Crooked, Scenario 2, Part 1

Crooked, Scenario 2, Part 1

ACC/556

Crooked, Scenario 2, Part 1

After reviewing the depreciation schedule provided by Mr. Hart, it appears that there is a strong probability that Fixed Asset Valuation fraud is present. Not only do the net fixed assets appear to be overstated due to various degrees of valuation errors or fraud, but it is questionable whether some of them exist without further observation. There are eleven Back Hoes on the depreciation schedule each bought on the same day each year for eleven consecutive years for the same exact price each year. The likelihood of this being accurate is very unlikely. It appears that the spreadsheet author typed the first asset and used the drag and copy feature of the spreadsheet software to enter the year purchased as the 20×10 and 20×11 would normally be written as 20y0 and 20y1. However, assuming that the assets all exist, there are additional capitalization and valuation problems to be addressed.

There are several items on the depreciation schedule that should not be capitalized, but rather expensed in the year purchased. GL1, Tools, WC1, HHG1, HHG2, HHG3, SN1, and ST 1-67 are all examples of expenses that should not be capitalized. Assets should only be capitalized if they “have been incurred for the purpose of generating future revenues and those revenues must be likely to be generated. If costs do not meet these requirements, they should be expensed in the period in which they are incurred” (Albrect et al p.466). Items such as employee snacks, gloves, hard hats and goggles, and similar small tools and equipment are all considered short term supplies that would be expensed in the period in which they were purchased. Instead, the assets all have long useful lives. This treatment inflates fixed assets on the Balance Sheet and drastically increases the current period’s Operating Income.

The short term supplies are not the only assets with excessive useful lives. Although the “Employee Snacks – 2 years” asset has a useful life of four years and the training DVDs are expected to provide benefits for more than forty years, all of the Back Hoe assets have useful lives of thirty years. Most machinery has a useful life five to ten years according to MACRS depending on the industry, so a thirty-year useful life minimizes the depreciation expense for each year and greatly increases the net assets (irs.gov). If the abnormally long useful lives were accurate, the salvage value of the assets would be expected to much lower than their current values.

The salvage values are abnormally high across all assets. For example, asset #EM1 – Earth Mover has an acquisition cost of $350,000 and a salvage value of $300,000. However, a ten-year-old Earth Mover on average can be found on a CAT vendor’s website for $150,000 (AlbanCAT). This over valuation has two significant effects on the financial statements. First, the net assets on the Balance Sheet are overstated vastly improving any long term or total asset to liability ratios by increasing the assets. Additionally, depreciation is grossly understated so that the Income Statement shows a stronger Operating Income than what would occur from normal depreciation. All properly recorded fixed assets have this apparent inflated salvage value. In fact, the consumable snacks have a salvage value.

Notwithstanding the issues above, the depreciation expense itself is miscalculated for all of the assets not using straight-line deprecation. The Back Hoes are using sum-of-the-year digits while the larger equipment is double declining balance. Both of these methods are designed to accelerate depreciation expense in the beginning of the asset’s life to account for the quick degradation of the equipment’s efficiency that subsequently levels off as it gets older. In the excel sheet, the formula used for all assets is “(C#-F#)/E#”. This takes the depreciable amount and determines the monthly depreciation charge for straight line depreciation and thus improperly reduces the current period expenses for newer assets.

In conclusion, the depreciation schedule provided by Mr. Hart for the use of CRookED’s application of a note is negligent at best and fraudulently at worst. Considering the widespread use of all of the different techniques to commit fixed asset fraud, it is probable that the depreciation is evidence of financial statement fraud.

REFERENCE

AlbanCAT. Used excavators for sale, Retrieved on February 19, 2016 at

http://www.albancat.com/used/for-sale/excavators/

Albrecht W.S., Albrecht, C.O., Albrecht, C.C., &Zimbleman, M.F., (2016). Fraud Examination,

Fifth Edition, 466

U.S. Internal Revenue Service. Publication 946 – Additional Material (2014). Retrieved on

February 19, 2016 at https://www.irs.gov/publications/p946/ar02.html