Accounting for Managers

To : Cheryl Thompson

From : Independent Auditor

October 2005

Red Desert 's Financial Statements

I have come across the following unusual matters after studying the company 's financial statements from 1998 to 2000 , the official figures for 2001 , the company background statement and the financial statements of Xelicon , Formiga and Qdrive

The booking , component ing and revenue recognition processes

Sales grew by about 66 in 2000 over 1999 , but inventories grew by 176 and accounts receivable by 155 in the same period . The days inventory held has gone up even

further for official 2001 : the days accounts receivable in 2001 is only marginally over 2000 . The Management allows client representatives to interact directly and closely with the product design process , admits to sales being affected by component shortages and does not invest in patents and trademarks . There is a mention of cancellations and the T Accounts for 2001 include sales on account equivalent to almost the entire amount of official 2001 sales ! I recommend that key design processes should be kept confidential , clients should be asked to commit non-refundable funds to support s , and that the Management claim of component s being placed only against firm business , be implemented in practice

Bankruptcy

Xelicon 's sales have been virtually stagnant in 2000 , with a modest growth of 16 in 2001 . Qdrive has witnessed a slow-down in sales growth during 2001 , and suffers from gross margin decline . The giant Formiga has suffered de-growth for the last 2 years in a row , and seems to sell almost at cost . These are companies that Red Desert 's Management praises as being better at Marketing and having more resources . The massive increase in Red Desert 's long-term debt and investment in additional production capacity is a matter of grave concern . Repayment obligations of the senior note and convertible debentures are not known . The OEM business is subject to rapid technological change as per my general knowledge , and Red Desert is in possible danger of being unable to service its debt . The Cash Flow from operations to unhealthy at a third of the 1999 level it may even be unviable already if s are cancelled in significant amounts without proportionate compensation and if some inventories have to be written off . It is worth noting that Red Drive has just about 33 days Accounts Payable outstanding , while Qdrive has 318 ! Red Desert should negotiate more flexible terms with its suppliers , so that losses due to cancelled s are kept low , if not eliminated

Expense recognition

The 82 mio . on account payment in the 2001 T Accounts , with large unexplained transactions in income statement accounts , should be treated as red flags PAGE 1

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