Powder Company Case Summary

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1. The most noticeable audit risk factor in this case is that less than five percent of Powders revenue came from gas and oil sales. Almost all of their sales came from “property and working interests sales”, which adds risk because these accounts require judgement and estimation. The transactions themselves were very unusual, and should have been examined critically. In addition, on these working interest accounts, they promised to pay back the investors 9 percent no matter how the working interests performed. This could indicate a going concern issue because the payments would “almost certainly exceed the company’s oil and gas revenues by a wide margin”.
Another factor is the nature of the oil and petroleum industry. This industry is highly competitive and not very friendly to the smaller companies …show more content…
The working interests and guaranteed payments should have resembled a loan payable. Powder was recognizing them as a sale, which is completely inappropriate. This misconduct effectively overstated sales and understated liabilities in one single transaction. Accounting for this like a loan at purchase, and at payment dates, would be most appropriate. Revenue should still be recorded at the time of record, just not as high as they were recording. It seems as though they concealed this by not recording the appropriate loan principle, and including it in revenue. Instead of expensing the repayments, Powder was putting them into a prepaid asset account, or a contra revenue account. This overstated sales and assets, while understating expenses. The payments of the loan would include an interest expense and the loan debited, while cash should be credited. This would accurately represent the guaranteed 9 percent repayments accurately representing the transactions. In order for this to happen, the “revenue” must be recorded in the correct account. The financial statements of Powder were materially misstated in favor of themselves because of this inaccurate
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