Crazy Eddie, Inc.
Case 1.6
Crazy Eddie Facts
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
High school drop out at age sixteen. Began his career by peddlimg TVsets in
his Brooklyn neighborhood.
Famous for his “crazy” sales tactics and advertisements. Sometimes he would
lock the door until the customer bought an item. His TV and radio ads were
memorable as well as annoying.
Most distinctive trait was his inability to trust anyone outside his large
extended family; evidenced by their appointment as officers of his company.
In the early 1980s, sales of electronics exploded. Crazy Eddie had seven
distinct product lines by 1987.
In 1984, Crazy Eddie went public. It took the underwriting firm more than a
year to publicly offer the stock as they found the company’s financial records
to be in disarray (extensive related party transactions, interest-free loans to
employees, highly speculative investments, and numerous family member
executives).
Crazy Eddie Facts, cont’d
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Once public, Antar strived to convince the world that his firm was financially
strong and well managed. His efforts worked as analysts from prominent
investment firms wrote glowing reports regarding Crazy Eddie’s management
team and the company’s bright prospects for the future.
In 1986, Antar resigned as company president after realizing more than $50 M
on the sale of Crazy Eddie stock. In his absence, the company’s financial
condition worsened rapidly.
Shortly after a hostile takeover in November 1987, a physical inventory count
revealed a $65 M shortage of inventory that equaled the total profits reported
by Crazy Eddie since going public in 1984.
What were Antar’s tactics for accounting irregularities? He required
subordinates to book false entries (sales and inventory that didn’t exist) and
prepare inventory count sheets for items that did not exist.
Four different accounting firms audited Crazy Eddie’s financial statements
over its turbulent history.
Crazy Eddie Facts, cont’d
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Main Hurdman supposedly “lowballed” to obtain the Crazy Eddie audit. The
accounting firm’s objectivity was questioned as it audited the inventory system
that it developed itself. Their independence was questioned because many of
Crazy Eddie’s accountants were former members of that accounting firm.
During court cases, it was revealed that Antar and his associates engaged in a
large-scale plan to deceive the auditors (collusion). They destroyed
incriminating physical documents to conceal inventory shortages; stopped
using the sophisticated, computer based inventory system and returned to the
old manual system to make it more difficult to find irregularities; and shipped
inventory from store to store just before they were to have inventory counts.
When finally caught in May 1994, Antar was sentenced to 12 years in prison
and ordered to pay restitution of $121 M to former stockholders and creditors.
Financial Analysis and Red Flags
Student 1
Crazy Eddi e, I nc.
Common Size Balance Sheet
Consolidated
(000's omitted)
% of total assets
March 1, 1987
Current assets
Cash
Short-term investments
Receivables
Merchandise inventories
Prepaid expenses
Total current assets
Restricted cash
Due from affiliates
Property, plant and equipment
Construction in process
Other assets
Total assets
Current liabilities
Accounts payable
Notes payable
Short-term debt
Unearned revenue
Accrued expenses
Total current liabilities
Long-term debt
Convertible subordinated debentures
Unearned revenue
Stockholder's equity
Common stock
Additional paid-in capital
Retained earnings
Total stockholder's equity
Total liabilities and
stockholder's equity
$
% of total assets
March 2, 1986
% of total assets
March 3, 1985
% of total assets
May 31, 1984
3%
41%
4%
37%
4%
89%
9%
2%
100%
10%
21%
2%
47%
2%
82%
3%
6%
5%
4%
100%
34%
4%
41%
1%
80%
11%
6%
2%
2%
100%
4%
7%
64%
1%
76%
16%
5%
3%
100%
17%
17%
1%
2%
37%
3%
27%
1%
41%
2%
3%
13%
59%
6%
1%
35%
1%
2%
13%
51%
12%
1%
55%
8%
0%
2%
17%
82%
0%
1%
$
0%
20%
12%
32%
0%
14%
19%
34%
0%
19%
17%
36%
0%
2%
15%
17%
$
100%
100%
100%
100%
$
$
$
$
Crazy Eddie, I nc.
Common Size Income Statement
Consolidated
(000's omitted)
% of net sales % of net sales % of net sales % of net sales
March 1, 1987 March 2, 1986 March 3 1985 May 31, 1984
Net sales
$
Cost of goods sold
Gross profit
$
Selling, general and
administrative expense
Interest and other income
Interest expense
Income before taxes
Pension contribution
Income taxes
Net income
$
100.0%
(77.2%)
22.8%
(17.4%)
100.0%
(74.1%)
25.9%
(16.4%)
100.0%
(75.9%)
24.1%
(15.0%)
100.0%
(77.9%)
22.1%
(16.4%)
2.1%
(1.5%)
6.0%
(.1%)
(2.8%)
3.0%
1.2%
(.3%)
10.4%
(.3%)
(5.1%)
5.0%
0.9%
(0.3%)
9.7%
(0.4%)
4.9%
4.3%
0.5%
(0.4%)
5.8%
(3.1%)
2.7%
Crazy Eddie, I nc.
Analytical Review: Balance Sheet
Year Ended March 1, 1987
(000's omitted)
March 1, 1987
Current assets
Cash
Short-term investments
Receivables
Merchandise inventories
Prepaid expenses
Total current assets
Restricted cash
Due from affiliates
Property, plant and equipment
Construction in process
Other assets
Total assets
Current liabilities
Accounts payable
Notes payable
Short-term debt
Unearned revenue
Accrued expenses
Total current liabilities
Long-term debt
Convertible subordinated debentures
Unearned revenue
Stockholder's equity
Common stock
Additional paid-in capital
Retained earnings
Total stockholder's equity
Total liabilities and
stockholder's equity
$
March 2, 1986
$ Change
% Change
9,347
121,957
10,846
109,072
10,639
261,861
26,401
6,596
294,858
13,296
26,840
2,246
59,864
2,363
104,609
3,356
7,172
6,253
5,560
126,950
(3,949)
95,117
8,600
49,208
8,276
157,252
(3,356)
19,229
(6,253)
1,036
167,908
-29.7%
354.4%
382.9%
82.2%
350.2%
150.3%
-100.0%
268.1%
-100.0%
18.6%
132.3%
50,022
49,571
3,641
5,593
108,827
8,459
80,975
3,337
51,723
2,254
3,696
17,126
74,799
7,701
1,829
(1,701)
47,317
(55)
(11,533)
34,028
758
80,975
1,508
-3.3%
2099.2%
-1.5%
-67.3%
45.5%
9.8%
100.0%
82.4%
$
313
57,678
35,269
93,260
280
17,668
24,673
42,621
33
40,010
10,596
50,639
11.8%
226.5%
42.9%
118.8%
$
294,858
126,950
167,908
132.3%
$
$
$
$
Crazy Eddi e, I nc.
Analytical Review: Balance Sheet
Year Ended March 2, 1986
(000's omitted)
March 2, 1986
Current assets
Cash
Short-term investments
Receivables
Merchandise inventories
Prepaid expenses
Total current assets
Restricted cash
Due from affiliates
Property, plant and equipment
Construction in process
Other assets
Total assets
Current liabilities
Accounts payable
Notes payable
Short-term debt
Unearned revenue
Accrued expenses
Total current liabilities
Long-term debt
Convertible subordinated debentures
Unearned revenue
Stockholder's equity
Common stock
Additional paid-in capital
Retained earnings
Total stockholder's equity
Total liabilities and
stockholder's equity
$
March 3, 1985
$ Change
% Change
13,296
26,840
2,246
59,864
2,363
104,609
3,356
7,172
6,253
5,560
126,950
22,273
2,740
26,543
645
52,201
7,058
3,696
1,154
1,419
65,528
(8,977)
26,840
(494)
33,321
1,718
52,408
(3,702)
3,476
5,099
4,141
61,422
-40.3%
100.0%
-18.0%
125.5%
266.4%
100.4%
-52.5%
94.0%
441.9%
291.8%
93.7%
51,723
2,254
3,696
17,126
74,799
7,701
1,829
23,078
423
1,173
8,733
33,407
7,625
635
28,645
1,831
2,523
8,393
41,392
76
1,194
124.1%
432.9%
215.1%
96.1%
123.9%
1.0%
188.0%
$
280
17,668
24,673
42,621
134
12,298
11,429
23,861
146
5,370
13,244
18,760
109.0%
43.7%
115.9%
78.6%
$
126,950
65,528
61,422
93.7%
$
$
$
$
Crazy Eddi e, I nc.
Analytical Review: Balance Sheet
Year Ended March 3, 1985
(000's omitted)
March 3, 1985
Current assets
Cash
Short-term investments
Receivables
Merchandise inventories
Prepaid expenses
Total current assets
Restricted cash
Due from affiliates
Property, plant and equipment
Construction in process
Other assets
Total assets
Current liabilities
Accounts payable
Notes payable
Short-term debt
Unearned revenue
Accrued expenses
Total current liabilities
Long-term debt
Convertible subordinated debentures
Unearned revenue
Stockholder's equity
Common stock
Additional paid-in capital
Retained earnings
Total stockholder's equity
Total liabilities and
stockholder's equity
$
May 31, 1984
$ Change
% Change
22,273
2,740
26,543
645
52,201
7,058
3,696
1,154
1,419
65,528
1,375
2,604
23,343
514
27,836
5,739
1,845
1,149
36,569
20,898
26,840
136
3,200
131
24,365
7,058
(5,739)
1,851
1,154
270
28,959
1519.9%
100.0%
5.2%
13.7%
25.5%
87.5%
100.0%
-100.0%
100.3%
100.0%
23.5%
79.2%
23,078
423
1,173
8,733
33,407
7,625
635
20,106
2,900
124
764
6,078
29,972
46
327
2,972
(2,900)
299
409
2,655
3,435
7,579
308
14.8%
-100.0%
241.1%
53.5%
43.7%
11.5%
16476.1%
94.2%
$
134
12,298
11,429
23,861
50
574
5,600
6,224
84
11,724
5,829
17,637
168.0%
2042.5%
104.1%
283.4%
$
65,528
36,569
28,959
79.2%
$
$
$
$
Crazy Eddie, I nc.
Analytical Review: Income Statement
Year Ended March 1, 1987
(000's omitted)
March 1, 1987 March 2, 1986 $ Change
Net sales
$
Cost of goods sold
Gross profit
$
Selling, general and
administrative expense
Interest and other income
Interest expense
Income before taxes
Pension contribution
Income taxes
Net income
$
% Change
352,523
(272,255)
80,268
(61,341)
262,268
(194,371)
67,897
(42,975)
90,255
(77,884)
12,371
(18,366)
34.4%
7,403
(5,233)
21,097
(500)
(10,001)
10,596
3,210
(820)
27,312
(800)
(13,268)
13,244
4,193
(4,413)
(6,215)
300
3,267
(2,648)
130.6%
40.1%
18.2%
42.7%
538.2%
-22.8%
-37.5%
-24.6%
-20.0%
Crazy Eddie, I nc.
Analytical Review: Income Statement
Year Ended March 2, 1986
(000's omitted)
March 2, 1986 March 3, 1985 $ Change % Change
Net sales
$
Cost of goods sold
Gross profit
$
Selling, general and
administrative expense
Interest and other income
Interest expense
Income before taxes
Pension contribution
Income taxes
Net income
$
262,268
(194,371)
67,897
(42,975)
136,319
(103,421)
32,898
(20,508)
125,949
(90,950)
34,999
(22,467)
3,210
(820)
27,312
(800)
(13,268)
13,244
1,211
(438)
13,163
(600)
(6,734)
5,829
1,999
(382)
14,149
(200)
(6,534)
7,415
92.4%
87.9%
106.4%
109.6%
165.1%
87.2%
107.5%
33.3%
97.0%
127.2%
Crazy Eddie, I nc.
Analytical Review: Income Statement
Year Ended March 3, 1985
(000's omitted)
March 3, 1985
Net sales
$
Cost of goods sold
Gross profit
$
Selling, general and
administrative expense
Interest and other income
Interest expense
Income before taxes
Pension contribution
Income taxes
Net income
$
May 31, 1984 $ Change % Change
136,319
(103,421)
32,898
(20,508)
137,285
(106,934)
30,351
(22,560)
(966)
3,513
2,547
2,052
-0.7%
1,211
(438)
13,163
(600)
(6,734)
5,829
706
(522)
7,975
(4,202)
3,773
505
84
5,188
(600)
(2,532)
2,056
71.5%
-3.3%
8.4%
-9.1%
-16.1%
65.1%
100.0%
60.3%
54.5%
Red Flags: Financial
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Current Ratio is going up. Inventory represents half of total assets and
since inventory is volatile, then that ratio should be questioned further.
Inventory Turnover is getting slower. Since sales are going up, you’d
assume inventory would be turning over faster.
Consider the electronics industry: you would assume that the goods
would turnover more often than 4 months (113 days).
Accounts Receivable Turnover: every 7 days? Seems odd…
Gross margin and Profit margin going down, but sales going up…
something is fishy.
Sales went from -7% to +92% to +34%. Very volatile.
Red Flags: Nonfinancial
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Integrity of Antar: high school dropout; began business by pedalling
TVs in his Brooklyn neighborhood
Related Parties: large number of the company’s officers were family
members
Switched auditors four times
Crazy Eddie’s accountants were former employees of their auditing
firm (Main Hurdman)
Irregularities
Student 2
Irregularities

Falsification of inventory count sheets
– Analytical procedures
 Inventory turnover ratio [113 days -’87 v. 162 in’86]
 Age of Inventory [112 days - ‘87 v. 80 in ‘86]
 Compare actual v. budget
 Compare client to industry
 Review nonfinancial and outside information
 Trace to supporting documentation
Irregularities ,cont’d
– Physical Inventory (GAAS - AU 331)
 Appropriate instructions
 Cut off procedures
 Trace tags to physical counts
 Vouch inventory to accounts payable
 Inquire about consigned goods
 Note any obsolete inventory
– Cutoff
Irregularities, cont’d
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
Bogus Debit Memos for Accounts Payable
– Analytical procedures
 Scan detail for debit memos
 Compare with prior years and industry
 Inquire as to nature
– Trace to supporting documentation
– Statistical sampling (SAS 39)
Recording of transshipping transactions as retail sales
– Valuation
 Compare recorded costs to current vendor costs
 Review related party transactions
– Cutoff
Irregularities, cont’d

Inclusion of consigned goods in inventory
– Physical observation
 Inquire with client personnel
– Review correspondence
 Possible confirmation (SAS 67)
– Evaluate sales and receivable records
 Vouch purchases to detect unrecognized consigned
goods
Changing Industry and Lowballing
Student 3
Retail Consumer Electronics Industry


During the early 1980s, the electronics industry was undergoing
dramatic changes.
How do the changes within an industry affect audit planning
decisions?
– The primary concern involves the increased inherent risk of the audit.
In this particular case, the electronics industry introduces the possibility
of inventory obsolescence. The correct response to these demands
would be different staffing of the audit team. For instance, the audit team
may consist of several seniors and managers rather than the typical team,
which includes staff accountants and seniors.
– In addition, audit planning involves developing an overall strategy for the
expected conduct and scope of the audit. (AU 311).
Discussion of Audit Planning (cont’d)
– Moreover, the audit planning varies with the size and complexity of the
entity, experience with the entity, and knowledge of the entity’s business.

The auditor should obtain a level of knowledge of the entity’s business
that will enable him to plan and perform his audit in accordance with
GAAS. That level of knowledge should enable him to obtain an
understanding of the events, transactions, and practices that may have
a significant effect on the financial statements. The knowledge helps
the auditor identify areas that need special consideration; assess
conditions under which accounting data are produced, processed,
reviewed, and accumulated; evaluate the reasonableness of estimates;
and make judgments about the appropriateness of accounting
principles.
Discussion of Audit Planning (cont’d)

The auditor should also obtain a knowledge of matters that relate
to the nature of the entity’s business, its organization, and operating
characteristics. These matters include types of business; types
of products and services; capital structure; related parties;
locations; and production, distribution, and compensation methods.
Additional consideration should be given to the economic conditions,
gov’t regulations and changes in technology.

That knowledge is ordinarily obtained through experience with the entity
or industry and inquiry of personnel of the entity. Working papers from
prior years may provide some additional insight about the entity and
its industry. Other sources that the auditor may consult include AICPA
accounting and auditing guides, industry publications, F/S of other
entities in the industry, textbooks, periodicals, and individuals with
knowledge of the industry (specialists).
The Importance of Understanding the Clients Industry





In the case of Crazy Eddie, Inc., understanding the clients industry was
of utmost importance in detecting errors and misstatements in the financial
statements.
More specifically, the inventory account should have been examined carefully
due to the nature of technology and the potential for obsolete inventory.
In addition, a closer look into the transactions of Crazy Eddie, Inc. may have
potentially uncovered some of the problems with the inventory account.
For instance, the practice of buying electronics at wholesale prices and
selling them for just below retail to competitors does not seem to be a
normal industry practice for a retail electronics dealer.
Furthermore, the examination of Crazy Eddie’s distribution methods may have
uncovered the stockpiling of inventory scheme that enabled the corporation to
overstate the inventory balance by $65 million.
Another factor involves the hiring of family members to run the corporation,
which was experiencing a period of phenomenal growth.
Lowballing and Its Effects on Audits

Lowballing (quasi rents) is a practice
utilized by auditors, whereby the
auditing firm bids for an audit at a
price below its cost.

In other words, the firm is charging
a fee below the marginal cost of
the audit.
The primary reason that auditors
employ this practice is to ensure that
receive and retain a client base.


The theory is that the initial loss will
be recovered in future years when
the audit costs remain constant
while audit fees increase.
120
100
80
Rev
60
Cost
40
20
0
1
2
3
4
5
6
7
8
9
10
The Effect of Lowballing on Independent Audit Services



Critics of the auditing profession often allege that the practice of
lowballing creates a potential incentive to auditors to reduce the
quality of the audit.
This contention states that auditors will make concessions
(about accounting treatment) to their clients in order to retain
the client in future engagements.
As a result, many studies have been conducted on this relatively
new issue. However, no definitive answer has been reached
about this contention.
Audit Sampling and Independence
Student 4
Audit Sampling






Question #5 You test the year-end inventory cutoff procedures, and
10 out of 30 invoices are missing. What course of action would be
appropriate?
Find this to be material, since 10 missing invoices constitutes one
third of the sample
Ask questions to the individuals involved with the transactions
– Trace receiveing report to related purchase voucher
Get in touch with the customers involved with the transactions for
independent verification
Report to the senior manager your findings
AU Section 331- “Inventories”
Independence


Question # 6 What are the pros and cons of hiring individuals
who have formerly served as a company’s independent auditor?
Cons
– Independence becomes questionable
– Ability to objectively audit the company becomes
questionable
– Critics say “A company that hires one of its former auditor
can more easily conceal fraudulent activities during the
course of audits”
– AU Section 220 Independence
– ET Section 102 Integrity and Objectivity
Independence, cont’d

Pros
– Big accounting firms encourage their personnel to work for
clients in the apparent belief that it helps cement the
accountant-client relationship
– The former independent auditor would have a greater
understanding and greater knowledge of the business and
how it functions
– AU Section 8310 Knowledge of the Business
Related Academic Research
Additional
comments/Information
Questions?