Question: Chips Ahoy. Follow the instructions preceding hilem. Write the audit approach section following the cases in the chapter. The following is an excerpt from an article, "Memory Chip Trader Gets 14 Years for Bank Fraud," The Straits Times (Singapore), February 13, 2009:

Through most of the 1990s, entrepreneur Kelvin Ang Ah Peng rode the crest of a wave as his company traded in memory chips and recycled used ones for sale at a good price. His story, which follows the ebb and flow of the integrated circuit (IC) chip business, started at ECAsia International (ECI) in 1993. Computer chips were expensive, so his business did well. A major earthquake in Taiwan in 1999 totaled the computer chip factories there. Production halted and the market price of computer chips soared even higher. The bubble burst the following year, when the Taiwan factories recovered and several computer chip businesses folded. In 2001, as ECI struggled to keep afloat, Ang started abusing its credit facilities. Between that year and early 2007, he bought and sold worthless memory chips and created fake orders and invoices to receive payment from banks. He was charged in October 2008 on 687 charges involving US$290 million; last month, he pleaded guilty to 30 charges-28 for cheating and 2 for money laundering and falsifying revenues in ECI's initial public offering (IPO) prospectus. Deputy Public Prosecutor David Chew Siong Tai said that, to secure credit in the absence of incoming orders, Ang fashioned an elaborate scheme with the help of Hong Kong firms. He got ECI's partners to issue the necessary trade documents and to circulate computer chips and money between Hong Kong and Singapore.

Chips were actually shipped in these sham transactions as if they were bona fide business trades. In reality these were worthless, defective chips due for scrapping by ECI. In November 2006 when asked about ECI's unusually large inventory in Hong Kong and the huge debts owed by the firm's Hong Kong "customers," Ang confessed to an ECI subsidiary's director that 90 per cent of the inventory did not exist and that its billings were all faked. Yesterday, Ang, 44, was jailed for 14 years for having swindled banks of US$23 million (S$35 million) and laundering these proceeds through Hong Kong. The Australian-listed ECI is now being liquidated, and Ang was declared a bankrupt last year. trades. In reality these were worthless, defective chips due for scrapping by ECI. In November 2006 when asked about ECI's unusually large inventory in Hong Kong and the huge debts owed by the firm's Hong Kong "customers," Ang confessed to an ECI subsidiary's director that 90 per cent of the inventory did not exist and that its billings were all faked. Yesterday, Ang, 44, was jailed for 14 years for having swindled banks of US$23 million (S$35 million) and laundering these proceeds through Hong Kong. The Australian-listed ECI is now being liquidated, and Ang was declared a bankrupt last year.

Problem: Toying around with the Numbers. Mattel Inc., a manufacturer of toys, failed to write off obsolete inventory, thereby overstating inventory and improperly deferred tooling costs, both of which understated cost of goods sold and overstated income. "Excess" inventory was identified by comparing types of toys (wheels, general toys, dolls, and games), parts, and raw materials with the forecasted sales or usage; lower of cost or market (LCM) determinations then were made to calculate the obsolescence write-off. Obsolescence was expected and the target for the year was $700,000. The first comparison computer run showed $21 million "excess" inventory! The company "adjusted" the forecast by increasing the quantities of expected sales for many toy lines. (Forty percent of items had forecasted sales more than their actual recent sales.) Another "adjustment" was to forecast toy closeout sales not at reduced prices but at regular prices. In addition, certain parts were labeled "interchangeable" without the normal reference to a new toy product. These adjustments to the forecast reduced the excess inventory exposed to LCM valuation and write-off. The cost of setting up machines, preparing dies, and other preparations for manufacture are tooling costs. They benefit the lifetime run of the toy manufactured. The company capitalized them as prepaid expenses and amortized them in the ratio of current-year sales to expected product lifetime sales (much like a natural resource depletion calculation). To lower the amortization cost, the company transferred unamortized tooling costs from toys with low forecasted sales to ones with high forecasted sales.

This caused the year's amortization ratio to be lower, the calculated cost write-off lower, and the cost of goods sold lower than it should have been. The computerized forecast runs of expected usage of interchangeable parts provided a space for a reference to the code number of the new toy where the part would be used. Some of these references contained the code number of the part itself, not a new toy. In othercases, the forecast of toy sales and parts usage contained the quantity on hand, not a forecast number. In the tooling cost detailed records, unamortized cost was classified by lines of toys (similar to classifying asset cost by asset name or description). Unamortized balances were carried forward to the next year. The company changed the classifications shown at the prior year-end to other toy lines that had no balances or different balances. In other words, the balances of unamortized cost at the end of the prior year did not match the beginning balances of the current year except for the total prepaid expense amount. For lack of obsolescence write-offs, inventory was overstated at $4 million. The company recorded a $700,000 obsolescence write-off. It should have been about $4.7 million, as later determined. The tooling cost manipulations overstated the prepaid expense by $3.6 million. The company reported net income (after taxes) of $12.1 million in the year before the manipulations took place. If pretax income were in the $20 to $28 million range in the year of the misstatements, the obsolescence and tooling misstatements alone amounted to about 32 percent income overstatement.