Management Control

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Case 2

Case 2 is divided into two independent parts. You have to complete both parts.   Part 1: Case “Spice is right” (Hall, Chapter 4, Internal control case) (max 1-2 pages) Only point c (COSO), not a, b, and d. Part 2: Case “Vouch and Trace” (max 2-3 pages)

Vouch and Trace You are a new accounting graduate and this is your first week on the job at the Los Angeles office of a CPA firm. You are still adapting to Los Angeles and to your new job in this fast-paced and exciting environment. Here you are, plucked from a small city located among farmland in the Midwest, adjusting to the big-city lifestyle. You earn more than you ever imagined and you live in an overpriced, tiny apartment. Last night, you couldn’t fall asleep because of the street noise and the excitement of your move, so you stayed up far too late reading a book called The Financial Numbers Game: Detecting Creative Accounting Practices (Mulford and Comiskey 2002). The last chapter you read was called ‘‘Recognizing Premature and Fictitious Revenue’’ (Mulford and Comiskey 2002, 159–196). You finally fell asleep thinking about the topic and your first training session for new employees, scheduled to start the next day. The previous week you had read another intriguing book called The Number: How the Drive for Quarterly Earnings Corrupted Wall Street and Corporate America (Berenson 2003), which had also piqued your interest in this topic. You arrive at the conference center early. The only other person in the seminar room is Ms. Claire Rogers, a senior partner from San Francisco who is the instructor for the first training session on Revenue Recognition. ‘‘Good morning. Please sit down,’’ Claire Rogers says. ‘‘What do you think of Los Angeles? I’m very interested in hearing about your initial impression of your new job.’’ ‘‘As you might imagine, this is all very new and exciting to me,’’ you reply. ‘‘In fact, I was reading a book last night that I believe will help me with this training.’’ ‘‘I’m impressed. What were you reading about?’’ she asks. ‘‘How to detect premature or fictitious revenue,’’ you answer, because the last chapter you read is the first one that comes to mind. ‘‘Although we covered the topic in our auditing class at college, I did not realize that this type of financial statement fraud was so pervasive in the real world.’’ You are now on a roll. Before Ms. Rogers has a chance to respond, you continue: ‘‘The Association of Certified Fraud Examiners conducted a fraud survey in 2006. This investigation of 120 reported cases of financial statement fraud found that fictitious revenues accounted for 43 percent of such fraud schemes. Schemes involving timing differences, where the fraudsters manipulate net income by recording sales in the last month of one fiscal year and the matching expenses in the first month of the next financial year, accounted for 28 percent of the fraud schemes (ACFE 2006). An older study sponsored by the Committee of Sponsoring Organizations (COSO) found that more than half of financial statement frauds involve revenue and/or accounts receivable, the two most common types being fictitious and premature revenues (Beasley et al. 1999). Also, the Securities and Exchange Commission (SEC) identifies revenue recognition as an issue that surfaces in a significant number of

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enforcement cases and the largest single issue involved in restatements of financial statements (Turner 2001). This is not a new problem. It’s been around for a long time.’’ When Ms. Rogers finally gets a word in, she says: ‘‘Yes, there are many high-profile cases involving misstatement of revenue. For example, in 2002 it was reported that AOL inflated sales by recording barter deals and advertisements sold on behalf of others as revenue to keep up its growth rate. This was done in an effort to seal the deal in AOL’s bid for Time Warner (Wells 2005). Your research is very timely for this training session, but don’t forget that revenue misstatements can...
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