8/13/2019 Perry Drug Stores Synopsis

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8/13/2019 Perry Drug Stores Synopsis

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Richard Valade and a subordinate prepared a General Risk Analysis memorandum for 1992 Perry audit.

This memo indicated that Andersen expected an overall moderate audit risk for the engagement. This

assessment reflects that auditor expects errors but has reason to believe they are not likely to be

material in relation the financial statements. The overall materiality standard of $700,000 was

established for the engagement. The SEC identified the following audit procedures that Andersen

completed during the 1992 Perry audit: conducted extensive analytical tests to evaluate the

reasonableness of the estimated gross profit margin Perry used during 1992, performed tests to

investigate whether theft or changes in Perrys merchandising plans and business policies be the cause

of the inventory shortage, observe and tested physical inventory counts at five Perry stores, reviewed

the results of Perrys investigations to identify the source of inventory shortage, and reviewed the

results of the study of the computer risk management group.

These audit procedures failed to uncover the source of the inventory shortage. During the companys

board of directors meeting, Richard Valade did not object to the inclusion of the Store 100 inventory as

an asset on Perrys balance sheet, which values $20.3 million, he would give an unqualified opinion and

he recommended that Perry should have a company-wide physical inventory to find the source ofinventory shortage. Perry submitted the income statement and the balance sheet to SEC in their 10-k

report, with the $8.3 million income, $20.3 million Store 100 inventory account and unqualified opinion

of Valade.

The company-wide physical inventory confirmed the large inventory shortage discovered by the

company. $33.4 million was written off in the fourth-quarter adjustment of 1993 since management

deemed that $20.3 million write-off resulted from a change in estimate. The write-off was not

reported separately in their 1993 fiscal report and no restatement of 1992 financial statement for the

Store 100 inventory account. SEC discovered the $33.4 million adjustment recorded the company and

insisted to restate their 1992 and 1993 financial statements. This would increase their cost of sales by$20.3 million in 1993 and decrease by $20.3 million in 1992 financial statement. After Perry restated

their financial statements, SEC launched an investigation of the company with the reason of the not

writing off the balance of the Store 100 account in fiscal 1992. In 1998, SEC issued two enforcement

releases regarding the investigation.

The first enforcement release, SEC chastised Stone for signing Perrys 1992 10-k and sanctioned him for

failing to correct Perrys 1992 financial statements, which stopped him from making any violation and

future violation. The second enforcement release, SEC criticized Valade for highly relying on physical

examination rather than indirect tests to uncover inventory shortages which were unreliable. Valade

failed to obtain sufficient competent evidential matter by failing to require Perry to reconcile book

inventory and physical inventory and adjusting them to the books and records, failing to discredit either

recorded inventory or physical inventory, failing to issue a qualified opinion and failing to refrain from

issuing an audit opinion until the matter was resolved. Also in the second enforcement release, SEC

censured Valade for his conduct during the 1992 Perry audit meaning he needs to comply in the future

with all applicable practice requirements for auditors of SEC registrants. Both Jerry Stone and Richard

Valade consented to the SEC sanctions.