Financial Statement Analysis

This assignment presents three periods of financial statements (likely balance sheets) for a company. The analysis focuses on the classification and values of its assets, liabilities, and stockholders' equity. Key components include current and non-current classifications within liabilities, details about short-term debt, accounts payable, deferred revenues, and long-term debt. The summary also mentions 'additional paid-in capital,' 'retained earnings,' and 'accumulated other comprehensive income,' indicating a focus on understanding the company's equity structure.

Running head: AUDITING
Auditing
Name of the Student:
Name of the University:
Author’s Note:
Course ID:

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Executive Summary:
The current report aims to evaluate the industry and the overall business environment of
the Bayou Hedge Fund Group from the perspective of a trainee auditor in an accounting firm. In
addition, it lays stress on the corporate governance practices, risk analysis, factors and issues
causing the collapse of the fund. It has been found that the primary reasons behind the inability
of the Bayou Hedge Fund Group to cope up with the situation unlike the other hedge funds
include the ineffective ethical practices, lack of core group of norms and strong ideology, which
promote the well-being of the stakeholders of the organisation.
The stock price of the organisation is highly overvalued and hence, the investors have
encountered massive losses due to the collapse of the same. From the ratio and trend analyses
conducted, it could be inferred that the accountants have manipulated the accounting figures and
the organisation had bribed the external auditing firm to certify its financial statements in
compliance with the then prevailing accounting norms of the nation.

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Table of Contents
1. Introduction:................................................................................................................................3
2. Industry and business environment:............................................................................................3
3. Corporate governance:.................................................................................................................4
4. Risk analysis:...............................................................................................................................5
5. Factors of collapse:......................................................................................................................6
6. Ratio, trend analysis or analytical procedures:............................................................................8
7. Conclusion:................................................................................................................................13
References:....................................................................................................................................15
Appendices:...................................................................................................................................17

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1. Introduction:
In 1995, Samuel Israel III had established the Bayou Hedge Fund Group, termed as the
fund, in Stamford, Connecticut with the aim of producing greater returns for the investors. There
was absence of good intentions at the time the organisation had suffered losses immediately. Due
to this, Mr. Israel has adopted unscrupulous activities for keeping the view of success alive. The
resulting fund life was filled up with fraudulent, illicit and unethical activities, which has lead the
organisation to bankruptcy and Mr. Israel along with few of his key associates have been
imprisoned (Bodellini 2016).
This report aims to evaluate the industry and the overall business environment of the
Bayou Hedge Fund Group from the perspective of a trainee auditor in an accounting firm. In
addition, it lays stress on the corporate governance practices, risk analysis, factors and issues
causing the collapse of the fund. Finally, the report sheds light on conducting the ratio analysis
and trend analysis of the chosen organisation to depict the misleading financial statements, which
are prepared on the part of the unknown auditors.
2. Industry and business environment:
The industry and business environment of hedge fund could be characterised with the
help of the following features:
 The industry is open to the qualified investors only, as hedge funds are allowed only to
obtain money from the accredited investors. The individuals having annual income of
above $200,000 for the last two years or net worth above 1 million excluding their
primary residences have the power to invest in hedge funds (Fishman 2014).

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 Although the hedge funds provide broader investment latitude compared to other funds,
the mandate limits the investment of the funds. For instance, the investors in Bayou
Hedge Fund Group had invested in land, stocks, derivatives, currencies and real estate.
 Since the hedge fund industry is involved in employing leverage, they often utilise
borrowed money for amplifying their overall returns (Gupta, Becam and Gregoriou
2016). However, leverage in financial crisis wipes out hedge funds and in case of Bayou
Hedge Fund Group, the occurrence is prior to the financial crisis.
 The hedge funds often charge both performance fee and expense ratio, instead of
charging only expense ratio. The fee structure is termed as “Two and Twenty”, which is
2% fee related to asset management and 20% cut of any gains generated.
3. Corporate governance:
The management of Bayou Hedge Fund Group did not provide adequate respect to its
stakeholders. Mr. Israel and some of his associates have been greedy, as their main motive is to
make profit due to which they started to make poor or making one-sided decisions (Jaitly 2016).
The external pressure from the market, especially from the stock market of the nation, had lead
to the collapse of the organisation.
As pointed out by Jaitly (2016), the primary reasons behind the inability of the Bayou
Hedge Fund Group to cope up with the situation unlike the other hedge funds include the
ineffective ethical practices, lack of core group of norms and strong ideology, which promote the
well-being of the stakeholders of the organisation. The main stakeholders of the Bayou Hedge
Fund Group comprise of the insurers, investors, organisational staffs, government, lenders and

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borrowers and these groups have been influenced adversely due to the unethical decisions made
on the part of the management.
In the words of Jorion and Schwarz (2014), the corporate governance of the Bayou
Hedge Fund Group could be considered as deontology, since in a business decision, it is not
possible for anyone to remain aware of the consequences in the beginning years. However, the
organisation could have adopted set of ethical policies and norms that it could follow in the
beginning years. These ethical norms would take care of the decisions automatically, since such
rules could not control the consequences of such decisions. Hence, Bayou Hedge Fund Group or
its executives could have undertaken ethical decisions from the initial stage that could have
saved the organisation from bankruptcy (Kaal 2013).
In addition, the board of directors of the Bayou Hedge Fund Group could have
concentrated on making ethical decisions and ethical theory decades ago. If such practice had
been adopted, it could have helped in protecting and navigating the fund from such illegal
activities (Pascalau 2014). However, the organisation has failed to manage the situation due to
the market deficiencies and greed had besieged the top executives.
4. Risk analysis:
The risk analysis of the Bayou Hedge Fund Group could be represented as follows:
Standard deviation:
It is the most common measure of risk used in hedge funds and it ascertains the volatility
level of returns expressed in percentage terms (Ang 2017). However, in case of the Bayou Hedge

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Fund Group, standard deviation fails to provide a complete risk picture of the returns due to the
absence of normally distributed returns.
Value-at-risk (VaR):
VaR gauges the dollar-loss expectation, which could happen with a probability of 5%.
This measure provides additional overview into the past returns of a hedge fund, since it captures
the lower end of the returns to the down side (Li 2016). In the case of Bayou Hedge Fund Group,
this measure had not been used on the part of the management and thus, the investors could not
obtain an insight about the volatility of stocks. As a result, the risk had increased massively and
the investors had encountered severe losses after the collapse of the organisation.
Downside capture:
In association with hedge funds, the measure of downside capture could indicate the way
of correlation of a fund with a market at the time of decline. A lower downside capture is always
favourable, since the fund could preserve additional wealth during market downturns (Markham
2013). In the case of Bayou Hedge Fund Group, the downside capture is high, as Mr. Israel has
used the funds for personal purpose and this has resulted in the downfall of the organisation.
5. Factors of collapse:
The following are the main factors identified behind the collapse of the Bayou Hedge
Fund Group:
Board weaknesses:

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The main board members of the Bayou Hedge Fund Group comprised of Mr. Israel, the
co-founder, Mr. James Marquez and the Chief Financial Officer, Mr. Dan Morino. These
personnel were associated with the withdrawals and gross misappropriation of investor funds.
Since Mr. Israel enjoyed the maximum power in the shareholding of the fund, the personnel had
undertaken many independent decisions about the daily operations having no regulatory body in
checking the day-to-day activities. However, neither of the founders had experience or
qualification in managing the funds of the investors (Kaal 2016).
The criminal past of Mr. Israel had been unveiled during the public trial of the
organisation, which any investor could be able to find out with the help of legal arms. A former
staff had filed a federal lawsuit claiming breach of SEC norms of hedge funds and this has
placed the matter into arbitration. In addition, the corporate boards had failed to depict the
interests of the shareholders adequately along with exerting scrutiny over incumbent
management. The group board of the organisation depicts structural weaknesses comprising of
lack of autonomy and the positions.
Management weaknesses (fraudulent management practices):
The managers receive incentives in different types on accomplishing the performance
expectations, which often result in accounting fraud. This is because the non-financial intentions
are highly powerful and they are the strong reasons for conducting accounting fraud (Kokkila
2016). The scandal occurred at the time the regulators of Arizona seized $100 million from Karl
Johnson holding the money for Mr. Israel to invest in bank instruments yielding over $7.1 billion
in above 10 years. During seizure, the regulators did not have an insight of the ongoing situation.
The organisation had passed a board resolution that Mr. Israel should hold $100 million for

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offshore investments. The personnel had been involved in sending mails daily to the investors
along with informing them about the closure of the fund operations to devote time for family and
that the investors would receive funds in mid-August. This was the last communication made to
the clients and after that; the investors had not obtained their funds.
6. Ratio, trend analysis or analytical procedures:
The following ratios have been considered to evaluate the reasons behind the collapse of
the Bayou Hedge Fund Group:
Profitability ratios:
Particulars Details 2004 2005
Revenue A
1,16,19
9
1,18,71
9
Net income B
2,37
7
2,35
0
Operating
income C
3,62
4
3,67
2
Total assets D
33,44
0
33,16
3
Total current
liabilities E
16,54
0
15,57
5
Net margin B/A 2.05% 1.98%
Return on
capital
C/(D-E) 21.44% 20.88%

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employed
(ROCE)
According to the above table, it could be found that despite the increase in net revenue,
the organisation has experienced a fall in net income. The reason depicted is the rise in operating
expenses. However, the accountants of the fund have manipulated the operating income figure to
show lower net income for distributing lower dividends to the shareholders (Mirabile 2016). As a
result, it has helped in minimising the overall ROCE for providing lower returns to the investors.
Liquidity ratios:
Particulars Details 2004 2005
Current assets A
17,29
9
15,21
8
Inventories B
8,90
8
8,96
9
Current
liabilities C
16,54
0
15,57
5
Current ratio A/C 1.05 0.98
Quick ratio
(A-
B)/C
0.5
1
0.4
0
Based on the above table, it could be found that the Bayou Hedge Fund Group had
experienced a fall in its liquidity position due to the fall in current assets significantly. In

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addition, there is an increase in inventory base as depicted in the annual report in contrast to the
market demand, which has further dampened its liquidity position. The management of the
organisation took advantage of this situation by extending the payment time of the creditors.
Efficiency ratios:
Particulars Details 2004 2005
Revenue A
1,16,19
9
1,18,71
9
Cost of revenue B
1,01,06
5
1,02,90
1
Opening inventory C
8,45
6
8,90
8
Closing inventory D
8,90
8
8,96
9
Average inventory
E=(C+D)/
2
8,68
2
8,93
9
Opening receivables F
1,14
8
1,22
4
Closing receivables G
1,22
4
1,25
2
Average receivables
H=(F+G)/
2
1,18
6
1,23
8
Inventory turnover 365/(B/E) 31.36 31.71

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Receivables
turnover 365/(A/H) 3.73 3.81
The above table clearly depicts that Bayou Hedge Fund Group had managed to increase
its inventory rate in 2005 by providing misleading information to the stakeholders. In addition,
the payment time of the debtors had been extremely low and this helped Mr. Israel to accumulate
sufficient amount of cash for conducting the fraudulent activity.
Investor ratios:
Particulars Details 2004 2005
Net income A
2,37
7
2,35
0
Opening
shareholders'
equity B
12,30
3
10,61
7
Closing
shareholders'
equity C
10,61
7
12,07
9
Average
shareholders'
equity
D=(B+C)/
2
11,46
0
11,34
8
Market price
per share E 29.38 36.78

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Earnings per
share F 5.41 5.36
Return on
equity A/D 20.74% 20.71%
Price/
earnings ratio E/F 5.43 6.86
The investor ratios clearly signify that the fund has managed to provide sufficient return
on equity to the investor within the first quarter of 2005. However, as the price/earnings ratio is
above 2, it is clearly understood that the stock of the fund is overpriced (Park 2014). In this case,
the stock price of the organisation is highly overvalued and hence, the investors have
encountered massive losses due to the collapse of the same.
Trend analysis or analytical procedures:
Revenue
Net income
Total non-current assets
Total non-current liabilities
Total stockholders' equity
-15.00%
-10.00%
-5.00%
0.00%
5.00%
10.00%
15.00%
20.00%
2.17%
-1.14%
11.18%
-12.32%
13.77%
Trend Analysis of main items in
financial statements
Percent change

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The main items that have been extracted from the financial statements of the Bayou
Hedge Fund Group include revenue, net income, non-current assets, non-current liabilities and
stockholders’ equity. The percentage change has been considered, in which it has been found that
despite the increase in net revenue, the organisation has experienced a fall in net income. In
addition, the non-current asset base and stockholders’ equity had increased with fall in non-
current liabilities. This depicts that the accountants have manipulated the accounting figures and
the organisation had bribed the external auditing firm to certify its financial statements in
compliance with the then prevailing accounting norms of the nation (Strine 2017).
7. Conclusion:
From the above discussion, it has been evaluated that the management of Bayou Hedge
Fund Group did not provide adequate respect to its stakeholders. Mr. Israel and some of his
associates have been greedy, as their main motive is to make profit due to which they started to
make poor or making one-sided decisions. The external pressure from the market, especially
from the stock market of the nation, had lead to the collapse of the organisation. Mr. Israel had
been involved in sending mails daily to the investors along with informing them about the
closure of the fund operations to devote time for family and that the investors would receive
funds in mid-August. This was the last communication made to the clients and after that; the
investors had not obtained their funds. From the ratio and trend analyses conducted, it could be
inferred that the accountants have manipulated the accounting figures and the organisation had
bribed the external auditing firm to certify its financial statements in compliance with the then
prevailing accounting norms of the nation.

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References:
Ang, G.L.I., 2017. Risk Measurement and Management for Hedge Funds. Hedge Funds:
Structure, Strategies, and Performance, p.283.
Bodellini, M., 2016. From systemic risk to financial scandals: The shortcomings of US hedge
fund regulation. Brook. J. Corp. Fin. & Com. L., 11, p.417.
Fishman, J., 2014. What Went Wrong: Prudent Management of Endowment Funds and
Imprudent Endowment Investing Policies. Browser Download This Paper.
Gupta, J., Becam, A. and Gregoriou, A., 2016. Impact of Fund Size on Hedge Funds Liquidation.
Jaitly, R., 2016. List of Fund Managers. Practical Operational Due Diligence on Hedge Funds:
Processes, Procedures and Case Studies, pp.805-820.
Jaitly, R., 2016. Practical Operational Due Diligence on Hedge Funds: Processes, Procedures,
and Case Studies. John Wiley & Sons.
Jorion, P. and Schwarz, C., 2014. Are hedge fund managers systematically misreporting? Or
not?. Journal of Financial Economics, 111(2), pp.311-327.
Kaal, W.A., 2013. Hedge Fund Manager Registration Under the Dodd-Frank Act. San Diego L.
Rev., 50, p.243.
Kaal, W.A., 2016. Private Fund Investor Due Diligence–Evidence from 1995 to 2015.
Kokkila, A., 2016. AIFMD Impact on European Hedge Fund Industry.

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Li, Y., 2016. A Study of Hedge Fund Redemption and Its Bankruptcy Implications. US-China L.
Rev., 13, p.34.
Markham, J.W., 2013. Custodial Requirements for Customer Funds. Brook. J. Corp. Fin. &
Com. L., 8, p.92.
Mirabile, K.R., 2016. Hedge fund investing: a practical approach to understanding investor
motivation, manager profits, and fund performance. John Wiley & Sons.
Park, J., 2014. Enforcement of Securities Law in the Global Marketplace: Cross-Border
Cooperation in the Prosecution of Transnational Hedge Fund Fraud. Brook. J. Int'l L., 39, p.231
Pascalau, R., 2014. Risk Management and Hedge Funds. Investment Risk Management, p.442.
Strine, L.E., 2017. Who Bleeds When the Wolves Bite? A Flesh-and-Blood Perspective on
Hedge Fund Activism and Our Strange Corporate Governance System.

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Appendices:
Appendix 1: Income statement of Bayou Hedge Fund Group for the years 2004-2005
Particulars 2004 (in million $) 2005 (in million $)
Revenue 1,16,199 1,18,719
Cost of revenue 1,01,065 1,02,901
Gross profit 15,134 15,818
Operating expenses
Sales, General and administrative 11,510 12,146
Total operating expenses 11,510 12,146
Operating income 3,624 3,672
Interest Expense 124 133
Other income (expense) 104 80
Income before income taxes 3,604 3,619
Provision for income taxes 1,195 1,243
Minority interest 32 26
Other income 32 26
Net income from continuing operations 2,409 2,376
Other -32 -26
Net income 2,377 2,350
Net income available to common
shareholders 2,377 2,350
Earnings per share

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Basic 5.41 5.36
Diluted 5.37 5.33
Weighted average shares outstanding
Basic 439 439
Diluted 443 441
EBITDA 4,855 5,007