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ABSTRACT: This case focuses on the use of financial statement analysis in the detection of earnings manipulation.1 Specifically, it draws on advances in the accounting research literature and provides a way of integrating this knowledge into an auditing or master's level accounting/financial statement analysis course. Students are required to assess the probability that a set of financial statements contain fraud by analyzing excerpts from the company's financial and proxy statements, and applying the Beneish (1997) probit model for detecting earnings manipulation. Students are also encouraged to utilize the Compustat database to compare the company's financial data to a peer group of firms in the industry. The appendix provides a discussion of academic research relevant to the analysis, including a description of simple analytical procedures, a listing of important qualitative risk factors to consider in assessing the likelihood of fraud (in part from Statement on Auditing Standards No. 822), and an in-depth description of the Beneish (1997) probit model. A spreadsheet is made accessible via the Internet for easy application of the model to the company in this case and to other companies.
CIRCUIT INDUSTRIES INC.3
It is April 1991 and you are intern ing for a major accounting firm. Rebecca Stern, the partner in your area, has approached you to conduct some analysis about a company, Circuit Industries, Inc. (CII). The firm is considering accepting CII as a new client but wants to conduct extensive analysis before making a decision. As a young public company in the volatile computer industry, Stern views this company as being at higher risk for earnings manipulation. She is wary of the recent departure of cofounder and former executive Harvey L. Penniman and his filing of a lawsuit relating to his termination. There are also risks associated with the company's plan to issue new equity during 1991. However, the company is growing at a tremendous rate and has a very bright future.
She asks you to analyze the company's most recent proxy and financial statements for signs of any possible accounting "irregularities." She points out that the company did receive a clean audit report by KPMG Peat Marwick on its most recent financial statements, the year ended December 31, 1990. However, she remains cautious about accepting this client and...