Case 5
The Anonymous Caller:
Recognizing It’s a Fraud
And Evaluating What to do
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Mark S. Beasley, Frank A. Buckless,
Steven M. Glover, Douglas F. Prawith
LEARNING OBJECTIVES
After completing and discussing this case, you should be able to
-Appereciate real-world pressures for meeting financial expectations
-Distinguish financial statement fraud from aggressive accounting
-Identify alternative actions when confronted with suspected financial statement fraud
-Develop arguments to resist or prevent inappropriate accounting techniques
BACKGROUND
It was 9:30 A.M. on a Monday morning when the call came through. “Hi Dr. Mitchell, do you have a minute?”
“Sure,” the professor replied.
“I am one of your former students, but if you don’t mind, I would prefer to remain anonymous. I think it is best for both of us if I not reveal my name or company to you. I am concerned that the senior executives of the company where I serve as controller just provided our local bank fraudulently misstated financial statements. I need some fast advice about what to do. Currently, I am on my car phone and need help evaluating my next step before I head to my office this morning. May I briefly describe what’s going on and get some input from you?” she asked.
“Go ahead, let me see if there is some way I can help,” responded Dr. Mitchell.
“I am the controller of a privately-held small start-up company that I joined three and one-half
months ago On Friday of last week, the company’s chief executive officer (CEO), the vice president of
operations, and the chief financial officer (CFO) met with representatives of the bank that funds the
company’s line of credit. One of the
The case was prepared by Mark S. Beasley, Ph.D. and Frank A. Buckless, Ph.D. of North Carolina State University and Steven M. Glover, Ph.D. and Douglas F. Prawitt, Ph.D. of Brigham Young University, as a basis for class discussion. It is not intended to illustrate either effective or ineffective handling of an administrative situation.
Copyright © 2003 by Pearson Education, Inc., Upper Saddle River, NJ 074568.
Beasley / Buckless / Glover / Prawitt
Purposes of the meeting was to provide our most recent quarterly financial statements. The company is experiencing a severe cash shortage, and the bank recently halted funding the line of credit until we could present our most recent operating results. It was at that meeting, just three days ago, that our senior executive team knowingly submitted financial statements to the overstated sales and receivables accounts.”
“Earlier on Friday, prior to the bank meeting, I vehemently refused to sign the commitment letter required by the bank because of my concerns about the meet revenue recognition criteria specified by GAAP. I explained to the CEO and CFO that I believed including those transactions in the quarterly results would constitute fraud. They continued to insist that the financial statements needed to reflect the transactions, because without them, the bank would not continue funding the line of credit. They accused me of living in an “ivory tower” and emphasized that companies booked these kinds of transactions all the time. Although they acted like they appreciated my desires for perfection and exactness, they made me feel like it was my lack of experience in the real world that kept me from having a more practical perspective to a common business practice. Unfortunately, none of the senior executives have accounting – related backgrounds. I am the top – level accounting person at the company.”
“Over the weekend I had time to think about the situation, and now I am even more convinced that this is clearly fraud. My CEO and CFO have been arm-twisting the accounting staff to book sales transactions before sales occur. As a matter of fact, the customers haven’t placed any kind of orders with our company and no goods have been shipped to them. The CEO and CFO noted that booking these kinds of credit sales transactions is a common business practice, even if it isn’t technically compliant with GAAP given that the transactions represent sales expected in very near future, perhaps even next week.”
“As it turns out, the CEO even instructed the accounts payable clerk, while I was out of the office for a couple of days, to record entries the CEO had handwritten on a piece of paper. The accounts payable clerk has never worked with sales and receivables. The CEO told the clerk, who works part time while finishing his accounting degree at your university, to not mention the entries to me, unless I specifically asked. In that event, the clerk was supposed to tell me that the entries related to new sales generated by the CEO and that all was under control. Fortunately, the student clerk is currently taking your auditing course, where financial statement fraud is a topic, and he was uncomfortable with what had tran