In this assignment, you will evaluate internal controls of a manufacturing plant and how the lack of physical controls and incorrect processes can lead to financial exposure and lack of trust within an industry. To begin, read the following information about Koss Corporation.
Koss Corporation: Where were the internal controls?
Koss Corporation is a publicly traded company that designs and sells stereo headphones. The Koss family controls a majority of the company’s stock. On November 17, 2010, Sujata “Sue” Sachdeva, the former vice president of finance, was sentenced to 11 years in prison for embezzling $34 million from the company. On September 2, 2010, the Securities & Exchange Commission brought an action against Sujata Sachdeva, vice president of finance, and Koss Senior Accountant and subordinate Julie Mulvaney, who allegedly helped Sachdeva cover up the fraudulent scheme. The SEC alleged that Sachdeva and Mulvaney caused Koss to submit false and misleading financial statements. Sachdeva regularly relied on Mulvaney to reconcile the cash shortfalls and to balance the books.
Sachdeva and Mulvaney primarily hid the embezzlement by making false entries on the company’s general journal. For example, the false journal entries disguised the theft by overstating assets, expenses, and cost of sales, and understating liabilities and sales. Mulvaney maintained binders that detailed numerous false journal entries that were made to the company’s accounting books and records. With those entries, Mulvaney reclassified company funds—with no supporting documentation and no legitimate explanation. Mulvaney also maintained a series of folders that included documentation of over 100 fraudulent transactions that were included in the company’s accounting books and records.
Sachdeva and Mulvaney were able to hide the substantial embezzlements in part because the company did not adequately maintain internal controls to reasonably assure the accuracy and reliability of financial reporting. Koss’s internal controls policy required Michael Koss to approve invoices of $5,000 or more for payment. However, Koss allegedly delegated duties typically done by the chief financial officer (CFO) to Sachdeva on a regular basis. Koss also had little or no educational background or experience in accounting or finance. Many of the cashier’s checks exceeded $5,000, and some exceeded $100,000. However, its controls did not prevent Sachdeva and Mulvaney from processing large wire transfers and cashier’s checks outside of the accounts payable system to pay for Sachdeva’s personal purchases without seeking or obtaining Michael Koss’s approval. In addition, many account reconciliations were not prepared, maintained, or reviewed as part of Koss’s accounting records. Koss’s computerized accounting system was almost 30 years old.
After reading the case, compose a paper that addresses the following. Be sure to present a thorough analysis and apply course concept in your response.
- Describe the major internal controls that were missing within Koss Corporation’s internal control system.
- Explain what internal controls should have been implemented or applied to ensure proper controls over the company’s recorded transactions?
- Explain how the lack of internal controls and weak internal processes lead to financial exposure and lack of credibility within an organization?
- Apply this case to the field of auditing. Discuss the types of documentation and/or evidence that you would recommend for evaluating the firm and obtain a better understanding of its adherence to GAAP?.
- Based on the case, what types of technology controls should have been applied to reduce the likelihood of this fraud? Should the accounts payable systems have had stricter verification procedures such as authentication methods, encryption, or sign-on security controls?
- The case stated the system was almost 30 years old. What are the risks of an outdated system? What type of system features would you advise the firm to implement to replace the current one?
- In your own opinion, do you think the proper application of auditing tests and standards would have prevented this fraud from occurring? Do you think this type of fraudulent activity is more common than we think, but we just have more solidified rules in place?
Your completed response must be at least three pages in length, and you must use at least two references. Any sources used must be cited and referenced in APA Style.
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Charlie Sokola, CPA, is interested in testing the fairness of the ending inventory balance during the audit of Mountain Company. Charlie has relatively little experience using statistical sampling methods and, quite frankly, does not like to turn anything over to random chance—especially the selection of items to test. Charlie used a judgmental method of selecting items for testing. The method involves testing the inventory-item balances that he deems most risky or most likely to be misstated. Charlie identified items to test based on size of balance, findings from prior years, age of inventory, description, and professional judgment.
He selected 26 items with a total book value of several thousand dollars. In his sample, he found a large amount in overstatement errors. The book value of inventory on the entity’s records is $1,290,000. Overall materiality for the engagement is $700,000. Doug’s policy is to use 50 percent or less of overall materiality as tolerable misstatement for any one account.
Based on this information, answer the following questions:
- What is your opinion of Charlie’s method of selecting his sample? Is this a good strategy? Explain. Define the different sampling methods commonly used.
- Evaluate Charlie’s results. Does he have sufficient evidence to conclude the balance is fairly stated? If not, what evidence would be more relevant and applicable? Did Charlie dig deep enough into the data and processes? Explain with examples.
- Looking back at this situation, explain some of the tests of controls and substantive tests that should be performed. What are common similarities and differences between audit sampling for tests of controls and substantive tests of details of account balances? How important are these tests when it comes to obtaining evidence and assessing a firm’s accounting processes?
Your response must be at least two pages in length, and you must use at least two relevant academic sources. Any source used must be cited and referenced in APA Style.
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In this journal submission of at least 500 words, you will synthesize unit concepts as you reflect on how you would handle a fraud investigation. The journal measures your mastery of ULOs 2.2, 4.5, and 4.6 and is worth 6% of your course grade.
In the Case Studies section (not Short Cases), of Chapter 10 read Case Study 3 (James and Earl) and answer the following questions. Note: These questions are different from than those in the following the case in the eTextbook. Ensure you answer each of the following questions:
- Which people would you interview first, and why?
- How would you approach each of the individuals, and why?
- What type of information would you seek? Indicate the type of question you would need to use to get each type of information you seek.
- Summarize the components you should include in your fraud report.
- Explain why attention to language in the report is critical.
Your response must be at least 500 words in length. No references or citations are necessary.