Reference no: EM132612099

Question - Green Corporation had a temporary cash squeeze near its balance sheet date. It needed cash badly to cover a seasonal dip in sales. However, if any additional money were borrowed, the company would violate a loan covenant requiring that a defined debt/equity ratio be maintained. To get around this requirement, the top two officers Green Corporation set up another corporation called Blue, Inc. Green made a large sale of inventory to Blue at cost. Blue used the inventory as collateral for a three-month loan from a local bank. The money from the loan was used to pay Green for the inventory transaction. At the end of the three-month period, Green intended to repurchase the inventory from Blue at a price that would allow Blue repay the loan plus interest.

Required -

A) How would this transaction enable Green Corporation to maintain its required debt/equity ratio and obtain the cash it needs?

B) What tests of controls and/or substantive procedures would lead an auditor to detect this scheme?