Fraud Case

GAMMA CONSTRUCTION COMPANY

Gamma Construction Company builds and furnishes hotels for third parties. Some of its largest clients include the Helton and Sheradon Corporations. While its construction projects take place throughout the world, its project accounting is centralized in one location. This requires fairly sophisticated accounting information technology systems. For example, to purchase materials for a project, a project supervisor enters a purchase requisition (PR) electronically at the job site. The PR includes a description of the item(s) to be purchased, the vendor from whom the purchase is to be made, and the purchase price. Because of its geographically disbursed operations, the company has approximately 1,500 authorized vendors.

The PR must be electronically approved by the Accounting Department before the Purchasing Department may initiate the purchase. If the PR is for a purchase from an authorized vendor and is within the project’s budget, it is approved electronically by the corporate controller. If the PR does not include an authorized vendor or is not within the project’s budget, the controller determines whether the chief financial officer’s (CFO’s) approval is needed. If needed, once the CFO’s approval is obtained, the controller adds the vendor to the list of authorized vendors—including the vendor’s contact information—or revises the project’s budget estimate. The PR is then sent electronically to the Purchasing Department, where the goods are ordered. Depending on the urgency of the goods, the order is placed by mail, phone, or Internet. The project supervisor receives an email stating that the order has been placed. Once the goods have been received at the project site, the Accounting Department receives an electronic notification from the project supervisor which serves as the final authorization to pay. The CFO signs all checks. Checks in the amount of $100,000 or more also require the president’s signature.

The CFO and controller have both been with the company for in excess of five years. The controller’s spouse recently obtained a degree in construction management and was hired by Gamma to be a project supervisor.

The controller’s daughter was recently diagnosed with a rare disease. The disease is curable, but requires extensive treatment and hospital stays, much of which is not covered by insurance. The controller’s spouse has finally graduated and is now working, but student loan payments are coming due. The controller expects to be promoted to CFO within the year, and a large increase in pay comes with the promotion. This means that money issues are likely only temporary.

As a way of receiving a much needed ‘‘advance’’ on his salary, the controller suggests that his spouse, a project supervisor, place a fictitious order for goods needed on her project in the amount of $99,500. The controller also makes sure that the fictitious order is associated with a start-up project so that the PR will not result in the project being over budget. The order should be placed with the company, American Products—a fictitious vendor with a name very close to one of the company’s authorized vendors, American Projects.

The controller authorizes the fictitious PR after updating the approved vendor list to include American Products and its contact information (a post office box established by the controller). The order is placed by mail in the Purchasing Department. The controller’s spouse, as project supervisor, sends an electronic notification of the goods receipt to the Accounting Department. The Accounting Department processes the payment. The CFO signs the check. The check is mailed to American Products post office box, where the controller picks it up and deposits it.

Questions to Consider:

1. What are the red flags present that suggest the possibility of fraud? Are there conditions present suggested by the fraud triangle that may facilitate fraud? Are there IT-related issues that could facilitate fraud?

2. How would the fraud impact the financial statements? What accounts would be misstated?

JANNIE’S JEWELRY STORES

Jannie’s Jewelry Stores is a large corporation founded in 1998 that operates 23 retail jewelry stores located throughout the Southeastern United States. Jannie’s tailors its product line to middle-class shoppers, and specializes in engagement and wedding rings. Each store offers a large variety of jewelry (approximately 1,200 different items) with a fairly narrow price range ($50 to $3,500). Although sales increased rapidly during the first years of Jannie’s operations, sales during the last three years were flat. In an effort to increase sales, Jannie’s recently initiated its own credit card program.

The credit card program required new manual and new IT systems. Among other things, a credit department was established and an accounts receivable (AR) IT program was installed. The credit department’s responsibilities include approving customers for the company’s credit cards, following up on past-due receivables, and determining when customer accounts should be written off. The credit department has two employees: a credit manager and an AR clerk.

Customers’ credit card requests are initiated by the customer completing an online application in any of Jannie’s 23 retail locations. The online application requests the customer’s name, address, current monthly income, and Social Security number, among other information. Once the credit application is completed, the IT system automatically interfaces with an independent credit bureau. If the information included in the customer’s application matches the information in the credit bureau’s database, and if the customer has a credit score of in excess of a predetermined minimum score, the customer is extended a credit limit equal to 10 percent of his/her current monthly income. Higher credit limits require the approval of the credit manager.

The AR IT system interfaces with the company’s point-of-sale system, automatically posting sales transactions that occur at the company’s stores to the AR trial balance. Customers’ payments are received at a lockbox, posted to the company’s bank accounts daily by the bank. Copies of customer checks and remittance advices are received by the Credit Department, where the AR clerk posts them to customers’ accounts. Monthly customer statements are automatically generated by the IT system. Each month-end, a report of all customers with past-due balances is generated by the IT system. The credit manager reviews the report and instructs the AR clerk to follow-up on specific customer accounts.

Based on the results of the AR clerk’s follow-up activities, the credit manager determines which accounts should be written off, and processes any necessary adjustments through the IT system. The credit manager meets quarterly with Jannie’s CFO to discuss any particularly problematic accounts or unusual write-offs of customer accounts.

The Fraud

Before accepting a position with Jannie’s Jewelry, the credit manager was employed by Fred’s Fashions in a similar position. Fred’s owner decided to discontinue Fred’s credit card program and eliminated the credit manager’s position. The credit manager purchased a new home just prior to being laid off. The night prior to being laid off, the credit manager got engaged, promising that he and his new fiance´e would soon shop for an engagement ring. Even though the position at Jannie’s paid $20,000 less than the position at Fred’s, the credit manager was assured by Jannie’s president that as long as the company’s credit card program went well, the credit manager was sure to receive raises that would soon make the salary comparable to his former salary. In addition, the credit manager was looking forward to taking advantage of Jannie’s employee discount program when purchasing his fiance´e’s engagement ring.

The credit manager selected a $3,500 ring for his fiancee´, which with his employee discount cost $2,900. The purchase was financed on a Jannie’s credit card, by the credit manager overriding the company policy of granting a credit limit of 10 percent of a customer’s current monthly salary. The credit manager quickly fell behind in his required credit card payments. Although his account began to show up on the AR past-due report, the credit manager avoided directing the AR clerk to perform follow-up procedures for several months. When he learned that the company’s auditors would be visiting his department soon, he wrote his remaining account balance off using the IT system, fully intending to repay the balance when he receives his promised raise.

Questions to Consider:

1. What are the red flags present that suggest the possibility of fraud? Are there conditions present suggested by the fraud triangle that may facilitate fraud? Are there IT-related issues that could facilitate fraud?

2. How would the fraud impact the financial statements? What accounts would be misstated?

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