Audit accounting unit 7

After reading Chapter 13 of your Forensic Accounting and Fraud Examination textbook, complete the following problems, which will help you apply your knowledge of fraud perpetrated by employees and vendors:

· Case 51 on page 407.

· Case 52 on page 408.

51.Tenkey Book Company operates a chain of retail bookstores throughout the United States. Sandra Hawthorn, Tenkey's controller, runs a fairly tight internal control system with rigorous requirements for the segregation of duties throughout the company. Even the best systems can have problems, and recently someone called in a tip to the company's anonymous hotline saying that Tenkey was losing a significant amount of inventory to employee theft and that the problem was pervasive through many of the company stores. The caller left no details as to who was committing the thefts or how they were being committed.

Sandra was alarmed because inventories constituted a large percentage of Tenkey's assets, and if losses could occur in even one store, they could probably occur in others too. She called a staff meeting that included the IT director and the general accounting manager. “We need a plan to investigate this,” she told them. “Any suggestions?”

Tom Clockspeed, the IT director, jumped right in. “Let's do a complete inventory of all of our stores,” he said.

Anna Aburida, the general accounting manager, began shaking her head. “We're not due to take inventory for another six months. It would cost us a whole lot of overtime if we do it now.”

Sandra glared at Anna and said, “You're just going to have to do better than that.”

“Okay,” said Anna. “We need a plan. Let's start by considering likely suspects. Then we can evaluate the internal controls surrounding everyone who might be in a position to steal. There has to be a weak point somewhere.”

“This is a little crazy,” said Tom. “You're making all of these plans when we're not even sure if the phone caller was telling the truth. Let's at least do an inventory of one store before we do anything else.”

Anna frowned. “That's great Tom. So what happens if we inventory one store and don't find any inventory shortage? Then what do we do?”

Tom slid back in his seat and laughed. “Right,” he said. “But what happens next if you don't find any control problems? Then we've just wasted time. And even if you do find control problems, there's no guarantee that fixing them will fix them. And remember, we don't even know for sure if we do have a problem.”

Sandra pounded her fist on the table. “This is going nowhere. I'm going to bring in a forensic accountant to find out what to do.”

a. If you are brought in as Sandra's outside forensic accountant, what advice would you give her?

b. Which employees could be stealing inventory? Describe one or two possible schemes applicable to this case.

52.John Markov runs a family-owned department store in St. Louis. The store consists of nine different departments, each with its own department manager. Store hours are Monday through Saturday from 10:00 A.M. to 7:00 P.M., and from noon until 5:00 P.M. on Sunday.

Each department has its own cash register, and two salespersons are assigned to each register. To prevent any confusion, each salesperson must enter his or her own secret code with each transaction. At the end of each day, the sales manager in each department tallies the department's register, collects the money (cash and checks) from the register, and prepares a transmittal slip for the general manager to review and sign. The general manager then double-checks the Cash count before signing the transmittal slips.

After collecting all cash receipts from all departments, the general manager prepares a daily cash sales report and sends it to the store's finance manager. The finance manager again counts the money and signs three copies of the daily cash sales report. She keeps one copy for herself, a second copy goes to the store accountant, and the last copy goes to the store manager. The finance manager then puts all of the cash into the company safe, where it stays until the next morning when it is picked up by an armored car service.

The store accountant reconciles copies of cash sales reports with bank deposit slips and with credits on the monthly bank statement.

John has a close relationship with the bank, so he is always called first when there is any kind of issue or problem. He just received a call from one of the bank's customer service representatives who suggested that he look into some customer checks that had recently bounced. The bank representative said that some of the payer names on the checks had come up in bad checks written to a number of other local businesses.

“You have an insider working against you,” said the bank employee. “This is happening all over town, and I heard a police investigator say that there's always an insider involved.”

a. What possible check fraud schemes might the company be a victim of?

b. Given the store's procedures for processing cash receipts, which persons in the store are in a position to participate in a check fraud scheme?

After reading Chapter 14 of your Forensic Accounting and Fraud Examination textbook, complete the following problems, which will help you apply your knowledge of financial statement fraud:

· Case 51 on page 436.

· Case 52 on page 436.

· Case 53 on page 437.

51.The Sunbeam Corporation is a famous case in which the CEO Al “Chainsaw” Dunlap was charged with utilizing earnings manipulation to achieve fraudulent financial goals. Find information about this case on the Internet and discuss the earnings management methods used in this case. Did the company “take a big bath” by taking a large deduction for prepaid expenses in 1996? How were accruals used to achieve management's goals?

52. In Zzzz Best, Inc., Barry Minkow wowed Wall Street with his carpet cleaning company. What methods of concealment and fraud did he use? How could this fraud have been prevented? Discuss the safeguards that need to be implemented to avoid this manipulation. What do auditors need to do differently to avoid audit failures like Zzzz Best, Inc.?

53.Mary Milken is the CFO of the Rbeck Company in Miami, Florida. The company is a closely held custom yacht builder with about 200 technical workers (engineers, marine architects, mechanics, boat workers, and so on), and 12 employees in its main office staff. Her primary job is to prepare the financial statements with the assistance of two full-time accountants. She normally follows generally accepted accounting principles, but she sometimes ignores them when she thinks they do not lead to what she considers best practices for the small number of her company's shareholders.

In the previous decade, the company was owned by three sisters, each of whom served on the board of directors. One of the three, Vanessa Rbeck, served as the CEO during that period. The other two have always deferred to her with respect to her operational management decisions.

Only a month ago, however, Vanessa's sisters were killed when their private plane crashed en route to the Bahamas, which they frequently visited on weekends for relaxation. Upon their death, all of their shares in the Rbeck company transferred to a single trustee in one of the large South Florida banks. Each sister had held her shares in revocable living trusts with the same bank named as successor trustee.

As soon as the funerals were over, Mary and Vanessa met with the trustee, Annie Crusher. The meeting did not go well. Annie had grown up working in a family-owned retail boat business, and she thought her knowledge of the industry transferred to the yacht-building business. She began asking Vanessa a rapid succession of unfriendly questions in an adversarial tone of voice. Her questions strongly implied that a yacht-building business did not belong in South Florida but offshore where labor is cheaper. After the meeting, both Mary and Vanessa became afraid that Annie would do something crazy like fire them both or liquidate the business.

For the previous five years, Rbeck's stock had sold for a steady $12 per share, with $8 per share in dividends. Vanessa received a good salary, but she depended on the dividends to send her children to private schools and to pay the large mortgage on her waterfront home in South Beach. She immediately realized that she was now at Annie's mercy; she could easily cut off Vanessa's dividends, lower her salary, or put her out of work.

To make things worse, Mary was almost finished with the most recent annual report, and it appeared that earnings were down for the first time ever. Her preliminary calculations showed earnings per share somewhere near $8.

The problem with earnings had been caused by large bad debts from three clients who had been arrested for drug trafficking. Rbeck had entirely financed luxury yachts for the three clients because of their excellent credit history and prominence in the business community. However, the federal government seized all of the clients' assets, leaving nothing for Rbeck but the three half-built yachts.

After thinking things over, Vanessa asked Mary to find a way to avoid having to report lower earnings because of her concern as to how Annie might respond to the decline in earnings. Mary considered various options:

· Increase the estimated percentage of completion on all yachts in work-in-process inventory by 15 percent. This would wipe out most of the loss. Work in process estimates have always been very conservative anyway.

· Recognize revenue on the three yachts in default. It would be very difficult to sell them at a good price, but she could always argue that they could be sold if she could keep a straight face. The best strategy would be to find new buyers for them, but that could take a couple of years.

· Switch to mark-to-market accounting for some of the yachts in progress so the company could recognize all of the profit when contracts with other clients are signed.

a. Is any option that Mary is considering acceptable under generally accepted accounting principles? Why or why not?

b. Do any of the options being considered by Mary constitute financial statements fraud?

c. How would you handle the entire situation if you were in Mary's shoes?