musyokiones

Cooking the Books

Alexis Babb

John is CFO at a venture-backed tech startup with revenues of $20 million and approximately 80 employees. He's worked at the company for several years, and now reports to Ralph, the company's newly hired CEO.

The company had been doing really well, but recently big customers have been placing fewer orders and Ralph is feeling pressure to show growth. This pressure is amplified because the company is venture-backed, and the investors expect results.  While the company did well in the first round of funding, if they don't perform now, they may have trouble with gaining sufficient funding in the second round, which could mean the end of the company.

All of this was on John's mind when Ralph came to him about recording a major order that was still under negotiation. The deal had not gone through, although both parties expected to complete the deal in the next week. With the current quarter ending in the next few days, including this order would give a significant boost to the company's financial reports. Nonetheless, under the generally accepted accounting principles (GAAP), it is clear that this order does not qualify as revenue.

Even so, Ralph was adamant about John booking the order, which could make all the difference in the company's ability to stay afloat. John knew that doing so would constitute fraud; particularly because the Sarbanes Oxley Act requires the CEO and CFO to sign off on all quarterly reports. At the same time, John knew that this order could make all the difference.

What should John do?

Fraudulent Reporting

Noah Rickling

After majoring in accounting at Santa Clara University, Scott was hired as an associate auditor for a Bay Area accounting firm. He is currently auditing a local company's financial statements, a project he's been working on for about two months. The senior associate responsible for tracking billable hours has been pressuring Scott and other associates to report fewer hours than they actually worked. The senior associate would appear more successful if his team reported fewer hours, and the firm would also be better positioned to win similar contracts in the future. Scott is salaried, so billable hours don't affect his compensation directly. However, he knows that underreporting billable hours is against company policy.

In accounting firms, offering low billable hours is attractive to potential customers, as the bid with the lowest overall cost will get the business. At the start of any bid, the client agrees to pay a fee for the company's services, including all staff time. If the employees report fewer hours, the company looks more attractive and will more likely get the contract.

Pressure to report fewer billable hours comes from the "utilization metric" used to determine how efficiently an employee is working. Employees who report fewer hours than their peers will be seen as more efficient, due to a higher utilization rate. Scott remembers a case where one of his colleagues was promoted, partially because of his extremely high utilization rate. He knows that if he were to clock all of his actual hours worked, he would be at a disadvantage for the year-end performance review.

If Scott decides to clock all his billable hours per company policy, he risks losing the competitive edge with his colleagues, nearly all of which participate in under billing. Scott is uncomfortable with the practice, but fears his options are limited.

What should Scott Do?

Financial Reporting

Amanda Nelson

Ben is a recent Santa Clara University graduate who has just started his first job in the finance department of a publicly traded Silicon Valley company. One of his main responsibilities is to create and distribute extensive Microsoft Excel reports that analyze costs and revenues for different divisions. Ben sends completed reports to his direct supervisor and the CFO. The CFO then uses the information to create the company's financial reports, in addition to the strategy and forecasting formulation.

While Ben considers himself to be detailed-oriented, the complicated nature of and the sheer volume of data sometimes overwhelm him, which is exacerbated by their strict deadlines. While Ben works hard to prepare the reports as accurately as possible, he often finds errors after he has submitted his final report. When the errors are critical, he revises the reports and resends them. However, some of the errors are minor, in Ben's estimation, and he doubts that the CFO will use or look at these figures. Ben is ambitious and wants to be promoted, but worries that if he frequently sends out revised reports he will appear unreliable and unqualified. At the same time, the potential consequences from inaccurate financial reports put the company, the CFO and CEO, and Ben himself at risk.

What actions should Ben take when he catches a mistake? Is he obligated to report every error, particularly since he works for a publicly traded company? Is there such a thing as a small error in this context?

Bank Fraud

Saayeli Mukherji

Joe Mann, a senior consultant, was working with a small company that created capital equipment for semiconductor manufacturers such as Intel. The company's products were quickly becoming obsolete, and the management had taken on a considerable amount of debt. As the semiconductor market stalled in 1985-1986, there was not a significant need for new production equipment, and the future looked grim for the company.

Joe and his partner proposed a new add-on for existing systems, which they hoped could help rejuvenate sales. The consulting team acknowledged that the company had a cash flow problem, and agreed to take a minimal fee upfront for the design, and royalties from product sales thereafter. The consultants designed and tested the equipment themselves, and eventually the new product had all the makings of a smash hit for the struggling company.

One day, Joe entered the company's warehouse to do final testing on his products, only to find that a series of partially assembled, untested systems were ready to be shipped out. When he investigated further, a worker told him: “We're only shipping it to the inventory facility so we can use it as collateral for an asset based loan. We'll ship the products back after we get the loan.”

Joe was genuinely concerned that company's shipping practice was an instance of bank fraud. But at the same time, his future success was intertwined with the company with his future royalty earnings being dependent on the company succeeding.

What should Joe do?

Reporting Inflated Numbers

     

Jessica Silliman

Barbara King graduated from Santa Clara University at the perfect time. It was the peak of the dot-com boom and businesses were competing for recent graduates. Barbara had no problem getting her first job in the high-tech industry as a corporate communications specialist.

Many of her friends struggled when entering the corporate world, but Barbara didn't have any problems. The workplace had a casual atmosphere, she enjoyed a salary far above that of her friends, she received perks regularly and she enjoyed Mai-Tai Fridays at the office every week.

She was at the job for less than two months when the company released the quarterly numbers. As the internal communications representative, Barbara was responsible for reporting the numbers to all the employees within the company. Because the company was not publicly traded, only those within the organization were privy to the information.

"I was aware something wasn't quite right with the numbers," said Barbara. "But I was so young and naive-I never thought they could be wrong." She knew the company was doing well, but Barbara had been tracking the high-tech industry and was conscious of the usual financial targets. She also knew that the industry was getting out of control and each company was willing to do anything to get ahead. After asking her coworkers, she realized that they all knew the numbers were intentionally inflated every quarter. Barbara took the hints from her coworkers and passed the numbers on without question.

"We were a young company and we needed our stock price to rise so that we could stay competitive in the booming industry," said Barbara. "Everyone questioned the numbers, but, because of the hip work culture that everyone enjoyed and the potential for riches, there was an underlying pressure to be loyal."

The inflated numbers became another part of the culture. Barbara observed coworkers laughing when they picked up the paper and read the headlines about their company's booming quarter.

"Everyone was just enjoying the ride and didn't want it to end," said Barbara. "Venture capitalists were practically throwing money at our company and we were spending it faster than we thought possible."

"I was new at the company, was making great money and had great benefits-why would I jeopardize all of that?" said Barbara.

How would you describe the fundamental ethical dilemma that Barbara faces? Who benefits by Barbara passing on the incorrect information? Who is harmed by her doing so? Do you think Barbara handled this situation correctly? Would you handle it differently?