02 Carpenter Dissertation

7/30/2019 02 Carpenter Dissertation

1/84

APPENDIX A

EXPERIMENTAL INSTRUMENT

FRAUD RISK ASSESSMENT CASE

PART I

Please print your name and address of the practice office below.

Name (printed): ___________________________________

Practice Office Address: ___________________________________

___________________________________

___________________________________

The results of this study will be published in the aggregate and your materials will remain confidential, tothe extent allowed by law, only the property of the researcher, Tina Carpenter. The results of this researchstudy may be published, but your name will not be used. The data will be locked in the researchers officeand stored electronically with password protection.

If you would like to learn more about the results of this study, please contact Tina Carpenter, doctoralstudent at [email protected]. You may also contact Jane Reimers, doctoral advisor [email protected].

If you have any questions about your rights as a subject/participant in this research, or if you feel youhave been placed at risk, you can contact the Chair of the Human Subjects Committee, InstitutionalReview Board, through the Vice President for the Office of Research at (850) 644-8633.

44


2/84

GREETING AND INTRODUCTION

(Read aloud by experimenter)

Hello, my name is Tina Carpenter and I am a Ph.D. student at Florida State University. I once worked as aCPA and public accountant just like you and I have worked diligently will several partners from Big 4firms to make this project as useful and interesting to you as possible.

Thank you participating in my dissertation research today. I know how valuable your time is, and Itherefore appreciate you taking part in my experiment. The partners in your office strongly support thisproject and all of the materials have been reviewed by partners and managers among the Big 4 firms andhave been tested through other audit teams.

The results of this experiment will be sent to and reviewed by partners in your office and you will thus beasked to fill out your name and practice office. Since your name will be on the materials, please take greatcare and thought in formulating your responses as you would on an audit in practice.

At this time, please take a minute to print your name and practice office on the front page of yourbooklets.

PAUSE

Now that you have all put your name on the booklets, I would like you to turn to the first page where youwill be doing a warm up exercise in order to help prepare you for the remainder of the materials thatfollow. You will be given 2 minutes to complete this exercise from when I say start. When time is up, Iwill ask you to stop and put down your pencils. What I am about to read is printed at the top of the pagewhere you will be working, so it is not necessary to read it again.

Your task is as follows: A common self-test of creative thinking is the Paper Clip Quiz. Here is howit goes: you will have two minutes to brainstorm and list all possible uses for an ordinary paper clip.

Write down your answers as fast as you can. Ill call STOP at the end of two minutes.

PAUSE

Now that you have completed this exercise, you may turn the page again and begin. Please make sure toCAREFULLY read each set of instructions. You will be given 45 minutes to complete this next section. Iwill ask you to Stop at the end of those 45 minutes. You may begin.

PAUSE

Please take a 5 minute break while I get assistance copying portions of your materials so that you can usethem during the remainder of the experiment. Please do not discuss any of the experiment with others inthe room. When I return, you will be given copies and we will begin Part II in your teams.

PAUSE

45


3/84

PART II INSTRUCTIONS

(Read aloud by experimenter)

Please turn over your case booklets. The member of the team with the sticker has been randomly chosen

to be the group recorder. The group recorder will be recording the group response for this entire part. Thegroup recorder should take great care to write down everything that is discussed in the group (as manyunique ideas as possible). Please signal to the experimenter who your group recorder is by raising yourhand so that you can be handed the materials to complete for the group.

DISCUSSION AMONG ENGAGEMENT PERSONNEL REGARDING THE RISKS OF MATERIALMISSTATEMENT DUE TO FRAUD

SAS No. 99, Consideration of Fraud in a Financial Statement Audit, suggests the overall objective ofbrainstorming is to identify how and where the entitys financial statements might be susceptible tomaterial misstatement due to fraud and how management could perpetrate and conceal it.

It suggests that the discussion among the audit team members about the susceptibility of the entitysfinancial statements to material misstatement due to fraud should include a consideration of the knownexternal and internal factors affecting the entity that might a) create incentives/pressures for managementand others to commit fraud, b) provide the opportunity for fraud to be perpetrated, and c) indicate aculture or environment that enables management to rationalize committing fraud.

The discussion should occur with an attitude that includes a questioning mind, setting aside any priorbeliefs the audit team members have that management is honest and has integrity. In this regard, thediscussion should include a consideration of the risk of management overriding controls. The discussionamong the audit team members should emphasize the need to maintain a questioning mind and to exerciseprofessional skepticism.

It is VERY important for each group recorder to read aloud the instructions provided in each group taskbooklet for PART II. Please realize that there are no right or wrong answers and your case is most likelydifferent than any other group in the room. Therefore, it is of no use to listen to other group conversations.Please focus on these tasks as your own group, as you did when performing the tasks earlier individually.Please signal to me when you have completed this session and I will provide you with Part III, the finalmaterials, which you will complete individually.

46


4/84

Warm Up Exercise

A common self-test of creative thinking is the Paper Clip Quiz. Here is how it goes: you will

have two minutes to brainstorm and list all possible uses for an ordinary paper clip in the

space provided below. Write down your answers as fast as you can. Ill call STOP at the

end of two minutes.

47


5/84

INSTRUCTIONS

Participation is voluntary and there is no penalty for non-participation. If you would like to participate, bycontinuing on at this point, you are providing consent. Thank you for agreeing to participate in this study. Thepurpose of this study is to investigate judgments auditors make during financial statement audits. Moreprecisely, the study examines how auditors formulate judgments when performing analytical procedures and

assessing the risk of fraud.

In the following pages, you will be asked to complete several tasks. Please recognize that there are no right orwrong answers, as most of the questions deal with matters of professional judgment, so please provide your bestjudgments. Your individual responses will be coded with a corresponding participant number and all results willbe reported in aggregate, not revealing your identity and remaining confidential to the extent allowed by law.

SAS No. 99, Consideration of Fraud in a Financial Statement Audit, requires members of the audit team todiscuss the potential for material misstatement due to fraud. The discussion should include: an exchange of ideasor brainstorming among the audit team members about how and where they believe that entitys financialstatements might be susceptible to material misstatement due to fraud and how management could perpetrateand conceal fraudulent financial reporting. For purposes of this standard,fraudis an intentional act that results

in a material misstatement in the financial statements that are the subject of an audit.

The standard also suggests that the auditor should consider any unusual or unexpected relationships that havebeen identified in performing analytical procedures in planning the audit. Analytical procedures and analysis ofbackground information about the client should be performed by each individual prior to the groupbrainstorming in order to provide a similar level of understanding about the client.

Mimicking the guidance set forth in SAS No. 99, you will participate in a study today designed with three parts.Part I will ask that you perform analytical procedures on the financial statement information provided to you.You will then be asked to brainstorm individually, providing an initial list of unusual items, and identifying howand where the clients financial statements might be susceptible to material misstatement due to fraud.Additionally, you will list ways management could perpetrate and conceal this fraud, and you will be asked for

your overall fraud risk assessment.

When you have individually completed Part I, Part II will require that you work with two other auditors in agroup for the brainstorming session described in SAS No. 99. Part II will ask you (as part of this group) toprovide a list of how and where the clients financial statements might be susceptible to material misstatementdue to fraud; how management could perpetrate and conceal fraud; and for your groups overall fraud riskassessment.

When you have completed the group brainstorming and associated tasks, all of your materials will be collected.You will then be asked to complete the final set of tasks -Part III- individually.

If you have any questions during this study, please ask me, but please dont talk to others about this study while

you are taking part in it. In Part II, you will be asked to discuss items with other members of your group;however you should only confer with these group members at this specified time. Additionally, because othersfrom your firm and other firms in this area will also be participating in this research at a later time, please do nottalk to others about this study for at least two weeks after your participation.

Thank you,Tina D. CarpenterFlorida State University

48


6/84

PART I

You have been provided a case booklet concerning an audit client. The case booklet is separated from thispacket for easy reference and making notes. The booklet includes the following information:

A Narrative Description of the Company

Comparative Income Statements

Comparative Balance Sheets Notes to the Financial Statements

Common-sized Balance Sheets and Income Statements

Financial Ratios

Assume that you are in the preliminary planning stage of this clients audit for fiscal 2000. No auditprocedures have been performed other than general information gathering. All of the informationavailable to you about this Company is included in the case booklet.

Please perform preliminary analytical procedures on the financial statements for 2000 with the specificobjective of assessing the likelihood that financial statement fraud is or is not present. In Part I you will beasked to first indicate (there is paper available for this purpose) unusual items noted and to generate what

you consider to be the most likely explanation for the unusual items identified. In developing yourexplanations, you may refer to the case information, perform calculations, and make assumptions, ifnecessary. Second, you will be asked to brainstorm individually listing how and where you believe theCompanys financial statements may be susceptible to material misstatement due to fraud and howmanagement could perpetrate and conceal fraudulent financial reporting. Third, you will be asked toprovide a fraud risk assessment and complete an individual questionnaire. You will be givenapproximately 45 minutes to complete the three tasks described above. Feel free to refer to the casebooklet at any time while completing these tasks.

While helping to construct this case, the engagement partner on this audit expressed numerous times hisconcern about the associated costs of implementing brainstorming on this engagement. Specifically, he isconcerned about the audit team members being overly sensitive to unusual account balance fluctuations

noted in the initial analytical procedures, as this sensitivity may lead to costly increases in unjustifiedinvestigations and efficiency losses on the audit. He would like the assessment of fraud risk and theassociated brainstorming to be sufficient to comply with the standard, but he hopes that you will be awareof the costs and complete this phase of the audit as efficiently as possible.

This partner will review your responses in the individual and group phases, so please take great care andthought in formulating your responses as you would on an audit in practice.

Please list three reasons that auditors can sometimes be overly sensitive to the cost of unjustifiedinvestigations, (i.e., efficiency), when evaluating a clients fraud risk in the planning stage of anengagement.

1. __________________________________________________________________2. __________________________________________________________________3. __________________________________________________________________

Please number these reasons in order of their impact on auditors judgments (1 representing the highestimpact and 3 the lowest).

Please note the current time, this time will mark the beginning of the task on the next page __________.

49


7/84

TASK I

Unusual Items Noted During Analytical Procedures

Please indicate unusual items noted and generate what you consider to be the most likely explanationfor the unusual items identified. In developing your explanations, you may refer to the case

information, perform calculations, and make assumptions, if necessary.

Feel free to refer to the case booklet at any time while completing this task. Additionally, the calculationsprovided in the common sized balance sheet, income statement and the financial ratios have beenrecalculated and are accurate.

Unusual items noted Most likely explanation for this unusual item

1.

2.

3.

4.

5.

6.

7.

8.

9.

10.

50


8/84

51

TASK II

How and Where the Financial Statements are Susceptible to Fraud and How Management Could Perpetrate and

Conceal It

Please brainstorm, listing how and where you believe the clients financial statements just reviewed might besusceptible to material misstatement due to fraud, and how management could perpetrate and conceal fraudulent

financial reporting. In developing this list, you may refer to the case information and any prior work, if necessary.

It may be helpful to identify events or conditions that indicate incentives/pressures to perpetrate fraud, opportunitiesto carry out the fraud, or attitudes/rationalizations to justify a fraudulent action. These events are referred to in SASNo. 99 as fraud risk factors. Fraud risk factors do not necessarily indicate the existence of fraud; however, theyoften are present in circumstances where fraud exists.

Feel free to refer to the case booklet at any time while completing this task.

You are to provide as many unique ideas as possible, as there are no dumb ideas.

How and where you believe the clients

financial statements might be susceptible to

material misstatement due to fraud?

How management could perpetrate and conceal

this fraudulent financial reporting?

1.

2.

3.

4.

5.

6.

7.

8.

9.

10.


9/84

TASK III

Individual Risk Assessments

52

INSTRUCTIONS

When responding to the following questions, please do not look back to the case materials.

SAS No. 56, Analytical Procedures, states that planning analytical procedures should focus on identifying areasthat may represent specific risks relevant to the audit. Based on your review of the financial statements, what is

your judgment of the likelihood of the following risks relevant to this client? Circle one number on the scalebelow corresponding to your judgment. For example, if after reading a statement you believe the likelihood ofrisk is neutral, you might respond by circling 5, as shown below.

Extremely [_____|_____|_____|_____|_____|_____|_____|_____|_____|_____] ExtremelyUnlikely 0 1 2 3 4 5 6 7 8 9 10 Likely

Neutral


10/84

53

TASK III

When responding to the following questions, please do not refer back to the case materials. Based on yourreview of the financial statements, what is your judgment of the likelihood of the following risks relevant to thisclient? Circle one number on the scale below corresponding to your judgment.

FRAUD RISK

LIKELIHOOD OF RISK: Financial statement fraud (an intentional act that results in a material misstatement inthe financial statements) is present.


Neutral

SIGNIFICANCE OF RISK: Financial statement fraud (an intentional act that results in a material misstatementin the financial statements) is present.

Highly [_____|_____|_____|_____|_____|_____|_____|_____|_____|_____] HighlyInsignificant 0 1 2 3 4 5 6 7 8 9 10 Significant

Neutral

PERVASIVENESS OF RISK: Financial statement fraud (an intentional act that results in a materialmisstatement in the financial statements) is present.

Extremely [_____|_____|_____|_____|_____|_____|_____|_____|_____|_____] ExtremelyNon-Pervasive 0 1 2 3 4 5 6 7 8 9 10 Pervasive

Neutral

CLIENT BUSINESS RISK: Risk that this entitys business objectives will not be attained as a result of theexternal and internal factors, pressures, and forces brought to bear on the entity and, ultimately, the riskassociated with the entitys survival and profitability.

Extremely [_____|_____|_____|_____|_____|_____|_____|_____|_____|_____] ExtremelyLow 0 1 2 3 4 5 6 7 8 9 10 High

Neutral

If you believe that the risk of material misstatement due to fraud is likely, can it be related to specific financialstatement account balances or classes of transactions? _______ Yes _______ No

Please indicate any overall trends in the financial statement information or any other information that signal ared flag to you that may heighten the risk of material misstatement due to fraud. (List all of them below).

__________________________________________________________________________________________

__________________________________________________________________________________________

What is your response to the risk of material misstatement of the financial statements due to fraud (i.e., whataudit procedures do you intend to perform if any)?

__________________________________________________________________________________________

__________________________________________________________________________________________


11/84

54

TASK IV

Statements that people use to describe themselves are given below. Please select the response that indicateshow you generally feel by circling the number that corresponds best to your feeling. There are no right orwrong answers. Do not spend too much time on any one statement.

Strongly StronglyDisagree Agree

1. I often accept other peoples explanations without further thought. ....... 1 2 3 4 5 6

2. I feel good about myself. ......................................................................... 1 2 3 4 5 6

3. I wait to decide on issues until I can get more information..................... 1 2 3 4 5 6

4. The prospect of learning excites me. ....................................................... 1 2 3 4 5 6

5. I am interested in what causes people to behavethe way that they do................................................................................. 1 2 3 4 5 6

6. I am confident of my abilities.................................................................. 1 2 3 4 5 6

7. I often reject statements unless I have proof that they are true ............... 1 2 3 4 5 6

8. Discovering new information is fun........................................................ 1 2 3 4 5 6

9. I take my time when making decisions ................................................... 1 2 3 4 5 6

10. I tend to immediately accept what other people tell me .......................... 1 2 3 4 5 6

11. Other peoples behavior doesnt interest me ........................................... 1 2 3 4 5 6

12. I am self-assured...................................................................................... 1 2 3 4 5 6

13. My friends tell me that I usually question things that I see or hear......... 1 2 3 4 5 6

14. I like to understand the reason for other peoples behavior .................... 1 2 3 4 5 6

15. I think that learning is exciting................................................................ 1 2 3 4 5 6

16. I usually accept things I see, read or hear at face value........................... 1 2 3 4 5 6

17. I dont feel sure of myself ....................................................................... 1 2 3 4 5 6

18. I usually notice inconsistencies in explanations...................................... 1 2 3 4 5 6

19. Most often I agree with what the others in my group think .................... 1 2 3 4 5 6

20. I dislike having to make decisions quickly.............................................. 1 2 3 4 5 6

21. I have confidence in myself..................................................................... 1 2 3 4 5 6

22. I dont like to decide until Ive looked at all of the readilyavailable information............................................................................... 1 2 3 4 5 6

23. I like searching for knowledge ................................................................ 1 2 3 4 5 624. I frequently question things that I see or hear ......................................... 1 2 3 4 5 6

Please turn over the page and continue answering questions.


12/84


25. It is easy for other people to convince me............................................... 1 2 3 4 5 6

26. I seldom consider why people behave in a certain way .......................... 1 2 3 4 5 6

27. I like to ensure that Ive considered most available informationbefore making a decision......................................................................... 1 2 3 4 5 6

28. I enjoy trying to determine if what I read or hear is true......................... 1 2 3 4 5 6

29. I relish learning........................................................................................ 1 2 3 4 5 6

30. The actions people take and the reasons for those actions arefascinating ... 1 2 3 4 5 6

55


13/84

56

You have now completed Part I, the first individual portion of this exercise. Please again note the current time,your completion time for this task _______.

You will turn in this portion and the contents will be copied. The original will be retained by the experimenter toensure that there are no changes made to this section of materials and a copy of your responses will be returnedto you for your use in other parts of this experiment.

Please signal to the experimenter that you have completed this section at this time.


14/84

57


PART II

Please print the practice office followed by each individual participant of this group below to aid in keeping

your responses in part one matched to your group responses in part two. Additionally, please designate the

position of each individual (i.e., staff, senior, manager) and who was randomly selected to be the group

recorder.

Practice Office: ___________________________________

Names and position (printed): ___________________________________

___________________________________

___________________________________

Group Recorder Name ___________________________________

Please introduce yourselves to each other at this time and write out a name tag to wear during this phase (a

nametag and pen have been provided to you for this purpose).


15/84

PART II

INSTRUCTIONS

Please read the following information and begin brainstorming as a group. All activities in this part of the casewill be done as a group.


Recall,that while helping to construct this case, the engagement partner on this audit expressed numeroustimes his concern about the associated costs of implementing brainstorming on this engagement. Specifically,he is concerned about the audit team members being overly sensitive to unusual account balance fluctuationsnoted in the initial analytical procedures, as this sensitivity may lead to costly increases in unjustified

investigations and efficiency losses on the audit. He would like the assessment of fraud risk and the associatedbrainstorming to be sufficient to comply with the standard, but he hopes that you will be aware of the costsand complete this phase of the audit as efficiently as possible.

Please note the current time, this time will mark the beginning of the task on the next page__________.

58


16/84

59

TASK I

How and Where the Financial Statements are Susceptible to Fraud and How Management Could Perpetrate

and Conceal It (Group Response)

Please brainstorm, listing how and where you believe the clients financial statements just reviewed might be

susceptible to material misstatement due to fraud, and how management could perpetrate and conceal fraudulentfinancial reporting. In developing this list, you may refer to the case information and any prior work, if necessary.

It may be helpful to identify events or conditions that indicate incentives/pressures to perpetrate fraud, opportunities tocarry out the fraud, or attitudes/rationalizations to justify a fraudulent action. These events are referred to in SAS No.99 as fraud risk factors. Fraud risk factors do not necessarily indicate the existence of fraud; however, they often arepresent in circumstances where fraud exists.

Feel free to refer to the case booklet at any time while completing this task.


How and where you believe the clients

financial statements might be susceptible to

material misstatement due to fraud?

How management could perpetrate and conceal

this fraudulent financial reporting?

1.

2.

3.

4.

5.

6.

7.

8.

9.

10.


17/84

60

TASK II- Group Risk Assessments

When responding to the following questions, please do not look back to the case materials. Based on your reviewof the financial statements, what is your judgment of the likelihood of the following risks relevant to this client?Circle one number on the scale below corresponding to your judgment. Because this is a group judgment, itshould reflect the consensus judgment of the group, not the individual response of the group recorder.

FRAUD RISK

LIKELIHOOD OF RISK: Financial statement fraud (an intentional act that results in a material misstatement inthe financial statements) is present.


Neutral

SIGNIFICANCE OF RISK: Financial statement fraud (an intentional act that results in a material misstatement inthe financial statements) is present.

Highly [_____|_____|_____|_____|_____|_____|_____|_____|_____|_____] HighlyInsignificant 0 1 2 3 4 5 6 7 8 9 10 Significant

Neutral

PERVASIVENESS OF RISK: Financial statement fraud (an intentional act that results in a material misstatementin the financial statements) is present.


Neutral

CLIENT BUSINESS RISK: Risk that this entitys business objectives will not be attained as a result of the

external and internal factors, pressures, and forces brought to bear on the entity and, ultimately, the risk associatedwith the entitys survival and profitability.


Neutral


Please indicate any overall trends in the financial statement information or any other information that signal a redflag to you that may heighten the risk of material misstatement due to fraud. (List all of them below).

___________________________________________________________________________________________

___________________________________________________________________________________________

What is your response to the risk of material misstatement of the financial statements due to fraud (i.e., what auditprocedures do you intend to perform if any)?

___________________________________________________________________________________________

__________________________________________________________________________________________


18/84

61

Group recorder: Please read aloud.

You have now completed Part II, the group portion of this exercise. Please again note the current time,the time that you completed this part _______.

At this time you will be given Part III of this case where you are again asked to respond individually.Please do not discuss this section with your group members and please do not simply write down yourprior individual or group responses unless these responses represent what you believe during this finalindividual phase.

Please signal to the experimenter that you have completed this section at this time.


19/84


PART III

Please print the practice office followed by your name below to aid in keeping your responses in part one

and your group responses in part two matched to your responses in this part, Part III.

Practice Office: ___________________________________

Name (printed): ___________________________________

62


20/84

PART III

INSTRUCTIONS

This is the final part of your participation. This part is to be completed individually without conferring with any

other members of your group or anyone else in the room. Please do not feel like you must denote the groupresponse from the last part or your initial individual responses from the first part unless these responses reflect yourindividual assessment at this time.

63


21/84

TASK I

When responding to the following questions, please do not refer back to the case materials. Based on your reviewof the financial statements, what is your judgment of the likelihood of the following risks relevant to this client?Circle one number on the scale below corresponding to your judgment.

FRAUD RISK

LIKELIHOOD OF RISK: Financial statement fraud (an intentional act that results in a material misstatement in thefinancial statements) is present.


Neutral

SIGNIFICANCE OF RISK: Financial statement fraud (an intentional act that results in a material misstatement inthe financial statements) is present.

Highly [_____|_____|_____|_____|_____|_____|_____|_____|_____|_____] HighlyInsignificant 0 1 2 3 4 5 6 7 8 9 10 SignificantNeutral

PERVASIVENESS OF RISK: Financial statement fraud (an intentional act that results in a material misstatementin the financial statements) is present.


Neutral

CLIENT BUSINESS RISK: Risk that this entitys business objectives will not be attained as a result of theexternal and internal factors, pressures, and forces brought to bear on the entity and, ultimately, the risk associated

with the entitys survival and profitability.


Neutral


Please indicate any overall trends in the financial statement information or any other information that signal a redflag to you that may heighten the risk of material misstatement due to fraud. (List all of them below).______________________________________________________________________________

______________________________________________________________________________

What is your response to the risk of material misstatement of the financial statements due to fraud (i.e., what auditprocedures do you intend to perform if any)?

______________________________________________________________________________

64


22/84

TASK II

Statements that people use to describe themselves are given below. Please select the response that indicateshow yougenerally feel. There are no right or wrong answers. Do not spend too much time on any one statement.

Strongly Strongly

Disagree Agree

1. I enjoy trying to determine if what I read or hear is true......................... 1 2 3 4 5 6

2. I relish learning........................................................................................ 1 2 3 4 5 6

3. The actions people take and the reasons for those actions arefascinating ....1 2 3 4 5 6

4. I am interested in what causes people to behavethe way that they do................................................................................. 1 2 3 4 5 6

5. I am confident of my abilities.................................................................. 1 2 3 4 5 6

6. I often reject statements unless I have proof that they are true ............... 1 2 3 4 5 6

7. Discovering new information is fun........................................................ 1 2 3 4 5 6

8. Other peoples behavior doesnt interest me ........................................... 1 2 3 4 5 6

9. I am self-assured...................................................................................... 1 2 3 4 5 6

10. My friends tell me that I usually question things that I see or hear......... 1 2 3 4 5 6

11. I like to understand the reason for other peoples behavior .................... 1 2 3 4 5 6

12. I think that learning is exciting................................................................ 1 2 3 4 5 6

13. I take my time when making decisions ................................................... 1 2 3 4 5 6

14. I tend to immediately accept what other people tell me .......................... 1 2 3 4 5 6

15. I usually accept things I see, read or hear at face value........................... 1 2 3 4 5 6

16. I dont feel sure of myself ....................................................................... 1 2 3 4 5 6

17. I usually notice inconsistencies in explanations...................................... 1 2 3 4 5 6

18. I dont like to decide until Ive looked at all of the readilyavailable information............................................................................... 1 2 3 4 5 6

19. I like searching for knowledge ................................................................ 1 2 3 4 5 6

20. I frequently question things that I see or hear ......................................... 1 2 3 4 5 6

Please turn over the page and continue answering questions.

65


23/84


21. I often accept other peoples explanations without further thought 1 2 3 4 5 6

22. I feel good about myself. ......................................................................... 1 2 3 4 5 6

23. I wait to decide on issues until I can get more information..................... 1 2 3 4 5 6

24. The prospect of learning excites me. ....................................................... 1 2 3 4 5 6

25. It is easy for other people to convince me............................................... 1 2 3 4 5 6

26. I seldom consider why people behave in a certain way .......................... 1 2 3 4 5 6

27. I like to ensure that Ive considered most available information

before making a decision......................................................................... 1 2 3 4 5 6

28. Most often I agree with what the others in my group think .................... 1 2 3 4 5 6

29. I dislike having to make decisions quickly.............................................. 1 2 3 4 5 6

30. I have confidence in myself..................................................................... 1 2 3 4 5 6

Please note the current time, this time will mark the end of this task __________.

66


24/84

GENERAL QUESTIONS

Please answer the following questions.

1. How long have you worked for your current employer? _______years, _______months.

2. What is your current position or rank in the firm? ______________ .

3. How long have you been at your current position or rank? _______years, _______ months.

4. How much audit experience do you have? ________ years, ________ months.

5. Approximately how many different audits (audit clients?) have you worked on? _____________.

6. In your firm, at what position or rank does an auditor typically perform preliminary analyticalprocedures?_____________.

7. Have you ever performed preliminary analytical procedures? Yes ____ No ____

If yes, on approximately how many audits? ____________.

8. Have you ever worked on an audit where management fraud was detected? Yes _____ No ____.

9. If you answered yes to the above question, was an adverse opinion actually issued on one or more of theseengagements? Yes _____ No ______.

10.What is your estimate of the percentage of all companies/entities that fail? _________%.

11.What is your estimate of the percentage of all companies/entities that have materially misstated financialstatements due to fraud? ___________%.

12.What is your estimate of the percentage of the companies/entities that fail due to fraudulent financialreporting? __________%.

13.What is your estimate of the percentage of fraud detected by the auditor prior to issuance of the financialstatements? ___________%.

14.Please indicate the extent of your education. Bachelors Degree ___ Masters Degree ___ Other ___

15.Are you a Certified Public Accountant (CPA)? Yes _____ No _____.

16.Have you been involved in a brainstorming session to discuss the likelihood of fraud on any of yourengagements thus far? Yes ______ No ______, if so how many engagements? _________.

17.Do you think that brainstorming will help auditors to better assess the risk of fraud, to create unique testsfor investigating its possibility and to lead to its ultimate detection better than previous techniquessuggested in the standards? Yes _______ No ______.

18. If you have participated in brainstorming on previous engagements, what is the average amount of timethat the engagement team usually spends on brainstorming? _________.

67


25/84

19. If you have participated in brainstorming on previous engagements, what individuals have been involved?______staff ______seniors _______ managers _____ partners.

20.Was the session conducted face to face _______, group support system ______ over email ________conference call _________, other (please describe) _______________________________________.

21.Have you worked previously with either of your group members before? Yes ______ No ______. If so,please name them _____________________________________ and describe the nature of your work,number of audit engagements ______________, relationship _____________________.

22. In Part I of todays case, and held constant throughout Part II and III, the engagement partner on this auditexpressed concern that team members implement brainstorming with which of these in mind. (Please checkONLY the one that applies).

_____ That audit team members should be aware of the costs of brainstorming and complete this phase ofthe audit as efficiently as possible.

_____ That audit team members should approach brainstorming with the appropriate level of professional

skepticism, and complete this phase of the audit as effectively as possible.

23. In completing the tasks in this case today, what was the significance of the partner preference to you inyour decisions?

Highly Highly

Insignificant Significant

[_____|_____|_____|_____|_____|_____|_____|_____|_____|_____]0 1 2 3 4 5 6 7 8 9 10

24.To what extent do you agree that the engagement partners concerns about brainstorming are realistic

across audit engagements? (circle one number)

Strongly Disagree Strongly Agree

[_____|_____|_____|_____|_____|_____|_____|_____|_____|_____]0 1 2 3 4 5 6 7 8 9 10

25.Please provide the name of the best member of your group (i.e., the individual in your group who youbelieve was the most knowledgeable, provided the most useful responses and was most accurate in his orher assessments), even if this person is you.

Name of best member: _____________________________.

26.Were you able to determine the actual company that the case materials were based on? Yes ____ No____.If you think so, please identify the company __________________________________.

27.Please list any comments that you may have on this study.____________________________________________________________________________________________________________________________________________________________

Thank you again for participating in this study. Your time and effort are greatly appreciated.

68


26/84

APPENDIX B

FINANCIAL STATEMENT CASE MATERIALS

CASE BOOKLET

FINANCIAL STATEMENT INFORMATION

Please print your name and address of the practice office below.

Name (printed): ___________________________________

Practice Office Address: _________________________________________________________________________________________________________

69


27/84

70

Narrative Description of the Company

Calico Corporation (Calico or Company) is engaged primarily in developing, manufacturing, andmarketing traditional and digital imaging. Calico is a leader in selling equipment and providing solutionsincluding hardware, services and software that enhance productivity and knowledge sharing. Referencesherein to us or our refer to Calico and consolidated subsidiaries unless the context specifically

requires otherwise. We distribute our products in the Western Hemisphere through divisions and wholly-owned subsidiaries. In Europe, Africa, the Middle East, India and parts of Asia, we distribute CalicoLimited and related companies (collectively Calico Limited). Calico had 92,500 employees at year-end2000.

Dao Calico Co., Limited, an unconsolidated entity jointly owned by Calico Limited and Dao Photo FilmCompany Limited, develops, manufactures and distributes film processing products in Japan and otherareas of the Pacific Rim, Australia and New Zealand. Japan represents approximately 80 percent of DaoCalico revenues, and Australia, New Zealand, and Singapore, Malaysia, Korea, Thailand and thePhilippines represent 10 percent. The remaining 10 percent of Dao Calico revenues are sales to Calico.Dao Calico conducts business in other Asian Pacific Rim countries through joint ventures anddistributors. In December 2000, as part of the asset disposition element of our turnaround plan, we

completed the sale of our China operations to Dao Calico for $550 million cash and their assumption of$118 million of debt. The sale included all of our manufacturing, sales and services functions in Chinaand Hong Kong, including ownership of Calico (China) Limited and Calico (Hong Kong) Limited. Thesale strengthened our liquidity and produced a $119 million after tax gain. In March 2001, we sold halfour ownership interest in Dao Calico to Dao Photo Film for $1,283 million in cash. The company retainssignificant rights as a minority shareholder. All product and technology agreements between Calico andDao Calico will continue, ensuring that the two companies retain uninterrupted access to each othersportfolio of patents, technology and products.

Nature of the Business

Our activities encompass developing, manufacturing, marketing, servicing and financing a completerange of film processing products, solutions and services designed to make organizations around theworld more productive. Calico is a major participant in infoimaging, composed of devices (digitalcameras and personal data assistants), infrastructure (online networks and delivery systems for images)and services and media (software, film and paper), enabling people to access, analyze and print images.Calico harnesses its technology, market reach and a host of industry partnerships to provide innovativeproducts and services for customers who need the information-rich context that images contain.


28/84

71

Calico CorporationConsolidated Balance Sheets (dollars in millions)

December 31,

2000 1999

(Unaudited)

AssetsCash and cash equivalents 1,741 126

Accounts receivable, net 2,281 2,633

Finance receivable, net 5,097 4,961

Inventories, net 1,932 2,290

Equipment on operating leases, net 724 695

Deferred taxes and other current assets 1,247 1,230

Total Current Assets 13,022 11,935

Finance receivables due after one year, net 7,957 8,058

Land, buildings and equipment, net 2,495 2,456

Investments in affiliates, at equity 1,362 1,615

Intangible and other assets, net 3,061 2,810

Goodwill, net 1,578 1,657

Total Assets 29,475 28,531

Liabilities and Equity

Short term debt and current portion of long term debt 2,693 3,957

Accounts Payable 1,033 1,016

Accrued compensation and benefits cost 662 715

Unearned income 250 186

Other current liabilities 1,630 2,176

Total Current Liabilities 6,268 8,050

Long Term Debt 15,404 11,044

Postretirement medical benefits 1,197 1,133

Deferred taxes and other liabilities 1,876 2,521

Deferred ESOP benefits (221) (299)Minorities interests in equity of subsidiaries 141 127

Obligation for equity put options 32 0

Company obligated, mandatorily redeemable preferredsecurities of subsidiary trust holding solelysubordinated debentures of the Company 638 638

Preferred Stock 647 669

Common shareholders equity 3,493 4,648

Total Liabilities and Equity 29,475 28,531


29/84

72

Calico CorporationConsolidated Income Statements (dollars in millions)

December 31,

2000(unaudited)

1999 1998

Revenues

Sales 10,059 10,441 10,668

Service, outsourcing and rentals 7,718 8,045 7,783

Finance income 924 1,081 1,142

Total Revenues 18,701 19,567 19,593

Costs and Expenses

Cost of Sales 6,197 5,944 5,880

Inventory charges 90 0 113

Cost of service, outsourcing andRentals 4,813 4,599 4,323

Equipment Financing Interest 605 547 570

Research and Development

Expenses 1,044 992 1,035Selling, administrative and general

Expenses 5,649 5,292 5,343

Restructuring charge and assetImpairment 540 0 1,531

Gain on affiliates sale of stock (21) 0 0

Purchased in-process research andDevelopment 27 0 0

Gain on sale of China operations (200) 0 0

Other, net 341 285 219

Total Costs and Expenses 19,085 17,659 19,014

Income (Loss) from ContinuingOperations before Income Taxes

(Benefits) Equity Income andMinorities Interest (384) 1,908 579

Income taxes (Benefits) (109) 588 145

Income (Loss) from ContinuingOperations after Income Taxes(Benefits) before Equity Income andMinorities Interests (275) 1,320 434

Equity in net income of unconsolidatedaffiliates 61 68 74

Minorities interests in earnings andsubsidiaries 43 49 45

Income (loss) from continuingOperations (257) 1,339 463

Discontinued Operations 0 0 (190)Net Income (Loss) (257) 1,339 273

Basic Earnings (Loss) per share (0.44) 1.96 0.34

Diluted Earnings (Loss) per share (0.44) 1.85 0.34


30/84

73

Calico CorporationCommon-sized Balance Sheets (dollars in millions)

December 31,

2000 1999

(Unaudited)

AssetsCash and cash equivalents 5.91% 0.44%

Accounts receivable, net 7.74% 9.23%

Finance receivable, net 17.29% 17.39%

Inventories, net 6.55% 8.03%

Equipment on operating leases, net 2.46% 2.44%

Deferred taxes and other current assets 4.23% 4.31%

Total Current Assets 44.18% 41.83%

Finance receivables due after one year, net 27.00% 28.24%

Land, buildings and equipment, net 8.46% 8.61%

Investments in affiliates, at equity 4.62% 5.66%

Intangible and other assets, net 10.39% 9.85%

Goodwill, net 5.35% 5.81%

Total Assets 100.00% 100.00%

Liabilities and Equity

Short term debt and current portion of long term debt 9.14% 13.87%

Accounts Payable 3.50% 3.56%

Accrued compensation and benefits cost 2.25% 2.51%

Unearned income 0.85% 0.65%

Other current liabilities 5.53% 7.63%

Total Current Liabilities 21.27% 28.21%

Long Term Debt 52.26% 38.71%

Postretirement medical benefits 4.06% 3.97%

Deferred taxes and other liabilities 6.36% 8.84%

Deferred ESOP benefits (0.75)% (1.05)%Minorities interests in equity of subsidiaries 0.48% 0.45%

Obligation for equity put options 0.11% 0.00%

Company obligated, mandatorily redeemable preferredsecurities of subsidiary trust holding solelysubordinated debentures of the Company 2.16% 2.24%

Preferred Stock 2.20% 2.34%

Common shareholders equity 11.85% 16.29%

Total Liabilities and Equity 100.00% 100.00%


31/84

74

Calico CorporationCommon-sized Income Statements (dollars in millions)

December 31,

2000(unaudited)

1999 1998

Revenues

Sales 53.79% 53.36% 54.45%

Service, outsourcing and rentals 41.27% 41.12% 39.72%

Finance income 4.94% 5.52% 5.83%

Total Revenues 100.00% 100.00% 100.00%

Costs and Expenses

Cost of Sales 33.14% 30.63% 30.01%

Inventory charges 0.48% 0.00% 0.58%

Cost of service, outsourcing andRentals 25.74%

23.50%

22.06%

Equipment Financing Interest 3.24% 2.80% 2.91%

Research and Development

Expenses 5.58%

5.07%

5.28%Selling, administrative and generalExpenses 30.21%

27.05%

27.27%

Restructuring charge and assetImpairment 2.89%

0.00%

7.81%

Gain on affiliates sale of stock (0.11)% 0.00% 0.00%

Purchased in-process research andDevelopment 0.14%

0.00%

0.00%

Gain on sale of China operations (1.07)% 0.00% 0.00%

Other, net 1.82% 1.46% 1.12%

Total Costs and Expenses 102.05% 90.25% 97.04%

Income (Loss) from Continuing

Operations before Income Taxes(Benefits) Equity Income andMinorities Interest (2.05)%

9.75%

2.96%

Income taxes (Benefits) (0.58)% 3.01% 0.74%

Income (Loss) from ContinuingOperations after Income Taxes(Benefits) before Equity Income andMinorities Interests (1.47)%

6.75%

2.22%

Equity in net income of unconsolidatedaffiliates 0.33%

0.35%

0.38%

Minorities interests in earnings andsubsidiaries 0.23%

0.25%

0.23%

Income (loss) from continuing

Operations (1.37)%

6.84%

2.36%Discontinued Operations 0.00% 0.00% (0.97)%

Net Income (Loss) (1.37)% 6.84% 1.39%


32/84

75

Calico CorporationFinancial Ratios

2000 1999

Liquidity:Current 2.08 1.48

Quick 1.77 1.20

Solvency:

Debt to Assets 0.83 0.79

Times Interest Earned 0.37 4.49

Long-Term Debt to Equity 3.11 1.82

Activity:

Inventory Turnover 3.21 2.62

Age of Inventory 112.15 days 137.41 days

Accounts Receivable Turnover 4.41 3.97

Age of Accounts Receivable 81.63 days 90.68 days

Total Asset Turnover 0.63 0.69

Profitability:Gross Margin 38.39% 42.59%

Profit Margin on Sales (1.37)% 6.84%

Return on Total Assets 1.18% 6.61%

Return on Equity (5.19)% 22.02%

Equations:

Current ratio: current assets / current liabilitiesQuick ratio: (current assets-inventory) / current liabilities

Debt to assets: total debt / total assets

Times interest earned: earnings before interest and taxes / interest chargesLong term Debt to Equity: long term debt / stockholders equityInventory turnover: cost of sales / inventoryAge of inventory: 360 days / inventory turnoverA/R turnover: sales / accounts receivableAge of A/R: 360 days / accounts receivable turnoverTotal asset turnover: total revenues / total assetsGross Margin: total gross margin (sales cost of sales) / salesProfit Margin on Sales: net income/ total revenuesReturn on Total Assets: (net income + interest expense) / total assetsReturn on Equity: net income / stockholders equity


33/84

76

Notes to Consolidated Financial Statements

(Dollars in millions, except per-share data and unless otherwise indicated)

1. Summary of Significant Accounting Policies

Description of Business. Calico Corporation is the leader in helping people take, share, enhance, preserve,print and enjoy images- for memories and for entertainment. Our activities encompass developing,manufacturing, marketing, servicing, and financing a complete range of film processing products andsolutions.

Basis of Consolidation. The Consolidated Financial Statements include the accounts of CalicoCorporation and all majority owned subsidiaries (the Company). All significant intercompany accountsand transactions have been eliminated. References herein to "we" or "our" refer to Calico andconsolidated subsidiaries unless the context specifically requires otherwise.

Calico Limited, Calico Holding (Nederland) BV, Calico Investments (Bermuda) Limited, CalicoHoldings (Bermuda) Limited and their respective subsidiaries are referred to as Calico Limited.

Investments in which we have a 20 to 50 percent ownership interest are generally accounted for on theequity method.

Upon the sale of stock by a subsidiary, we recognize a gain or loss in our consolidated statement ofoperations equal to our proportionate share of the increase or decrease in the subsidiary's equity.

For acquisitions accounted for by the purchase method, operating results are included in the consolidatedstatements of operations from the date of acquisition.

Earnings per Share. Basic earnings per share are based on net income less preferred stock dividendrequirements divided by the average common shares outstanding during the period. Diluted earnings per

share assume exercise of in-the-money stock options outstanding and full conversion of convertible debtand convertible preferred stock into common stock at the later of the beginning of the year or date ofissuance, unless they are antidilutive.

Income (loss) from Continuing Operations before Income Taxes (Benefits), Equity

Income and Minorities' Interests. Throughout these notes to Consolidated Financial Statements, we referto the effects of certain changes in estimates and other adjustments on Income (loss) from ContinuingOperations before Income Taxes (Benefits), Equity Income and Minorities' Interests. For convenience andease of reference, that financial statement caption is hereafter referred to as "pre-tax income (loss)."

Use of Estimates. The preparation of financial statements in accordance with generally acceptedaccounting principles requires management to make estimates and assumptions that affect the reported

amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of thefinancial statements, and the reported amounts of revenues and expenses duringthe reporting period. Estimates are used for, but not limited to: accounting for residual values; allocationof revenues and fair values in multiple element arrangements; allowance for doubtful accounts; inventoryvaluation; merger, restructuring and other related charges; asset impairments; depreciable lives of assets;


34/84

77

useful lives of intangible assets and goodwill; pension assumptions; and tax valuation allowances. Futureevents and their effects can not be perceived with certainty. Accordingly our accounting estimates requirethe exercise of judgment. The accounting estimates used in the preparation of our Consolidated FinancialStatements will change as new events occur, as more experience is acquired, as additional information isobtained and as the Company's operating environment changes. Actual results could differ from thoseestimates.

Changes in Estimates. In the ordinary course of accounting for items such as revenue allocations andrelated estimated fair values in multiple element arrangements, allowances for doubtful accounts,inventory valuation, and residual values, among others, we make changes in estimates as appropriate inthe circumstances. Such changes and refinements in estimation methodologies are reflected in reportedresults of operations and, if material, the approximate effects of changes in estimates are disclosed in theNotes to our Consolidated Financial Statements.

Accounting Changes-Accounting for Derivative Instruments. In 1998, the Financial Accounting StandardsBoard (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 133, "Accounting forDerivative Instruments and Hedging Activities." SFAS No. 133 requires companies to recognize allderivatives as assets or liabilities measured at their fair value. Gains or losses resulting from changes in

the fair value of derivatives would be recorded each period in current earnings or other comprehensiveincome, depending on whether a derivative is designated as part of a hedge transaction and, if it is,depending on the type of hedge transaction. SFAS No. 133, as amended, is effective for the Company asof January 1, 2001.

With the adoption of SFAS No. 133, we will record a net cumulative after-tax charge of $2 in ourstatements of operations and a net cumulative after-tax loss of $19 in Accumulated Other ComprehensiveIncome. Further, as a result of recognizing all derivatives at fair value, including the differences betweenthe carrying values and fair values of related hedged assets, liabilities and firm commitments, we willrecognize a $403 increase in Total Assets and a $424 increase in Total Liabilities.

We expect that the adoption of SFAS 133 will increase the future volatility of reported earnings and other

comprehensive income. In general, the amount of volatility will vary with the level of derivative andhedging activities and the market volatility during any period.

Reclassifications. The FASB Emerging Issues Task Force (EITF) issued a pronouncement that requires achange in the way we classify shipping and handling costs billed to customers. Commencing in the fourthquarter of 2000, the EITF required that all amounts billed to a third party customer related to productshipping and handling must be classified as revenue, and costs incurred must be classified as an expense.Shipping and handling amounts billed to customers have historically been recorded as a reduction of costof goods sold.

Prior period financial statements have been reclassified to conform with the 2000 presentation.

Revenue Recognition. In the normal course of business the Company generates revenue through the saleof equipment, services, and supplies and income associated with the financing of its equipment sales.Revenue is recognized when earned. More specifically revenue related to the Company's sales of itsproducts and services are as follows:


35/84

78

Equipment: Revenues from the sale of equipment under installment arrangements, from sales-type leasesor on credit are recognized at the time of sale or at the inception of the lease, respectively. For equipmentsales which require the Company to install the product at the customer location, revenue is recognizedwhen the equipment has been delivered to and installed at the customer location. Sales of customerinstallable and retail channels type products are recognized upon shipment. Revenues from equipmentunder other leases and similar arrangements are accounted for by the operating lease method and are

recognized over the lease term.Sales of equipment subject to the Company's operating leases to third party finance companies (thecounter-party) or through structured financings with third parties are recorded as sales at the time theequipment is accepted by the counter-party. The counter-party accepts the risks of ownership of theequipment. Remanufacturing and remarketing of off-lease equipment belonging to the counter-party isperformed by the Company for a fee on a non-discriminatory basis. In North America these transactionsare structured to provide cash proceeds up front from the counter-party versus collection over time. InLatin America the counter-party pays the Company a fixed amount each month, mitigating risk andvariability from the cash flow stream.

Services: Service revenues are derived primarily from maintenance contracts on our equipment sold tocustomers and are recognized over the term of the contracts.

Supplies: Supplies revenue generally is recognized upon shipment.

Financing: Finance income is earned on an accrual basis under an effective annual yield method.

The Company sells its equipment and services on a stand-alone basis and also enters into bundledarrangements which contain multiple deliverable elements. These multiple element arrangementstypically include equipment, services, supplies and financing components for which the customer pays asingle defined price for all elements. When separate prices are listed in these multiple elementarrangements with our customers they may not be representative of the fair values of those elementsbecause the prices of the different components of the arrangement may be altered in customernegotiations, although the aggregate consideration may remain the same. Therefore, revenues under these

arrangements are allocated based upon estimated fair values of each element, in accordance withGenerally Accepted Accounting Principles (GAAP). The fair value of each element is estimated based ona review of a number of factors including average selling prices for the elements when they are sold on astand-alone basis. The average selling prices are based on management's best estimates of marketconditions and competitive pricing considerations.

The principal change in estimate relating to such revenue allocations among multiple elements is madewith respect to the estimated fair value of those elements and their related margins. This is a significantfactor considered in our revenue allocation process along with other factors, such as pricing changes andcustomer discounts, which also affect the overall allocation process. The effect of such changes inestimates of fair values and related margins in the years 2000, 1999 and 1998 was $193, $202, and $141,respectively, which generally resulted in increases of sales revenues and decreases to deferred elements of

those arrangements. The net effects of such allocations when offset by corresponding decreases in theamortization of deferred revenues was to increase pre-tax income in 2000, 1999 and 1998 by $44, $102,and $101, respectively.


36/84

79

In December 1999, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 101"Revenue Recognition in Financial Statements" (SAB 101). SAB 101 summarizes certain of the staff'sviews in applying generally accepted accounting principles to revenue recognition in financial statements.We conducted a review of our revenue recognition policies during the fourth quarter of our fiscal yearended December 31, 2000. We have determined that our policies are in conformance with SAB 101 in allmaterial respects.

Cash and Cash Equivalents. Cash and cash equivalents consist of cash on hand and investments withoriginal maturities of three months or less.

Provisions for Losses on Uncollectible Receivables. The provisions for losses on uncollectible trade andfinance receivables are determined principally on the basis of past collection experience.

Inventories. Inventories are carried at the lower of average cost or realizable values.

Buildings and Equipment and Equipment on Operating Leases. Our fixed assets are depreciated over theirestimated useful lives. Equipment on operating leases is depreciated to its estimated residual value.Depreciation is computed using principally the straight-line method. Significant improvements are

capitalized; maintenance and repairs are expensed.

Goodwill. Goodwill represents the cost of acquired businesses in excess of the fair value of identifiablenet assets purchased, and is amortized on a straight-line basis over periods ranging from 15 to 40 years.Goodwill is reported net of accumulated amortization, and the recoverability of the carrying value isevaluated on a periodic basis by assessing current and future levels of income and cash flows as well asother factors. Accumulated amortization at December 31, 2000 and 1999 was $220 and $176,respectively.

Classification of Commercial Paper and Bank Notes Payable. As of December 31, 2000, all indebtednessis classified as a short-term or long-term liability based upon its contractual maturity date. In prior years,it was our policy to classify as long-term debt that portion of commercial paper and notes payable that

was intended to match fund finance receivables due after one year to the extent that we had the abilityunder our revolving credit agreement to refinance such commercial paper and notes payable on a long-term basis.

Foreign Currency Translation. The functional currency for most foreign operations is the local currency.Net assets are translated at current rates of exchange, and income and expense items are translated at theaverage exchange rate for the year. The resulting translation adjustments are recorded in AccumulatedOther Comprehensive Income. The U.S. dollar is used as the functional currency for certain subsidiariesthat conduct their business in U.S. dollars or operate in hyperinflationary economies. A combination ofcurrent and historical exchange rates is used in remeasuring the local currency transactions of thesesubsidiaries, and the resulting exchange adjustments are included in income. Aggregate foreign currencygains/(losses) were $99, $(1) and $(29) in 2000, 1999 and 1998, respectively, and are included in Other,

net in the consolidated statements of operations.

Stock-Based Compensation. The Company follows the intrinsic value-based method of accounting for itsstock-based compensation.


37/84

80

2.Restructuring

March 2000 Restructuring. In March 2000, we announced details of a worldwide restructuring program.In connection with this program, we initially recorded a pre-tax provision of $596 ($423 after taxes,including our $18 share of a restructuring provision recorded by Dao Calico, an unconsolidated affiliate).

The $596 pre-tax charge included severance costs related to the elimination of 5,200 positions worldwide.Approximately 65 percent of the positions to be eliminated are in the U.S., 20 percent are in Europe, andthe remainder is predominantly in Latin America. The employment reductions primarily affectedemployees in manufacturing, logistics, customer service and back office support functions. For facilityfixed assets to be disposed of, the impairment loss recognized is based on the fair value less cost to sell,with fair value based on estimates of existing market prices for similar assets. The inventory chargesrelate primarily to the consolidation of distribution centers and warehouses and the exit from certainproduct lines.Included in the original provision were reserves related to the incurrence of liabilities due to various thirdparties and several asset impairment charges. Liabilities recorded for lease cancellation and other costsoriginally aggregated $51 and included $32 for various contractual commitments, other than facilityoccupancy leases, that will be terminated early as a result of the restructuring. The commitments include

cancellation of supply contracts and outsourced vendor contracts. Included in the asset impairment chargeof $71 was: $44 for machinery and tooling for products that were discontinued or will be alternativelysourced; $7 for leasehold improvements at facilities that will be closed; and $20 of sundry surplus assets,individually insignificant, from various parts of our business. These impaired assets were primarilylocated in the U.S. and the related product lines generated an immaterial amount of revenue.Approximately $71 of the $90 of inventory charges related to excess inventory in many product linescreated by the consolidation of distribution centers and warehouses. The remainder was primarily relatedto the transition to inkjet technology in our wide format printing business.

Weakening business conditions and operating results during 2000 required a re-evaluation of theinitiatives announced in March 2000. As a result, we were unable to, and do not expect to, completecertain actions originally contemplated at the time that the March 2000 restructuring provision was

recorded. Accordingly, during the fourth quarter of 2000, and in connection with the turnaround programdiscussed below, $71 ($47 after taxes), $59 related to severance costs for 1,000 positions and $12 relatedto lease cancellation and other costs, of the original $596 provision, was reversed. The reversals primarilyrelate to delays in the consolidation and outsourcing of certain of our warehousing and logisticsoperations and the cancellation of certain European initiatives no longer necessary as a result of higherthan expected attrition.

As of December 31, 2000, approximately 2,400 employees have left the Company under the March 2000restructuring program.

Turnaround Program. During 2000, the significant business challenges that we began to experience in thesecond half of 1999 continued to adversely affect our financial performance. These challenges include:

the ineffective execution of a major sales force realignment, the ineffective consolidation of our U.S.customer administrative centers, increased competition and adverse economic conditions.

These operational challenges, exacerbated by significant technology and acquisition investments, have ledto a net loss in 2000, credit rating agency downgrades, limited access to capital markets and market-place


38/84

81

concerns regarding our liquidity. In response to these challenges, in October 2000, we announced aturnaround program which includes a wide-ranging plan to sell assets, cut costs and strengthen coreoperations. Additionally, we are exploring alternatives to provide financing for customers in a mannerthat does not involve the Calico balance sheet, and over time will provide financing for customers usingthird parties. In December 2000, we sold our operations in China to Dao Calico for $550. We are engagedin other activities which will enhance our liquidity. These activities include asset sales, strategic alliances,

and the sale or outsourcing of certain manufacturing operations. It is expected that in most cases assetsales will result in a gain.

Regarding the cost reductions, we are in the process of finalizing plans designed to reduce costs by atleast $1.0 billion annually. In connection therewith, during the fourth quarter of 2000, we recorded anadditional pre-tax restructuring provision totaling $105 ($87 after taxes, including our $19 share of anadditional provision recorded by Dao Calico) in connection with finalized initiatives under the turnaroundprogram. This charge included estimated costs of $71 for severance costs associated with work forcereductions related to the elimination of 2,300 positions worldwide and $34 of asset impairmentsassociated with the disposition of a non-core business. The severance costs relate to further streamliningof existing work processes, elimination of redundant resources and the consolidation of existing activitiesinto other existing operations.

The following table summarizes the status of the March 2000 restructuring reserve and the turnaroundprogram:

OriginalReserve

Reversals Charges AgainstReserve

12/31/00Balance

March 2000Restructuring:

Cash charges

Severance andrelated costs 384 (59) (130) 195

Lease Cancellationand other costs 51 (12) (19) 20

Subtotal 435 (71) (149) 215

Non-cash Charges

AssetImpairment 71 0 (71) 0

InventoryCharges 90 0 (90) 0

Subtotal 161 0 (161) 0

Currency changes0 0 (6) (6)

Subtotal 596 (71) (316) 209

TurnaroundProgram:

Severance andrelated costs 71 0 0 71

AssetImpairment 34 0 (34) 0

Subtotal 105 0 (350) 71

Total $701 $ (71) $ (34) $280


39/84

82

With respect to the March 2000 restructuring program as of March 31, 2001, the remaining liability is$131. All remaining liabilities represent committed obligations of the Company to be paid primarilyduring 2001 and are included in the caption Other current liabilities in the consolidated balance sheet.

1998 Restructuring. In 1998, we announced a worldwide restructuring program. In connection with thisprogram, we recorded a pre-tax provision of $1,644. As of December 31, 2000, this program has beensubstantially completed and the remaining liability balance is $107 after fourth quarter reversals of $11.The remaining liability is for salary continuance payments and the runoff of lease cancellation payments.There were no material changes to the program since its announcement in April 1998. The remainingliability is fully committed and the majority will be utilized throughout 2001.

3. Acquisitions

In January 2000, we and Dao Calico completed the acquisition of the Color Printing and ImagingDivision of Tektronix, Inc. (CPID). The aggregate consideration paid of $925 in cash, which includes $73paid directly by Dao Calico, is subject to certain post-closing adjustments. CPID manufactures and sells

color printers, ink and related products, and supplies. The acquisition was accounted for in accordancewith the purchase method of accounting.

The excess of cash paid over the fair value of net assets acquired has been allocated to identifiableintangible assets and goodwill using a discounted cash flow approach by an independent appraiser. Thevalue of the identifiable intangible assets includes $27 for purchased in-process research and developmentwhich was written off in 2000. This charge represents the fair value of certain acquired research anddevelopment projects that were determined not to have reached technological feasibility as of the date ofthe acquisition and was determined based on a methodology that focused on the after-tax cash flows ofthe in-process products and the stage of completion of the individual research and development projects.Other identifiable intangible assets are exclusive of intangible assets acquired by Dao Calico, and includethe installed customer base ($209), the distribution network ($123), the existing technology ($103), the

workforce ($71), and trademarks ($23). These identifiable assets are included in Intangibles and otherassets in the Consolidated Balance Sheets. The remaining excess has been assigned to Goodwill, howeversuch amount may be affected by any post-closing adjustments which could potentially reduce thepurchase price.

Other identifiable intangible assets and Goodwill are being amortized on a straight-line basis over theirestimated useful lives which range from 7 to 25 years. In connection with the CPID acquisition werecorded approximately $45 for anticipated costs associated with exiting certain activities of the acquiredoperations. These activities include: the consolidation of duplicate distribution facilities; therationalization of the service organization; and the exiting of certain lines of the CPID business. The costsassociated with these activities include inventory write-offs, severance charges, contract cancellationcosts and fixed asset impairment charges. We expect these actions to be completed in 2001.

In August 1999, we purchased the OmniFax division from Kilkenny Business Systems for $45 in cash.OmniFax is a supplier of business laser multifunction fax systems. The acquisition resulted in goodwill ofapproximately $22 (including transaction costs), which is being amortized over 15 years.


40/84

83

Also during 1999, we paid $62 to increase our ownership in our India operations from approximately 40percent to 68 percent. This transaction resulted in additional goodwill of $48, which is being amortizedover 40 years.

In May 1998, we acquired Systems Solutions, Inc., an information technology services company, and itsparent company, Intelligent Electronics, Inc., for $413 in cash. The transaction resulted in goodwill of

$395, which is being amortized over 25 years. The Company is continuing to integrate Systems SolutionsInc. with its Industry Solutions business segment. This integration is designed to increase the revenue ofour industry solutions operations, and to achieve cost savings and synergies. While this integration istaking longer than originally anticipated, the Company believes that events and changes in circumstancessince the acquisition do not presently indicate an impairment of goodwill. However, the Company intendsto continue the integration efforts and will perform an assessment of the recoverability of goodwill shouldcircumstances change.

4. Divestitures

In December 2000 we sold our China operations to Dao Calico for $550. In connection with the sale, DaoCalico assumed $118 of indebtedness. The pre-tax gain recorded in the fourth quarter of 2000, was $200.

In June 2000, we sold the U.S. and Canadian commodity paper business, including an exclusive licensefor the Calico brand, to Papel Inc. and recorded a pre-tax gain of approximately $40 which is included inOther, net. In addition to the proceeds from the sale of the business, the Company will receive royaltypayments on future sales of Calico branded commodity paper by Papel Inc. and will earn commissions onCalico originated sales of commodity paper as an agent for Papel Inc.

In April 2000, we sold a 25 percent ownership interest in our wholly owned subsidiary, Security Inc., toSoftware Unlimited, Inc. for $50 and recognized a pre-tax gain of $23, which is included in Other, net.An additional pre-tax gain of $27 was deferred, pending the resolution of certain performance criteria,and is included in Unearned income in the Consolidated Balance Sheets. In connection with the sale,Security Inc. also received $40 from Software Unlimited for a non-exclusive license of its patents and

other intellectual property and a $25 advance against future royalty income from Software Unlimited onsales of products incorporating Security Inc.'s technology. The license payment is being amortized overthe life of the license agreement of 10 years and the royalty advance will be recognized in income asearned.


41/84

84

5. Receivables, Net

Finance Receivables. Finance receivables result from installment arrangements and sales-type leasesarising from the marketing of our business equipment products. These receivables generally mature overtwo to five years and are typically collateralized by a security interest in the underlying assets. Thecomponents of Finance receivables, net at December 31, 2000, 1999 and 1998 follow:

2000 1999 1998

Gross receivables $14,556 $14,478 $15,957

Unearned income (1,733) (1,733) (2,185)

Unguaranteed residual values 681 697 617

Allowance for doubtful accounts (450) (423) (441)

Finance receivables, net 13,054 13,019 13,948

Less current portion 5,097 4,961 5,055

Amounts due after one year, net $7,957 $ 8,058 $ 8,893

Contractual maturities of our gross finance receivables subsequent to December 31, 2000 follow:

2001 2002 2003 2004 2005 Thereafter

$5,654 $3,980 $2,706 $1,580 $540 $96

Experience has shown that a portion of these finance receivables will be prepaid prior to maturity.Accordingly, the preceding schedule of contractual maturities should not be considered a forecast offuture cash collections.

Unguaranteed residual values are assigned primarily to our high volume copying, printing and productionpublishing products. The assigned values are generally established in order to result in a normal profitmargin in the subsequent transaction.

In September 2000, we transferred $457 of finance receivables to a special purpose entity for cashproceeds of $411 and a retained interest of $46. The transfer agreement includes a repurchase option;accordingly the proceeds were accounted for as a secured borrowing. At December 31, 2000 the balanceof receivables transferred was $411 and is included in Finance receivables, net in the ConsolidatedBalance Sheets. The remaining secured borrowing balance of $325 is included in Debt.In 1999, we sold $1,495 of finance receivables and recorded a net increase in finance income ofapproximately $17 which includes the unfavorable flow-through impacts. The retained interestsremaining from these sales were not material at December 31, 2000.

Beginning in 1999 several Latin American affiliates entered into certain structured transactions involvingcontractual arrangements which transferred the risks of ownership of equipment subject to operatingleases to third party finance companies, who are obligated to pay the Company a fixed amount each

month. The Company accounts for these transactions similar to its sales-type leases. These transactionsresulted in sales of $126 and $280 in 2000 and 1999, respectively. The contribution to Pre-tax incomeresulting from these transactions was $92 and $155 in 2000 and 1999, respectively.


42/84

85

Finance Interest Rates. Financing income is determined by the discount rate applied to minimumcontractpayments, excluding service and supplies, used in the estimation ofthe fair value of the equipment.Finance interest rates include theaforementioned discount rates in customer arrangements, as well asrelatedsources of income. Over the years, the Company's finance interest rates havechanged as a resultof a number of factors including money market conditions;the economic environment; debt coverage;return on equity; debt to equityratios and other external factors which are particularly relevant to our

financing business. During the period of 1998 to 2000 such finance interestrates as a percentage of theaverage finance receivables portfolio and theCompany's average cost of funds used in our customerfinancing activities were:

2000 1999 1998

Average finance interest rates 8.3% 9.2% 9.3%

Average cost of funds 5.4% 4.7% 5.1%

In line with market comparables, the Company's financing operations are targeted to achieve a 15 percentreturn on equity. The Company periodically reviews, and may change, the discount rates in order to beconsistent with this objective and to reflect the estimated fair value of the financing component in its leasearrangements. Changes in the rate applied to a bundled arrangement may affect one or more elements of

the arrangement. In general, the following changes in discount rates are reflected as reciprocal changes inequipment revenues, partially offset by the resulting change in customer finance income.

Such changes in accounting estimate had the following approximate effects on pre-tax income (loss):

Increase/decrease 2000 1999 1998

Effect of changes in discount rates /1/ $24 $101 $128

/1/ Represents the impact of changes in customer finance rate estimates net of amortization of the relatedcumulative unearned income effects.

Accounts Receivable. In 2000, we entered into agreements to sell, on an ongoing basis, a defined pool of

accounts receivable to special purpose entities. At December 31, 2000, the total pool of accountsreceivable transferred was approximately $900. The special purpose entities, in turn, sell participatinginterests in such accounts receivable to investors up to a maximum amount of $330. Under the terms ofthe agreement, new receivables are added to the pool as collections reduce previously sold accountsreceivable. Investors have a priority collection interest in the entire pool of receivables, and as a result, wehave retained credit risk to the extent the pool exceeds the amount sold to investors. We continue toservice the receivables on behalf of the special purpose entities and receive a servicing fee adequate tocompensate for our responsibilities.At December 31, 2000, $328 in net proceeds were received from sales of participating interests toinvestors and were recorded as a reduction in Accounts receivable, net in the Consolidated BalanceSheets. The earnings impact related to the receivables sold under these agreements was not material.

Our retained interests, which are included in Accounts r

Documents

02 Carpenter Dissertation