Assessing business risk: The case of Premier Punch, Inc

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Journal of

Accounting Education

J. of Acc. Ed. 25 (2007) 168–192

www.elsevier.com/locate/jaccedu

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Assessing business risk: The case of Premier Punch, Inc Kevin F. Brown

a,1

, George T. Tsakumis

b,*

a

b

Department of Accountancy, Raj Soin College of Business, Wright State University, 208-J Rike Hall, Dayton, OH 45435, USA Department of Accounting and Taxation, LeBow College of Business, Drexel University, 3141 Chestnut Street, 400 Matheson Hall, Philadelphia, PA 19104, USA

Abstract The recently issued Statement on Auditing Standards No. 109, Understanding the Entity and Its Environment and Assessing the Risks of Material Misstatement, emphasizes the need for auditors to understand the client’s business and environment, particularly the client’s business risk [American Institute of Certified Public Accountants (AICPA) (2006a), understanding the entity and its environment and assessing the risks of material misstatement, Statement on Auditing Standards No. 109. New York, NY: AICPA]. However, the manner in which auditors obtain such an understanding, especially an auditor’s assessment of a client’s business risk, is often challenging for students because they lack the business experience necessary to perform such an assessment. This case provides students with an opportunity to assess business risk in a realistic context that includes evidence beyond the content of the financial statements. Company information is provided via a webpage (www.premierpunch.com) with content similar to that of an actual investor relations site. Students must evaluate the information presented in the company’s annual report, press releases and other sources, and consider the impact of that information on several facets of business risk. Students also perform an analytical review of the company’s financial statements and synthesize the case information into a professional memo containing their assessment of business risk. Ó 2007 Elsevier Ltd. All rights reserved. Keywords: Business risk; Risk assessment

*

1

Corresponding author. Tel./fax: +1 215 895 2118. E-mail addresses: [email protected] (K.F. Brown), [email protected] (G.T. Tsakumis). Tel.: +1 937 775 3138.

0748-5751/$ - see front matter Ó 2007 Elsevier Ltd. All rights reserved. doi:10.1016/j.jaccedu.2007.09.001

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1. Introduction Assume you have recently been promoted to senior auditor at Ross and Montgomery, a national public accounting firm. Dan Greene, a new partner in the firm, summons you to his office. ‘‘I’ve brought in a new client, Premier Punch,’’ Greene announces, ‘‘and you have been selected to serve as the ‘in-charge’ auditor for the engagement. It’s a small company now, but I think they have the potential for huge growth.’’ Greene then provides you with information about the client and tells you to begin planning the upcoming audit for the year ending December 31, 2007. 1.1. Company background Premier Punch, Inc. (‘‘the Company’’), a Texas corporation with its principal place of business in Jupiter, Maine, is a specialty beverage company. Since founding the Company in 1999, Seamus Sheridan has headed up Premier, serving as its President and CEO. Prior to founding Premier, Sheridan had been Vice President of Marketing for a large soft drink maker. Premier offered its shares of stock to the public for the first time in 2003 and is traded on the NASDAQ. Premier develops and markets two lines of energy beverages, including: (1) ‘‘Jazzy Juice,’’ an all-natural energy drink designed for endurance athletes such as marathon runners and (2) ‘‘Taurus Tonic,’’ another all-natural energy drink designed for athletes, such as short-distance runners and swimmers, who need a ‘‘quick boost.’’ In the mid to late 1990s, Premier developed and began marketing these energy drinks, which were made from mineral-rich Maine lake water and all natural herbal ingredients. At the time of their development, the ‘‘Jazzy Juice and ‘‘Taurus Tonic’’ energy drink lines represented truly unique creations in the expanding energy drink market. As is often the case in the industry, instead of manufacturing its products, Premier contracts with beverage producers to bottle and package its energy drinks according to Premier’s specifications. Despite incurring substantial marketing costs, to this point Premier has generated only limited national demand for its beverage lines as most of its sales are in New England and the Pacific Northwest. While initially experiencing significant losses, the company had profitable operations from 2003 to 2005, but experienced a sizable net loss in 2006. Premier’s cash flows from operations during this period have been somewhat weak, and its primary sources of cash have been borrowings and stock sales. Based on the results reported for the first quarter of 2007, which were audited by Marwick and Arthur, Premier’s former auditor, the Company’s performance appears to be improving, with net income moving again into positive territory. However, for the first time, Marwick and Arthur issued a going-concern opinion on Premier’s 2006 financial statements. For a copy of its most recent annual report, see Premier’s website, at www.premierpunch.com. Also, the website contents have been included in appendices. See Appendix A for a representative screenshot of the website, Appendix B for a copy of the predecessor auditor’s report, and Appendix C for Premier’s 2006 financial statements and March 31, 2007 quarterly income statement.

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2. One shareholder’s concerns During 2006, James Bulger, a well-known and controversial investor advocate and owner of a large block of Premier shares, became somewhat concerned about his investment. Since Bulger’s initial decision to invest in Premier came from his ‘‘gut,’’ he decided to take a closer look at Premier’s annual reports. While initially hoping to ease his concerns, Bulger became increasingly dismayed as he dug deeper into Premier’s financial statements. Bulger has made general comments about ‘‘red flags’’ at Premier which raise serious concerns about the company. Despite Bulger’s concerns, Premier’s President and CEO, Seamus Sheridan, continues to be optimistic about the company’s future prospects. Sheridan categorizes Bulger’s comments as, ‘‘. . . the ravings of a malcontent who is attempting to further his career and increase the visibility of his website through a series of half-truths and misdirection.’’ Further, Sheridan claimed, ‘‘Bulger may be acting on behalf of the ‘short and distort’ short-sellers who are trying to knock down our stock.’’ Premier’s press releases contain some of the information that CEO Sheridan considers, ‘‘. . . good news for everyone involved with Premier,’’ and Bulger considers ‘‘intentionally misleading.’’ The full text of the press releases can be found on Premier’s website. The full texts of Premier’s press releases and excerpts from its 2006 Annual Report Management’s Discussion and Analysis have been included in Appendix D. In addition to the press releases, Bulger describes faxes sent out by Premier as ‘‘problematic.’’ Specifically, during late 2006 and early 2007, Premier sent out an average of 3,000,000 monthly fax newsletters, which touted the company’s bright future prospects. An example of one of these faxes is presented in Exhibit 1. 3. Recent events At the beginning of 2007, before financial statements were filed, Premier’s largest bottler, Acme Bottling Co., notified the company that it would not renew the supply contract, because Premier had violated the terms of the agreement. Under the agreement, Premier was obligated to purchase at least 150,000 cases per year. From 2003 to 2006, Premier never ordered more than 75,000 cases from this bottler. Unless Premier renegotiates the supply contract, the bottling agreement will expire at the end of 2007. While finding another bottler willing to produce fewer than 100,000 cases per year remains an option, Sheridan has mentioned the possibility of raising the necessary capital for Premier to construct its own bottling facility during 2008. However, until such a facility is ready for operations, Sheridan is uncertain as to whether Premier will reach an arrangement with Acme or attempt to engage other bottlers to take its place. Despite the uncertainty surrounding the Company’s bottling capabilities, Premier’s stock price was recently at $2.88, up from $2.25 per share earlier in the year. 4. Requirements In planning for Premier’s 2007 audit, answer each of following questions: 1. What are the implications for the 2007 audit of Premier receiving a ‘‘going concern’’ audit opinion in 2006?

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2. Who are ‘‘short and distort’’ short-sellers and how would their activities affect audit planning? 3. What protection do the ‘safe-harbor’ statements included in Premier’s press releases provide? Why are such statements necessary? What is the auditor’s responsibility with regard to this type of information? 4. Evaluate James Bulger’s claims against Premier. Do you agree that Premier’s press releases and fax tout sheets are ‘‘misleading?’’ Do the investor advocate’s claims represent legitimate concerns or is Premier the ‘‘victim of unfair allegations,’’ as its CEO claims? Explain in detail and also consider how the Company’s information releases might impact the recent performance of the Company’s stock. 5. Perform an analytical review of Premier’s financial statements. Use your review to assess the Company’s performance and identify high-risk accounts. 6. In a memo to the engagement partner, Dan Greene, document your overall assessment of business risk for the upcoming Premier audit. 5. Learning objectives and implementation guidance 5.1. Learning objectives The overall objective of this case is to provide students with a better understanding of how an auditor assesses business risk. Students are exposed to several important aspects of a realistic business risk assessment and are required to synthesize the information presented in the case into a professional memo documenting their overall assessment of the client’s business risk. Business risk is the risk that a client will fail to meet its business objectives, and, thus, ultimately fall into bankruptcy. The necessity of assessing business risk is emphasized in the recently issued Statement on Auditing Standards (SAS) No. 109, Understanding the Entity and Its Environment and Assessing the Risks of Material Misstatement (AICPA, 2006a). Business risk assessment is important for audit planning due to its influence on the determination of audit risk. A client facing imminent failure presents a greater risk for material misstatement of financial statements (see AICPA, 2006a; Arens, Elder, & Beasley, 2008; Messier, Glover, & Prawitt, 2008; Whittington & Pany, 2008). Recent and ongoing corporate failures and scandals have provided unfortunate examples of business risk outcomes and underscore the vital role of this risk assessment. This case seeks to enhance the pedagogy for business risk assessment by offering engaging, web-based materials which allow a significant amount of information to be presented for the students’ evaluation. The amount and diversity of the case information helps to convey a sense of the complexity of business risk assessment and to provide a ‘‘real world’’ flavor for the case. Further, this case is patterned on a real company in this industry; i.e., Bulger and Sheridan have ‘‘real life’’ counterparts. 5.2. Implementation guidance This case is designed for students taking their first course in auditing at either the undergraduate or graduate level. In our implementation in undergraduate auditing classes, we distributed the case after covering material relating to planning and business risk assess-

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ment. Students were allowed approximately two weeks to complete the case requirements including the business risk assessment memo. On the day the case was due, we allowed approximately twenty minutes of class time for discussion of the case. While the case is designed primarily for completion by individual students outside of class, instructors may wish to modify the case to allow students to work in groups or use parts of the case as an in-class exercise. The Premier Punch case is worth 10% of the students’ overall course grade. Students are provided with a grading rubric containing the relative value of each question when the case is assigned. The following weights are used: question one, regarding the goingconcern opinion, 5%; question two, considering the actions of short sellers, 5%; question three, concerning safe harbor protections, 5%; question four, evaluating the investor’s claims, 20%; question five, performing the analytical review, 20%; and, question six, completing the business risk assessment memo, 45%. Students are instructed that they should support their business risk assessment memos with evidence included in the case materials and, particularly, to draw upon their answers to questions four and five as well. Instructors may be concerned that students are likely to ‘‘pass down’’ solutions to this case from one term to another. To address this concern, we have used alternative questions in subsequent assignments of the case. These questions include the following:  Do you agree with the firm’s decision to accept Premier as a client?  To gain an understanding of the Company’s business and industry, perform an in-depth analysis of the beverage industry. Additionally, instructors might wish to add information about internal control deficiencies in the prior year and ask students how such deficiencies might affect the planning of the upcoming audit. Alternatively, an additional press release could be added stating that the CEO has recently resigned and ask students how the change in top management will affect audit planning or the auditor’s assessment of Premier’s control environment. 6. Teaching notes 6.1. Question 1: What are the implications for the 2007 audit of Premier receiving a ‘‘going concern’’ audit opinion in 2006? In order to answer this question, students must first understand the meaning of a ‘‘going concern’’ opinion. Students should know that the additional ‘‘going concern’’ language is added to an unqualified audit opinion when the auditor has substantial doubt about a client’s ability to continue in the upcoming year. However, such explanatory language does not change the auditor’s opinion about the fair presentation of the financial statements. On the contrary, the purpose of such an opinion is to convey the auditor’s perception of the potential for the client’s imminent failure while affirming that the current financial statements are free of material misstatement.2 Often, students incorrectly assume that the

2

Note that the auditor is not required to issue an opinion in cases where uncertainties exist. As discussed in AU 341.12 (AICPA, 2006b), the auditor could choose to issue a disclaimer of opinion in such cases.

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additional language somehow changes the nature of the opinion on the financial statements. Discussion of this question provides an opportunity to clear up such confusion. In the context of assessing business risk, the ‘‘going concern’’ opinion issued to Premier in the prior year should increase the level of risk for the client in the upcoming audit. This opinion serves as a warning flag to the successor auditor and investors that likelihood of business failure is high. The issuance of a ‘‘going concern’’ opinion might even be a ‘‘selffulfilling prophecy’’ in that investors and creditors can be dissuaded to provide further funding for operations for the Company, thereby leading to the resulting bankruptcy. Since the doubts about Premier continuing were substantial just a few months prior to the performance of this planning task, students should consider whether the situation necessitating this additional explanatory language has changed. In the discussion of this question, instructors may wish to emphasize the importance of addressing the ‘‘going concern’’ doubts raised by the predecessor as part of the current business risk assessment. 6.2. Question 2: Who are ‘‘short and distort’’ short-sellers and how would their activities affect audit planning? It may be useful to begin the discussion of Question 2 with an introduction to short-selling and a brief explanation of why the SEC allows it to take place. Short-selling is the practice of selling borrowed stock in the hope that the stock price will decrease, allowing the short-seller to buy it back at a profit. For example, if an investor thinks Jim’s Arabian Horses, Inc. is overvalued at $100 and that the price is going to drop, the investor may borrow the stock and sell it for $100. If the stock goes down to $90, the investor, after buying it back and returning it, would make a profit of $10 per share. However, if the stock went up to $110, the investor would incur a loss of $10 per share.3 The SEC allows short-selling because it provides more information to the capital markets. Short-sellers often conduct extensive due diligence to uncover information that supports their opinion that a company’s stock is overvalued. As a result, the SEC views shortsellers’ efforts as beneficial to the health of the market (i.e., their due diligence leads to information being provided to the market that may not have otherwise been available). Further, short-selling also provides brokerage firms with an opportunity to generate additional commissions by lending shares in their custody to the short-sellers. In the case, Premier’s CEO accuses the investor advocate, James Bulger, of acting on behalf of ‘‘short and distort’’ traders. ‘‘Short and distort’’ short-sellers engage in an illegal version of short-selling by using fear and misinformation to manipulate stocks and push prices downward. For example, a ‘‘short and distort’’ short-seller (SDSS) may attempt to convince investors that supporters of the stock are somehow affiliated with the company and that the SEC is closely monitoring the company and may soon halt trading of its stock. While claiming that they only have investors’ best interests at heart, SDSSs will flood message boards (see www.ragingbull.com for an example of one of the most popular internet message boards) with negative information about the company, doing everything they can to keep investors from purchasing the stock and continue pushing the stock price down. In turn, because of their mistaken belief that the company is in serious trouble, 3 Students can be directed to a website such as http://www.investopedia.com to gain a better understanding of ‘‘short and distort’’ sellers. Some relevant search terms for the website include, ‘‘short and distort,’’ ‘‘pump and dump,’’ and ‘‘stock basher.’’

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investors who bought at higher prices sell their stock at lower prices, allowing the SDSSs to purchase the stock at artificially low prices and lock in their gains. Short sellers may, however, have valid information about the intrinsic value of a company. For example, short sellers might be aware of fraudulent financial reporting and sell a company’s shares short in anticipation of a precipitous decline in stock price when the fraud is revealed. Such short-selling activity is an important consideration for the auditor, so much so that it is included in SAS No. 99 (AICPA, 2002) as a factor to consider when assessing fraud risk. Therefore, students should be aware that the opportunistic behavior of short sellers might be nothing more than their attempt to convey false impressions about a target company or that the short sellers might actually be aware of fraud or other serious business problems not widely known outside of the company. 6.3. Question 3: What protection do the ‘safe-harbor’ statements included in Premier’s press releases provide? Why are such statements necessary? What is the auditor’s responsibility with regard to this type of information? The ‘safe-harbor’ statements included in Premier’s press releases are used by many publicly-traded companies and are a result of the Private Securities Litigation Reform Act of 1995 (the ‘‘Act’’). The purpose of the Act (PSLRA, 1995) was to create a legislative structure which permits legitimate lawsuits that seek to protect investors’ interests, while limiting abusive and frivolous securities lawsuits. The Act’s provisions limit liability by creating a safe harbor for forward-looking statements (e.g., sales projections, statements of future trends or expectations, statements of management plans for future operations) made by companies. In essence, the Act allows companies to use the forward-looking statement law as a disclaimer to fend off claims that a company is liable for providing investors with incorrect or misleading information. The instructor may find it beneficial to highlight some of the pros and cons of the Act’s safe harbor provisions (Mattson, 1996; Block & Hoff, 1999). The instructor may point out that the forward-looking statement protection gives companies a greater comfort level when releasing information, because it sets a higher standard for securities litigation. Specifically, plaintiffs must provide evidence that company management knowingly released false or incorrect information with the intention of misleading investors. In addition, the safe-harbor provisions have significantly reduced the number of securities-related lawsuits filed each year. This reduced risk has resulted in companies releasing more information to the public and encouraged companies that were not making forward-looking disclosures to begin doing so. While the safe-harbor provisions have succeeded in encouraging companies to be more transparent in their disclosures, there can be drawbacks. Critics argue that safe-harbor provisions are too ambiguous and give companies too much discretion with regard to the type of information to disclose and when to disclose it. Further, managers may make baseless claims and statements in an attempt to increase the company’s stock price, while hiding behind the Act’s safe-harbor provisions. As a result, critics argue that the safe-harbor provisions allow companies to influence investors’ decisions without fear of repercussions. The auditor does not opine or provide any level of assurance on a client’s press releases. With the exception of earnings announcements, the auditor typically will not review or read press releases before they are issued. While not responsible for the accuracy or veracity of the press releases, the auditor should read these releases as they provide significant

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information about the client’s activities and operations (e.g., new product development or expansion into new markets). Such information is important to the planning process, especially the auditor’s assessment of business risk. For example, new product lines could strain the client’s resources or impair profitability. Expansion into new markets may require significant promotion and distribution expenditures. In the Premier Punch case, due to the nature of the information presented, the press releases may provide some additional insight on management’s integrity. While the Act provides protection, it only offers such protection for those making forward-looking statements in ‘‘good faith’’. Thus, one might argue whether Premier’s management would be protected given the seemingly contradictory information disclosed in Premier’s Annual Report. The solution to Question 4 below provides instances where management’s press releases are qualitatively different than disclosures in the MD&A. 6.4. Question 4: Evaluate James Bulger’s claims against Premier. Do you agree that Premier’s press releases and fax tout sheet are ‘‘misleading?’’ Do the investor advocate’s claims represent legitimate concerns or is Premier the ‘‘victim of unfair allegations,’’ as its CEO claims? Explain in detail and also consider how the Company’s information releases might impact the recent performance of the Company’s stock Students should discover several apparent inconsistencies between management’s discussion and analysis (MD&A) and both the press releases and the fax tout sheet (Exhibit 1). Instructors may want to suggest that students structure their answer to Question 4 in two parts: (1) A comparison of the information contained in the press releases to disclosures made in the MD&A, and (2) an evaluation of the various claims and statements made in the fax tout sheet. 6.4.1. Press releases vs. MD&A A careful comparison of the press release statements to disclosures made in MD&A suggests that James Bulger’s concerns may be well founded. Specifically, Premier’s press releases contain a pattern of ambiguous statements, which should raise students’ concern that the Company may be attempting to mislead investors about its operations and future prospects. Students should note the following inconsistencies:  Press release (1) announces Premier’s distribution with APEX Drink Corp., India’s largest beverage distributor. The Company press release states that ‘‘Shipping of product has already begun . . .,’’ while the MD&A indicates somewhat limited current distribution of products by APEX, with hopes of future expansion.  Press release (2) presents an optimistic view of sales, implying significant actual growth with respect to Grand Market and Speedgas, stating that product is being shipped. While technically true, the MD&A suggests modest actual sales. Moreover, promises of sales growth in 2007 are tempered with quality problems taking place at an important bottler.  Press release (3) announces the Company’s financing agreement with its bottler. The CEO states that, ‘‘With financing in place, we have already financed a significant amount of inventory production . . .,’’ while the MD&A discloses that, ‘‘. . . the financing arrangement has funded no inventory production, due to some negotiation delays concerning the scope of the guarantor’s liability.’’

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Exhibit 1.

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 Press release (4) contains another seemingly definitive statement by management regarding success in obtaining a patent protecting the Company’s bacteria-free bottling process. However, the MD&A casts a shadow of ambiguity on this information, declaring that ‘‘. . . the Company’s product lines contain some patented components.’’ Students should question why MD&A is much less forthright about a feature the press release trumpets.  Press release (5) is somewhat different from the others in that it confirms, in April 2007, the outcome of a matter that was unresolved in the MD&A. This press release boasts of the Company’s agreement with Cowboy Bill’s grocery stores, stating that, ‘‘This agreement continues to serve as the takeoff point for Premier’s products . . .,’’ while the MD&A notes that, ‘‘. . . early in the year, Cowboy Bill’s began considering the reduction and/or elimination of the Company’s energy drink lines from its product mix.’’ Further, the MD&A states that, ‘‘Distribution negotiations between Company management and Cowboy Bill’s were ongoing as of the balance sheet date, but we are confident that Cowboy Bill’s will retain our product in their stores.’’ The press release, when compared to the MD&A disclosure, provides insight as to the resolution of this uncertainty. However, consistent with the other press releases, management puts an extremely positive ‘‘spin’’ on this development, portraying this seemingly damaging development as a victory, achieving a ‘‘takeoff point’’ agreement. 6.4.2. Fax-related issues Students should identify several problems with the fax tout sheet disseminated by the Company:  There does not appear to be any basis for the revenue or stock price projections provided in the report. Revenues have decreased considerably in the past two years and first quarter 2007 revenues are only $2.3 million, making it difficult to justify such an optimistic revenue number ($13.1 million). More importantly, a significant bottling agreement is set to expire, which should lead students to question where the Company anticipates earning the projected revenue number provided in the fax given a high likelihood of production disruptions. In addition, given the uncertainty surrounding the Company’s bottling agreement and declining revenues, the current stock price of $2.88 (up from $2.25 earlier in the year) appears to be inflated (the Company’s press releases and fax tout sheet probably contribute to investor exuberance). Therefore, students should conclude that the target price of $6.50 per share is highly unlikely.  Actual shares outstanding (per the financial statements) differ from the shares outstanding number on the fax. Students should be asked, ‘‘What does this discrepancy suggest?’’ This case is modeled after a real-life company that misrepresented the increasing number of shares in the float, which were being issued for funds that were used to finance the faxes to prospective investors. As noted in the fax disclaimer, Premier is paying the sender (faxmeup.net) a half cent per fax. The case indicates that Premier sent out an average of 3,000,000 monthly fax newsletters during the year (at a price of .5 cents per fax for a monthly cost of $15,000). Given the company’s weak cash position, it appears that Premier may be issuing additional shares to cover operating costs, including the cost of these fax transmissions.  The fax sheet touts Premier’s ‘‘patented technology.’’ However, as noted above, the MD&A disclosures downplay the significance of the Company’s patents.

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 The fax newsletter misrepresents Premier’s financial condition, portraying Premier as a successful and promising company. Given the Company’s deteriorating financial health and hindered bottling capabilities, much of the language used in the fax is too optimistic (e.g., ‘‘in a position to dominate’’).  Similar to the press releases, the fax tout sheet highlights the Company’s distribution agreement with the Doyle–Hellmuth distribution network. However, students should note here that the Company’s bottling problems and dearth of product shipments (per the MD&A) make this a very questionable statement.  Interestingly, the fax newsletter is a trademark of Premier. While this type of self-promotion is not uncommon for some smaller publicly-held companies, students should question why Premier would attempt to make its own promotional materials look like an independent investment research report. Clearly, this presents a cause for concern and students should note that this approach calls into question the integrity of Premier’s management. In summary, students should weigh the merits of Bulger’s claims by testing the press releases and the fax tout sheet against the content of MD&A. While the MD&A generally does not explicitly contradict the information in the press releases or the fax tout sheet, the optimistic promises of the Company’s ‘‘publicity’’ campaign are seldom confirmed with tangible results discussed in the MD&A. Rather, the MD&A seems to raise very real uncertainty as to the likelihood of favorable performance in key areas of operations. At best, one might interpret this as an extreme example of ‘‘over promise and under deliver.’’ An alternative interpretation may conclude intentional obfuscation and outright deception. Students usually expect press releases to contain a very optimistic tone. However, instructors may wish to point out that management has a responsibility to inform shareholders of significant developments, both positive and negative, on a timely basis. Also, some students question the realism of the fax tout sheet, as well as promotional e-mails and even direct mail promotions. However, instructors may point out how common such forms of promotion are for smaller companies that may not have any following by analysts or readily available independent research reports. 6.5. Question 5: Perform an analytical review of Premier’s financial statements. Use your review to assess the Company’s performance and identify high-risk accounts Instructors may want to specify particular types of formal analysis which they would prefer students to perform (i.e., common-size analysis, trend analysis, calculation of particular financial ratios). Alternatively, instructors may want to leave the question more open-ended and expect students to decide how to conduct such an analysis based on what they have learned about performing analytical procedures in the planning process. We have found that students are more confident about completing this requirement if they are given specific procedures to perform. In our later implementations, we have specified that students complete a common-size analysis, a trend analysis, and calculate several liquidity, efficiency and performance ratios (e.g., calculate the 2006 gross margin for Premier and compare it to the industry average). Several key areas of concern should be noted by students as they answer question five. First, Premier’s profitability declined precipitously in 2006, from net income of over $165,687 in 2005 to a net loss of $354,365 in 2006, as a result of a steep drop in revenues

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($2,345,000 or 22.3%) accompanied by less than commensurate declines in costs. Cost of goods sold and total operating expenses declined by only 17.2% and 20.8%, respectively. This performance in 2006 is in contrast to the general improvement in operations from 2004 to 2005. In 2005, revenues increased 9%, while cost of goods sold only increased 7.2%. These trends are corroborated by deteriorating margins. Gross profit margin decreased from 29.8% in 2005 to 25.2% in 2006. Similarly, the operating margin declined from 6.8% in 2005 to 1.8% in 2006. The significant drop in ‘‘promotion and advertising’’ expense in 2006, both in absolute terms and as a percentage of sales, may even be a signal of some desperation on the part of management in trying to control costs perhaps to the detriment of revenue growth. In analyzing Premier’s balance sheet, students should note the company’s perilous liquidity position as of year-end 2006. While current liabilities declined in 2006 by about 5%, current assets decreased more than 20%. A calculation of the company’s current ratio would yield a ratio of approximately 0.9 for 2006, down from approximately 1.1 in 2005. Students should identify the current ratio of less than one as a strong sign of Premier’s likely inability to pay its liabilities as they come due during 2007. However, instructors should note that Premier’s liquidity was not very strong in prior years either. The statement of cash flows reveals further evidence of deteriorating performance in 2006. Operating activity generated less cash in 2006 ($569,880) than in 2005 ($692,537). While a significant amount of cash was used to pay down debt, much less cash was used to purchase productive assets in 2006 compared to 2005 (a decline of over $1,000,000 or 83%). Overall, cash decreased by nearly $115,000, in contrast to positive cash flows in the previous two years. Additionally, students may also comment on trends in Premier’s accounts receivable and inventory. While a sharp decline (over 33%) in inventory in 2006 may not be surprising due to the decline in Premier’s sales, accounts receivable increased slightly (approximately 1.4%) in 2006. Students may identify this trend in accounts receivable as indicative of possible collection problems which might indicate greater valuation concerns for accounts receivable during the upcoming audit. Students are also provided with an income statement for the first quarter of 2007. The results included are somewhat ambiguous. While the Company reports a slight net income (less than $4,000), other indicators appear troubling. Even though sales for the first quarter of 2007 exceed first quarter 2006 sales, the gross margin percentage deteriorated to approximately 24.6%, compared to 25.8% for the first quarter of 2006 and 25.2% for all of 2006. Also, while the amount of total operating expenses decreased compared to the prior year, ‘‘promotion and advertising expense’’ decreased significantly (32.1%) from the first quarter of 2006. Again, this begs the question: is management jeopardizing future product sales and branding with such cost cutting? Students may also point out a significant increase in ‘‘legal and accounting expense’’ (26.4%) compared to the prior year. This increase may indicate the Company is facing more legal problems in the current year. Instructors might also require students to perform a comparative analysis of Premier to other companies in the beverage industry. To support instructors who may be interested in pursuing an industry analysis, we have included a mock-up of some key industry ratios to facilitate an industry comparison (adapted from RMA, 2006). As shown in Table 1, Premier’s troubles are further highlighted by their sub-par measures on several key industry ratios such as the gross margin, return on sales, current ratio, accounts receivable turnover, and inventory turnover statistics. Instructors could provide students with Table 1

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Table 1 Industry information Gross margin

Industry

Premier

2004 2005 2006

34.7% 34.5% 34.4%

28.6% 29.8% 25.2%

Return on sales 2004 2005 2006

3.2% 2.8% 3.3%

1.4% 1.6% (4.3)%

Current ratio 2005 2006

1.93 times 1.81 times

1.10 times 0.90 times

11.69 times 11.67 times

7.11 times 5.45 times

9.53 times 8.98 times

3.62 times 3.59 times

Accounts receivable turnover 2005 2006 Inventory turnover 2005 2006

Source: Industry information adapted from Risk Management Association (RMA). 2006.RMA annual statement studies. Philadelphia: Robert Morris Associates.

and require them to analyze Premier’s performance relative to the beverage industry. Alternatively, instructors could provide only the industry information and require students to calculate Premier’s ratios before presenting their comparative industry analysis.4 As required, students must also use the analytical results to identify high-risk accounts in Premier’s 2007 financial statements. Students should note several areas of concern, including overstatement of revenues due to possible ambiguity of revenue recognition resulting from contractual agreements with distributors and vendors, existence and valuation of accounts receivable arising from such sales, and understatement of expenses and liabilities to mask poor operating performance. Although the balance decreased from 2005 to 2006, inventory remains an area vulnerable to manipulation and is a favorite target of those perpetrating financial reporting fraud. Also, students should be aware that the Company’s financing of its operations, particularly the production of its inventory, may create contingent liabilities which should be included on its balance sheet. 6.6. Question 6: In a memo to the engagement partner, Dan Greene, document your overall assessment of business risk for the upcoming Premier audit The final question asks students to prepare a professional memo to the engagement partner documenting their assessment of business risk for Premier Punch. Students may find this requirement particularly challenging since preparation of such a memo is a relatively unstructured task. However, instructors may encourage students to consider the evidence presented in the case and their answers to the Questions 1 though 5 when preparing their memos. Students’ memos should synthesize their analytical review along with the background information and the information communicated by management through their press 4

The following website, http://moneycentral.msn.com/investor/invsub/results/compare.asp, provides a convenient source for comparative industry ratios.

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releases and the MD&A from the 2006 Annual Report. At best, the company’s financial position is very tenuous. Its recent performance is poor and a key operating relationship, its bottling arrangement, appears to place Premier in great jeopardy. The predecessor auditor’s ‘‘going concern’’ opinion sets the stage for such conclusions. However, students should be expected to draw even stronger conclusions about the precarious position of the Company. The clearly optimistic press releases by management appear to be contradicted or at least dampened by facts in its own MD&A. The dissident shareholder’s claims point to such inconsistencies. These problems may even be interpreted as evidence that management lacks integrity. While management may not necessarily be orchestrating an overt fraud, they may be trying to set the stage for a successful equity offering to resolve Premier’s liquidity crisis or to improve its chances of being sought out for acquisition by another company. Accordingly, students should identify the significantly heightened business risk which accompanies such circumstances. In evaluating students’ memos, we stress the importance of the technical aspects of the memo (e.g., good grammar, clarity, logical organization). Also, we note that students are often reluctant to make a definitive conclusion about business risk. Where in practice, professionals will typically approach such a task by stating their assessment and supporting the statement with evidence, we have found that students will often be very thorough in presenting evidence but fail to make a clear risk assessment. Frequently, students will not present their conclusion until the very end of the memo and then be very equivocal when stating the assessment. We emphasize to the students the problems with such an approach in a professional setting; namely, their supervisors may have difficulty following their arguments, will need to spend unnecessary time to determine their conclusions, or may be unable to interpret their conclusions. In later implementations of this case, students were specifically advised to state their conclusions at the beginning of their memos. This guidance seemed to improve the organization of many of the students’ memos. Additionally, some students have remarked in their memos that the audit firm should not have accepted such a client or that the firm should resign from the engagement. This presents a good opportunity to refer back to earlier discussions of the client acceptance decision and what information should be gathered in the acceptance process. It is also worthwhile to point out that not all clients will always be in perfect financial health. However, the risks of accepting such engagements (potential future litigation or damage to the auditor’s reputation) must be carefully considered. As noted above, the acceptance decision presents another opportunity for instructors to expand and tailor this case to fit their course requirements. Alternatively, instructors may wish to broaden the scope of the memo to include identification of specific risks faced by Premier. Such risks would include lack of control over its production process, fierce competition for shelf space in the retail marketplace, and the challenges of distributing its product outside the US. The quality difficulties mentioned in the case may also point to product liability concerns. 7. Instructional effectiveness Student feedback was obtained through surveys and informal discussion. The feedback indicates that the case is effective in helping students better understand business risk assessment and the audit planning process. In the initial implementation of the case, survey data from 43 students (i.e., undergraduate auditing students) were collected to provide an assessment of the effectiveness of the case as a pedagogical tool. Using a nine-point

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scale with endpoint 1 being the most negative response (e.g., not helpful, boring, unrealistic, strongly disagree) and endpoint 9 being the most positive response (e.g., helpful, realistic, interesting, strongly agree), students responded to items used to evaluate their assessment of various case-related issues. Students indicated that the case improved their overall understanding of the client business risk assessment process (mean = 6.53) and that the case itself represented a helpful tool in understanding business risk assessment (mean = 6.37). Students also found the company realistic (mean = 6.86) and the case interesting (mean = 6.37). These preliminary results suggest that the case was well-received by students and enhanced their understanding of the business risk assessment process. Similar results were obtained from students’ responses to questions relating to their understanding of the role that financial disclosure requirements and analytical procedures play in the business risk assessment process. In a subsequent implementation of the case, we used a pre-test and post-test survey to better evaluate the instructional effectiveness of the case. Survey data from 18 students in one auditing section were collected as a means to assess the case’s instructional effectiveness. Panel A of Table 2 shows three response items used to assess the effectiveness of the case as a pedagogical tool. The first two items measured students’ understanding of the business risk assessment process and their understanding of the difficulties faced by practitioners during the business risk assessment process, respectively. The third item captures students’ perceptions relating to whether the quality of a client’s financial reporting is important to business risk assessment. The results in Panel A of Table 2 indicate that the case improved students’ understanding of key issues relating to the business risk assessment process. For all three items (items 1 Table 2 Instructional effectiveness assessment data (n = 18)* Response item

Panel A 1. Understanding of business risk assessment 2. Understanding of difficulties faced in assessing business risk 3. Client’s financial reporting quality is important to business risk assessment

p**

Scores Pre-test mean (SD)

Post-test mean (SD)

5.29 (1.05) 5.59 (1.87) 7.41 (1.94)

7.06 (.75) 7.35 (1.32) 8.65 (.61)

.0001 .003 .017

Response item

Mean

p**

Panel B 4. Realism of Premier Punch case 5. Interest level of Premier Punch case 6. Better understanding of business risk assessment 7. Premier Punch case was a good use of my time

6.18 7.18 7.41 7.65

.046 .0001 .0001 .0001

* Students’ responses to items 1 and 2 were measured on a nine-point scale where 1 = ‘‘weak’’ and 9 = ‘‘strong’’ and their responses to item 3 were measured on another nine-point scale where 1 = ‘‘strongly disagree’’ and 9 = ‘‘strongly agree.’’ Response to items 4 through 7 were measured using a nine-point scale with endpoint 1 being the most negative response (e.g., unrealistic, boring, strongly disagree) and endpoint 9 being the most positive response (e.g., realistic, interesting, strongly agree). ** Indicates two-tailed p-values. For items 4 through 7, p-values indicate that means are significantly different from five, the scale midpoint.

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through 3) relating to key issues in the case, there were significant increases in students’ understanding from the pre-test to the post-test. The results for item 1 show that after completing the case, students felt that their understanding of the business risk assessment process had improved significantly (p = .0001). Item 2 also shows that after completing the case, students believed they had a significantly greater understanding of the difficulties practitioners face during the business risk assessment process (p = .003). The results for item 3 suggest that after completing the case, students felt even more strongly that a client’s financial reporting quality is a key consideration during the business risk assessment process (p = .017). Panel B of Table 2 shows that the case was well-received by students, as evidenced by their responses to several items included only on the post-test questionnaire. Students found the case to be of above average realism (mean = 6.18) and interesting (mean = 7.18). Students also felt that the case improved their understanding of assessing a client’s business risk (mean = 7.41) and was a good use of their time (mean = 7.65). Based on these students’ responses, the initial assessment data, and informal student feedback, we believe that the Premier Punch case adds significant value to the auditing course. Acknowledgement We would like to thank Dejan Antolic, Lori Berger, Mike Bitter, Amanda Coleman, Barb Grein, Susan Lightle, Paul Lin, Phyllis Mo, and Liga Spoge for their helpful comments and assistance. We also thank Jim Rebele (Editor), an anonymous reviewer, and participants at the 2006 American Accounting Association Annual Meeting and the 2006 American Accounting Association Auditing Midyear Conference for their helpful comments. Appendix A. Premier website screenshot

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Appendix B. Predecessor auditor’s report Marwick and Arthur LLP Report of Independent Registered Public Accounting Firm The Board of Directors and Stockholders Premier Punch, Inc.: We have audited the accompanying consolidated balance sheets of Premier Punch, Inc. as of December 31, 2006 and 2005 and the related consolidated statements of operations, stockholders’ equity and cash flows for each of the years in the period ended December 31, 2006. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and the schedule based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Premier Punch, Inc. at December 31, 2006 and 2005, and the consolidated results of its operations and its cash flows for each of the years in the period ended December 31, 2006 in conformity with US generally accepted accounting principles. We have also audited, in accordance with standards of the Public Company Accounting Oversight Board (United States), the effectiveness of internal control over financial reporting as of December 31, 2006, based on the criteria established in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated February 27, 2007 expressed an unqualified opinion on management’s assessment that Premier Punch maintains effective internal control and an unqualified opinion that internal control was effective. Premier Punch Inc.’s net loss and net working capital deficiency raise substantial doubt about its ability to continue as a going concern. The 2006 financial statements do not include any adjustments that might result from the outcome of this uncertainty. Marwick and Arthur LLP Boston, Massachusetts February 27, 2007

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Appendix C. Premier Punch, Inc. financial statements

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Appendix D. Press releases for Premier Punch, Inc (1) January 8, 2006, ‘‘Premier Taps into International Market’’ Albany, TX – Premier Punch, Inc. announced today that the company has signed an agreement with India’s largest beverage distributor, APEX Drink Corp., which has the capacity to distribute hundreds of thousands of bottles of Premier’s energy drinks throughout India. APEX is expected to help Premier significantly penetrate two of India’s most populous cities, Bombay and New Delhi. Premier CEO Seamus Sheridan stated that, ‘‘APEX loves our products and has added several new countries to their customer list. Shipping of product has already begun, although not in quantities that we ultimately expect.’’ Sheridan added that, ‘‘We are all very enthusiastic about this partnership and APEX has made excellent progress in the lines of a dedicated plant.’’ Safe Harbor Statement under the Private Securities Litigation Reform Act of 1995: This release includes forward-looking statements intended to qualify for the safe harbor from liability established by the Private Securities Litigation Reform Act of 1995. These forward-looking statements generally can be identified by phrases such as PREM or its

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management ‘‘believes,’’ ‘‘expects,’’ ‘‘anticipates,’’ ‘‘foresees,’’ ‘‘forecasts,’’ ‘‘estimates’’ or other words or phrases of similar import. Similarly, such statements in this release that describe the company’s business strategy, outlook, objectives, plans, intentions or goals also are forward-looking statements. All such forward-looking statements are subject to certain risks and uncertainties that could cause actual results to differ materially from those in forward-looking statements. These risks and uncertainties include, among other things, product price volatility, product demand, market competition and risk inherent in the operations of a company. We assume no obligation to update any written or oral forward-looking statement made by us or on our behalf as a result of new information, future events or other factors. (2) March 12, 2006, ‘‘Premier Expands Availability of its Products to Over 1200 Major Chain Retail Grocery and Convenience Store Outlets’’ Albany, TX – Premier Punch, Inc. announced today that its ‘‘Jazzy Juice’’ and ‘‘Taurus Tonic’’ energy drink product lines have been authorized for distribution in 3000 stores and approved for cold-box placement in approximately 1200 Grand Market grocery stores and Speedgas convenience stores. Shipping of product has already begun and distribution is being handled through the Doyle–Hellmuth global distribution network. ‘‘As a result of this agreement, Premier will become part of a giant marketing matrix reaching consumers around the globe,’’ stated Seamus Sheridan, President and CEO. Safe Harbor Statement under the Private Securities Litigation Reform Act of 1995: This release includes forward-looking statements intended to qualify for the safe harbor from liability established by the Private Securities Litigation Reform Act of 1995. These forward-looking statements generally can be identified by phrases such as PREM or its management ‘‘believes,’’ ‘‘expects,’’ ‘‘anticipates,’’ ‘‘foresees,’’ ‘‘forecasts,’’ ‘‘estimates’’ or other words or phrases of similar import. Similarly, such statements in this release that describe the company’s business strategy, outlook, objectives, plans, intentions or goals also are forward-looking statements. All such forward-looking statements are subject to certain risks and uncertainties that could cause actual results to differ materially from those in forward-looking statements. These risks and uncertainties include, among other things, product price volatility, product demand, market competition and risk inherent in the operations of a company. We assume no obligation to update any written or oral forward-looking statement made by us or on our behalf as a result of new information, future events or other factors. (3) November 17, 2006, ’’Premier Negotiates Advantageous Strategic Production Agreement’’ Albany, TX – Premier Punch, Inc. announced today that it is nearing agreement with a major new contract manufacturer and bottler for interest-free financing of the production and shipment of all of the company’s products. ‘‘With financing in place, we will be able to fund a significant amount of inventory production and will be poised to seize significant market opportunities as we expand our presence worldwide,’’ said Seamus Sheridan, Premier President and CEO. Safe Harbor Statement under the Private Securities Litigation Reform Act of 1995: This release includes forward-looking statements intended to qualify for the safe harbor from liability established by the Private Securities Litigation Reform Act of 1995. These forward-looking statements generally can be identified by phrases such as PREM or its management ‘‘believes,’’ ‘‘expects,’’ ‘‘anticipates,’’ ‘‘foresees,’’ ‘‘forecasts,’’ ‘‘estimates’’

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or other words or phrases of similar import. Similarly, such statements in this release that describe the company’s business strategy, outlook, objectives, plans, intentions or goals also are forward-looking statements. All such forward-looking statements are subject to certain risks and uncertainties that could cause actual results to differ materially from those in forward-looking statements. These risks and uncertainties include, among other things, product price volatility, product demand, market competition and risk inherent in the operations of a company. We assume no obligation to update any written or oral forward-looking statement made by us or on our behalf as a result of new information, future events or other factors. (4) December 20, 2006, Premier Enhances its Competitive Edge Albany, TX – Premier Punch, Inc. announced today that it has succeeded in obtaining a United States Patent Office patent, which protects Premier’s unique bacteriafree bottling process. ‘‘The patented process used to bottle Premier’s energy drink lines will be an enormous barrier to our competitors,’’ stated Premier CEO Seamus Sheridan. Sheridan added that, ‘‘This patented technology will serve as the delivery system for our product lines and puts us in a position to become a leader in the competitive energy drink market.’’ Safe Harbor Statement under the Private Securities Litigation Reform Act of 1995: This release includes forward-looking statements intended to qualify for the safe harbor from liability established by the Private Securities Litigation Reform Act of 1995. These forward-looking statements generally can be identified by phrases such as PREM or its management ‘‘believes,’’ ‘‘expects,’’ ‘‘anticipates,’’ ‘‘foresees,’’ ‘‘forecasts,’’ ‘‘estimates’’ or other words or phrases of similar import. Similarly, such statements in this release that describe the company’s business strategy, outlook, objectives, plans, intentions or goals also are forward-looking statements. All such forward-looking statements are subject to certain risks and uncertainties that could cause actual results to differ materially from those in forward-looking statements. These risks and uncertainties include, among other things, product price volatility, product demand, market competition and risk inherent in the operations of a company. We assume no obligation to update any written or oral forward-looking statement made by us or on our behalf as a result of new information, future events or other factors. (5) April 18, 2007, Premier Products Experience Excellent Consumer Acceptance Albany, TX – Premier President and CEO Seamus Sheridan published a statement announcing that, ‘‘Premier will continue to offer its ‘Jazzy Juice’ and ‘Taurus Tonic’ energy drink lines in all northern Washington Cowboy Bill’s grocery stores, making Premier’s energy drinks available in over 200 Cowboy Bill’s stores throughout the region. This agreement continues to serve as the takeoff point for Premier’s products – which are experiencing excellent consumer acceptance – to spread throughout the western United States.’’ Safe Harbor Statement under the Private Securities Litigation Reform Act of 1995: This release includes forward-looking statements intended to qualify for the safe harbor from liability established by the Private Securities Litigation Reform Act of 1995. These forward-looking statements generally can be identified by phrases such as PREM or its management ‘‘believes,’’ ‘‘expects,’’ ‘‘anticipates,’’ ‘‘foresees,’’ ‘‘forecasts,’’ ‘‘estimates’’ or other words or phrases of similar import. Similarly, such statements in this release that describe the company’s business strategy, outlook, objectives, plans, intentions or goals also are forward-looking statements. All such forward-looking statements

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are subject to certain risks and uncertainties that could cause actual results to differ materially from those in forward-looking statements. These risks and uncertainties include, among other things, product price volatility, product demand, market competition and risk inherent in the operations of a company. We assume no obligation to update any written or oral forward-looking statement made by us or on our behalf as a result of new information, future events or other factors. D.1. 2006 Annual report (excerpts) D.1.1. Management’s discussion and analysis (dated March 1, 2007) Throughout the period, Premier Punch, Inc. (‘‘the Company’’) continued to develop its strategy of incorporating greater brand awareness within newly established distribution channels, while exploring several opportunities for broadening its portfolio of all-natural energy drink products and corporate identification programs. Currently, the Company’s product lines contain some patented components. Further, we are investigating whether our trade secrets and/or product formulations may possess any additional patentable features. In the near future, we plan to expand our strategy of aggressive patent, copyright, and trademark development. As these corporate identification initiatives are completed, the Company will continue to expand and refine its product and corporate identification programs, which will be intensified concurrent with future production runs. Premier products are being distributed through the world’s leading marketer and distributor of beverages – the Doyle–Hellmuth global distribution network. Currently, the Company’s products are being featured in all-natural ‘‘store within a store’’ concepts, through various grocery and convenience store chains including Grand Market and Speedgas. To date, the means and ability to obtain meaningful sales volume is in place, with product poised to be on the shelves in over 1200 major chain retail grocery and convenience store outlets. As of the balance sheet date, there have been some delays in product shipments and the implementation of the Company’s consumer market advertising programs have been delayed due to negotiations with one of the Company’s bottling partners. This partner provides bottling service for approximately 30% of the Company’s inventory and there have been some product quality problems with inventory bottled by this partner. While the Company is working to conclude these negotiations and resolve the quality problems, this fact may have a substantial impact on the Company’s ability to meet some of its shipping and delivery schedule targets. Our greatest concentration of retail product availability is in the Pacific Northwest and Northeast regions of the United States. Cowboy Bill’s represents a key distribution partner in the Pacific Northwest. As of the balance sheet date, Cowboy Bill’s carried the Company’s products in over 200 stores throughout the region. However, early in the year, Cowboy Bill’s began considering the reduction and/or elimination of the Company’s energy drink lines from its product mix. Distribution negotiations between Company management and Cowboy Bill’s were ongoing as of the balance sheet date, but we are confident that Cowboy Bill’s will retain our product in their stores. In addition, the Company anticipates bolstering international product availability through its official relationship with APEX Drink Corp., India’s largest beverage distributor. At present, APEX is distributing one of the Company’s product lines to several of its major customers. The Company is very excited about its partnership with APEX and hopes to expand distribution to include all the Company’s product lines in the near future.

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In addition to several exciting ‘‘brick and mortar’’ distribution arrangements, the Company will continue to make product available direct to consumers through its website. The Internet represents a fantastic mechanism to deliver product to busy consumers and underserved markets. Premier wants its product distribution and availability as varied as the people who drink the product, and the Company is expending tremendous amounts of energy to make it all come together. As announced in November, the Company entered into a financing agreement with a major bottler, which is secured by the Company’s finished goods inventory. The financing of new inventory is further secured by a guarantee from a third party (not affiliated with the Company’s management). As of the balance sheet date, the financing arrangement has funded no inventory production, due to some negotiation delays concerning the scope of the guarantor’s liability. However, the Company expects to resolve the remaining details of the financing guarantee within the next six months. To alleviate potential production stress, the Company is exploring a new marketing model, the natural foods segment, for which the Company is eligible due to the all-natural ingredients of its energy drink lines. The Company and its management believe that this market venue may be more receptive and will require less capital for marketing and thereby provide higher profit margins. The Company’s results for the recent periods reflect static losses and depressed sales while this new marketing model is being evaluated. However, it is important to note that the Company is in the process of scheduling some of its largest production runs in almost two years for its existing products and is continuing to develop its distribution network for these products. All of us at Premier want the company to succeed. We want to disappoint the critics and surprise the skeptics. Above all, we want to make your investment in Premier well worth your time and money. Despite the detractors and those who have already thrown away their tickets and left the theater, the show is far from over. As a shareholder, you’re entitled to a front row seat. Be sure to remind us if we ever forget! References American Institute of Certified Public Accountants (AICPA) (2002). Consideration of fraud in a financial statement audit. Statement on Auditing Standards No. 99. New York, NY: AICPA. American Institute of Certified Public Accountants (AICPA) (2006a). Understanding the entity and its environment and assessing the risks of material misstatement. Statement on Auditing Standards No. 109. New York, NY: AICPA. American Institute of Certified Public Accountants (AICPA) (2006b). The auditor’s consideration of an entity’s ability to continue as a going concern. AU Section 341. New York, NY: AICPA. Arens, A. A., Elder, R. J., & Beasley, M. S. (2008). Auditing and assurance services: An integrated approach (12th ed.). Upper Saddle River, NJ: Prentice Hall. Block, D. J., & Hoff, M. (1999). Application of the safeharbor for forward-looking statements. New York Law Journal, October 6. Mattson, B. (1996). Companies use safe harbor law. The Business Journal (Minneapolis – St. Paul), November 15. Messier, W. F., Glover, S. M., & Prawitt, D. F. (2008). Auditing and assurance services (5th ed.). New York, NY: McGraw-Hill Irwin. Private Securities Litigation Reform Act of 1995 (PSLRA) (1995). Pub. L 104-67, 109 Stat. 737. Risk Management Association (RMA) (2006). RMA annual statement studies. Philadelphia: Robert Morris Associates. Whittington, O. R., & Pany, K. (2008). Principles of auditing and other assurance services (16th ed.). New York, NY: McGraw-Hill Irwin.