Crisp-Drinks is a California corporation headquartered in San Diego, California, United States. Crisp-Drinks’ common stock is registered with the Securities and Exchange Commission. Crisp-Drinks is engaged in the marketing, manufacturing, and distribution Crisp-Drinks beverages nationally. Historically, Crisp-Drinks has had three drinks representing the largest source of operating revenue. These are YumCoffee, AlcalWater, and FuzJuice. Crisp-Drinks has consistently met or exceeded earnings expectations while achieving annual earnings per share growth rate of more than twice the average growth rate of the SP 500. Crisp-Drinks’ superior earnings performance has resulted in its common stock trading at a price to earnings multiple twice that of the SP 500’s.

In recent years, Crisp-Drinks has begun experiencing increased competition and a more difficult economic environment.

Nevertheless, Crisp-Drinks continuously has issued press releases that its expected earnings per share will continue to grow between ten percent and twelve percent annually. 

For the purpose of generating additional revenues to meet both the annual business plan and earnings targets, close to the fiscal year-end, Crisp-Drinks asked its bottlers to make additional purchases of YumCoffee and FuzJuice. Even though the bottlers knew that these additional purchases exceeded the forecasted demands for these drinks, the bottlers continued to purchase these drinks to preserve their relationship with Crisp-Drinks. This practice authorized and implemented by the company’s management, effectively allowed Crisp-Drinks to meet Wall Street’s expectations. Furthermore, to entice bottlers to purchase more of the high margin drinks, Crisp-Drinks extended more favorable credit terms than usual, typically increasing payment terms from just ten days to thirty days.

Additionally, the bottlers were not allowed right to return any drink. CrispDrinks did not necessarily collect all receivables due from its bottlers nor did it record appropriate allowances for doubtful accounts, especially given these generous credit terms. 

The effect of selling to the bottlers without the right of returns moved revenues from future periods to the current period. As a result, Crisp-Drinks had a sales deficit at the beginning of each fiscal year simply because bottlers had more than they can sell already, so their inventory of unsold drinks was carried forward. To further maintain and achieve earnings targets, and to maintain an illusion of strong demand for these drinks, especially in years of increased competition, Crisp-Drinks overstated its inventories of YumCoffee and FuzJuice.

Over time, employees communicated that maintaining sales was not sustainable and sales had to decrease or cease entirely. As a result, Crisp-Drinks entered into round-trip transactions with Drinks America Corp. (DAC). DAC is wholly owned by the VP of operations of Crisp-Drinks.

These transactions were approved by the CEO of Crisp-Drinks and its VP of operations (i.e., the VP of operations was entering into these transactions as the owner and CEO of DAC). Over a period of a few years, DAC appeared to become the largest direct customer of Crisp-Drinks. The transactions between the company and DAC entailed the following: Crisp-Drinks promised to ship YumCoffee, AlcalWater, and FuzJuice to DAC at a future date. DAC agreed to transfer cash to Crisp-Drinks for future purchases. Crisp-Drinks then recorded the cash as a loan payable for sales to take place in future periods. Subsequently, Crisp-Drinks issued credit memos for sales returns that were recorded as purchases of inventory of raw material such as sugar, coloring agents, and flavors from DAC. As of the last few fiscal year-ends, no drink was actually shipped out to DAC.

To reduce its manufacturing costs, and due to potential increased government regulations that encourage and subsidize clean energy manufacturing practices, the company considered upgrading its manufacturing equipment. Crisp-Drinks entered into an agreement with a solar-power energy-efficient equipment manufacturer. Under the two-year agreement, the company would use the manufacturing equipment in its facilities for an annual fee. Crisp-Drinks reported this equipment on its balance sheet and described clearly the use of the equipment in its footnotes to property, plant, and equipment.

Moreover, to improve its cash flows from investing activities, Crisp-Drinks entered into a memorandum of understanding (MOU) to trade real estate with an Irish company. The Irish company would acquire and trade the real estate properties for sale in Europe for the benefit of Crisp-Drinks. Under the MOU, Crisp-Drinks did not acquire real estate. In its most recent year financial statements, Crisp-Drinks listed investment in real estate in Europe.

Examining the company’s financial statements, Crisp-Drinks did not disclose any information from which investors could determine the impact of the agreements with bottlers on current earnings, or the likely impact on future earnings. Additionally, Crisp-Drinks’ notes to the financial statements were vague at best or silent at worst about the transactions between the company and DAC and the Irish company.

Help with the questions below on the case study of forensic accounting (please highlight important points that happened in the case study to understand better):

1. Explain management and the auditor’s responsibilities regarding the financial statements and internal controls over financial reporting.
2. What is the purpose of management or financial statement assertions?

Answer rating: 100% (QA)

Management is responsible for establishing internal controls In order to maintain effective internal ... View the full answer