we would be pleased
to review them with you.

Very truly yours,

Anderson, Olds, and Watershed

Certified Public Accountants