FSA Session 12

Exhibit 5 Assumptions and Projections for HMM Forecasted Revenues for years ended June 30, 2014–2017 (in $ t
2014F 2015F 2016F 2017F

Renewals by HMM11 customers
Revenue from renewals continuing with HMM11 28,220 15,989 8,411 4,518
Revenue from renewals switching to HMM12 18,751 29,913 22,111
New customer revenues
HMM11 5,980 3,800 3,400 3,050
HMM12 3,900 6,868 9,541 11,140
Renewals by HMM12 customers
Revenue from renewals continuing with HMM12 3,315 23,134
Additional information
Percent HMM12 revenue recognized in year of sale
2014 10% 50% 40%
2015 25% 50% 25%
2016 25% 50%
2017 25%
HMM 12 Revenue Impact 2014F 2015F 2016F 2017F
Current Year Total Contract Value (Pro forma) 3,900 25,619 42,769 56,385
Current Year Total Contract Value (NEW REPORTING)

HMM 12
2014 Sales 390 1950 1560
2015 Sales 6404.75 12809.5 6404.75
2016 Sales 10692.25 21384.5
2017 Sales 14096.25
Total 390 8,355 25,062 41,886
Impact of Revenues -3,510 -17,264 -17,707 -14,500

June 30, 2014–2017 (in $ thousands)
Case 6-2
a) 1100 900 1200 1100
Shipment Collection Production
Income Statement ($) ($) Gross ($) Net ($)
(1100 units) (900 Units) (1200 units) (1100 units)
Sales @$9 9900 8100 10800 9900
Less: Cost and Expenses
COGS@$7 7700 6300 8400 7610
selling commission @10% 990 810 1080 990
Shippment @0.20 220 180 240 220
Net Income 990 810 1080 1080
Balance Sheet
Assets
cash (b/F) 1670 1670 1670 1670
Receivables 1800 1800 1800 1800
Cl. Inventory at Cost 700 700
cl. Inventory at M.V. 900 790
4170 4170 4370 4260
Liabilities
Initital capital 3000 3000 3000 3000
Retained earnings 990 810 1080 1080
Accrued Sales comm. 180 180 270 180
Accrued Shipment 20
deferred Revenue 180
4170 4170 4370 4260
b) The installment method delays the reporting of revenues and thereby delays the time for payment of taxes.
The time value of money is a major motivation for delaying cash payments for taxes.
c) Balance Sheet: Some Analysts prefer the installment method because it is more conservative. However, the
installment method attempts to value receivables (less deferred income) at the historical cost of inventory.
It would appear that the credit analysis should be future-oriented and view receivables at the expected future
cash inflow.
Income Statement: Some analysts prefer the installement method because it is more conservative. However,
this method has two critical weaknesses:
1. Revenues and profits are not recognized when performance (earning) occurs;instead, recognition is delayed
until cash is collected.
2. Selling costs are mismatched (this is most dramatic in a period of rapid growth or decline in sales).
The installment method does not show economic reality.

Problem 6-5
a. (1) Failing to timely record returned credit card purchases and membership cancellations: An accounts receivable analysi
to identifying this problem. We would examine for either continual growth in accounts receivable or unusual (unexpla
Ratios or techniques that compare cash collections to accounts receivable also could potentially identify a problem are
(2) Improperly capitalizing and amortizing expenses related to attracting new members: This behavior would be difficult t
understand the growth in reported intangible assets and deferred charges, and to assess its reasonableness. Unusual
potential red flag.
(3) Recording fictitious sales: One key to uncovering fictitious sales is to monitor the joint behavior of sales and accounts
Increasing sales should not necessarily lead to slower accounts receivable turnover. Increases in the accounts receiva
investigated because this can be caused by, among other factors, the recognition of fictitious or uncollectible sales.
b. The external auditor must conduct the audit according to generally accepted auditing standards. The culpability of audit
case by case basis. It is often difficult to detect a fraud if key client personnel are colluding and conspiring to cover up. H
was so widespread that auditor negligence is part of the problem. From an economic perspective, this question will ultim
Cl. Inventory at M.V. Amount ($)
Sales (100 units @ 9) 900
less: sales comm. (100*9*10%) 90
less: shippment (100*0.20) 20
790
Beg. Inventory 0
Add: Purchases (1200@7) 8400
less: cl. Inventory at M.V. 790
COGS 7610
Cash
Initial Investment 3000
Add: collection (900*9) 8100
11100
less: COGS (1200@7) 8400
less: selling commission (900*9*10% 810
less: shipment (1100*0.20) 220
Cash in hand 1670
Deferred Revenue
Sales (200 units@9) 1800
less: COGS (200@7) 1400
less: selling comm (200*9*10%) 180
less: shipment (200*0.20) 40
180
e for payment of taxes.
servative. However, the

orical cost of inventory.
les at the expected future
e conservative. However,
ead, recognition is delayed
decline in sales).
tions: An accounts receivable analysis would be the focal point
ounts receivable or unusual (unexplained) write-offs of receivables.
uld potentially identify a problem area or fraudulent behavior.
ers: This behavior would be difficult to uncover. The key is to

assess its reasonableness. Unusual increases should be viewed as a
joint behavior of sales and accounts receivable, simultaneously.

er. Increases in the accounts receivable turnover ratio should be
of fictitious or uncollectible sales.
g standards. The culpability of auditors in a fraud situation varies on a

luding and conspiring to cover up. However, in this case the fraud
c perspective, this question will ultimately be answered via litigation.

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Exhibit 5 Assumptions and Projections for HMM Forecasted Revenues for years ended June 30, 2014–2017 (in $ t

2014F 2015F 2016F 2017F

HMM 12 Revenue Impact 2014F 2015F 2016F 2017F

Current Year Total Contract Value (NEW REPORTING)

Impact of Revenues -3,510 -17,264 -17,707 -14,500

The installment method does not show economic reality.

e for payment of taxes.

servative. However, the

ead, recognition is delayed

ers: This behavior would be difficult to uncover. The key is to

joint behavior of sales and accounts receivable, simultaneously.

g standards. The culpability of auditors in a fraud situation varies on a

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