CAL TEMP SERVICES, INC CASE

1. CAL TEMP SERVICES, INCCASE GROUP 5 Katheryn Tejeda Deborah Plana Marie Franco Michael Medina

2. CAL TEMP SERVICES, INC • Company Background and Historical Facts: Cal Temp Services (CTS) was founded by Jack C Williamson in 1991 to provide engineering services, temporary personnel, and personnel training services for the Defense Contracting Industry.

3. CAL TEMP SERVICES, INCFINANCIAL ISSUES • As CTS expanded in the 1990’s, a need for financial fuel emerged • CTS established a line of credit for $600,000 with a local bank with first security interest in CTS Account Receivables • Williamson agreed with the bank to have CTS’s Financial Statements audited.

4. CAL TEMP SERVICES, INCFINANCIAL ISSUES • In May 1998, CTS negotiated a second line of credit in the amount of $1,000,000 • The audit of the Financial Statements for the years 1998/1999 disclosed a significant loss and the first decline in CTS’s Sales history • Leading relationship between 2nd Union Bank and CTS being under review

5. CAL TEMP SERVICES, INCACCOUNTING ISSUES • Revenue recognition principle: Companies must recognize revenue when: • 1) It is realized or realizable and earned, not when cash is received. • 2) Accounts receivable are reported net of allowance for uncollectibles.

6. CAL TEMP SERVICES, INCACCOUNTING ISSUES • CTS Financial Statements noted that:“Revenues for engineering services are recognized upon completion of projects, which are generally of short duration. Direct costs associated with customer engineering projects in process are included in inventory at the lower of costs or realizable value”.

7. CAL TEMP SERVICES, INCACCOUNTING ISSUES The account receivable balances have been overstated for both 1999 and 2000 • 1999 – overstated by $133,995 • 2000 – overstated by $636,242 The other balance sheet account that must be adjusted is Retained Earnings • 1999 – overstated by $133,995 • 2000 – overstated by $636,242 • The impact of the adjustments on pre-tax income is • 1999 - $133,995 decrease • 2000 -$636,242 decrease

8. CAL TEMP SERVICES, INCLITIGATION ISSUES • The evidence indicates that knowledge of financial statement and collateral fraud on the part of Williamson and Roberts is as follows: • 1999 – Management told CTS’s auditors, M & S, that payment from Penns Engineering for $75,000 for a Dec. 30th invoice had not been received after year-end because Penns approval and payment cycle was typically 120 days or more. • Credit memo was written to reverse invoice amount.

9. CAL TEMP SERVICES, INCLITIGATION ISSUES • 2000 – There were four incidents during this year that point to Roberts and Williams as being part of the scheme: • Nexus’ invoices for a total of $187,210: • Billed from October thru December 2000. • However, on Mar. 29, 2001 CTS processed a credit memo for the total amount of $187,210.

10. CAL TEMP SERVICES, INCLITIGATION ISSUES • CMI – There was an outstanding invoice for Nov. 2000 for a total of $197,697 • CTS recorded two credit memos, one on Feb. 6, 2001 for $107,697 and the second on Mar. 12, 2001. • Later found not to be for valid payments

11. CAL TEMP SERVICES, INCLITIGATION ISSUES • Roberts confessed to misleading the bank about receivable amounts • Rationalized that he and the other managers did it for the employees.

12. AUDITING ISSUES • Auditor’s responsibility in uncovering fraud in the financial statements is not 100%. • According to GAAS: Auditors need to provide reasonable assurance that the info. is free from material errors and fraud.

13. AUDITING ISSUES • M&S auditors in the case did not provide reasonable assurance • Lacked independence by advising Cal Tech to bank with Second Union, a bank that they had a relationship with.

14. AUDITING ISSUES • Auditors failed to see some red flags that fraud was going on as well: • The increase in accounts receivable that occurred in 2000 that coincided with a large loss in 1999 for the company. • Indicates that the company increased its amounts for credit sales in order to improve its financial condition after having suffered the loss.

15. AUDITING ISSUES • The firm also violated its independence from the client by aiding it in preparing interim financial statements for May 1999. • Book-keeping work and financial statement preparation should not be done by the audit firm since this results in the firm auditing its own work.

16. AUDITING ISSUES • In the 1999 trial balance receivables amounted to $1,023,623 of which $110,469 were over 90 days and $234,532 were between 61-90 days old. • This should have raised a red flag to the auditors in investigating why there was such a high level of uncollectible amounts

17. AUDITING ISSUES • The auditors should have taken time to request confirmations and see if these were true collectible items to begin with. • Auditors can accept fax confirmations for evidence in the confirmation process, but need to balance the risks associated with them.

18. AUDITING ISSUES • M&S was not justified in their reliance on management representations. • Auditors need to gather corroborating evidence and to challenge management’s assumptions and methods underlying the development of the information they present.

19. CONCLUSION • M&S auditors lacked independence and relied too much on the mgmt. of Cal Tech. • Used lax methods since they were comfortable with mgmt. • There is no doubt that independence is the cornerstone of the auditing profession. • Without independence an audit has no value at all.