Identifying inherent risk and control risk factors
Mark S. Beasley
Frank A. Buckless
Steven M. Glover
Douglas F. Prawitt
It was 9:30 A.M. on a monday morning when the call came through. “hi dr mitchell, do you have a minute?
A am on of your former students, but if you don’t mind, i would prefer to remain anymous. i think it is best for both us if i not reveal my name or my 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. although they acted like they appreciated my desires for perfection and exactness, they made me feel like it was my lack of experience in tehreal world that kept me from having a more practical perspective to a common business practice. i need some fast advice about what to do. currently, may i briefly describe what’s going on adn get some input from you?” she asked.
“go ahead, let me see if there 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 ceo met with representatives of the bank thaht funds the company’s line of credit. 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. fortunately, the student clerk is currently taking your auditing course, where financial statement fraud is a topic, and he was uncomfortable with what had transpired.it was at that meeting, just three days ago,that our senior executive team knowingly submitted financial statements to the bank that overstated sales and receivable 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 inclusion of sales transactions to customers on account that i knew did not meet revenue recognition criteria specified by GAAP. that commitment letter related to funding the loan right at close of the last fiscal year. so, my signature is on file at the bank related to prior year. i explained to the ceo and cfo that i believed including those transactions in the quarterly results would . they continued to insist that the financial statements needed to reflect the transactions, because without them, the bank would not continue funding constitute fraud the line of credit. one of the purposes of the meeting was to provide our most recent quarterly financial misstatements. unfortunaltey, none of the senior executive 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 cea and cfo have been arm-twisting the accounting staff to book sales transactions before sales occur.as best i can tell, these unusual activites began just recently given our poor result in the first quarter of this year. he immediately updated me on the day i returned about what had happened. 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 the 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 days, to record entries that ceo had handwrittern on a piece of paper.one of my accounting clerk resigned last week due to similiar concerns. our vice presideng of human resources discussed the resignation with me after leaving about the clerk’s concern during a final exit interview. They accused me of living in an “ivory tower” and emphasized that kinds of transactions time. i am on my cell phone and need help evaluating my next step before i head to my office this morning. the ceo told the clerk, who works part time while finishing his accounting degree at your university, not to mention the entries to him, unless i specially asked. in that event, the clerk was supposed to tell me that the clerk related to new sales generated by the ceo and that all was under control. as a matter of fact, the customers in question haven’t placed any kind of orders with our company and no goods have been shipped to them. because we aren not company, our external auditor has not performed any kind of interim review of the interim financial statements.”
“do you think this is limited to just one quarter?” dr mitchell asked
“i think so” the caller replied
“as i mentioned, i joined the company three and a half months ago. one of my first tasks involved closing out the prior fiscal year and assisting the external auditors with the year-end audit. they were not bouncing them, but they were not funding the line of credit until the first quarter results were presented on friday next week. our company is a start up enterprise that has been operating at a net income for a while. just now, the bank stopped clearing checks drawn off the company account. interestingly, the bank immediately started funding the line late friday and, i understand based on phone calls with my clerk this morning, the bank is continuing to fund the line this morning. these bizaree entries make up almost half of our first quarter’s sales. of course, given that these are quarterly financial statements, they are audited. the accounts receivales clerk has never worked with sales and receiveables. unfortunately, i had to sign a bank commitment letter only two weeks after joining the company. i really think the earning misstatements first occured this quarter and that the prior year audited financial statements are not misstated. but, given the current events, i refused to sign the documents delivered to the bank on friday. i might add, however, that the HR vice president is the wife of the ceo”
“anyway, i’m just not sure what responsibilities i have disclose the earning misstatements to outside parties. i am considering all sort of options and thought i would see what advice you could offer. what do you think i should do, dr mitchell?”