08-9: Fraud and Illegal Acts
Sean Chang, Billie Sayavong, John Hamilton,
September 24, 2011
Our project team analyzed the Fraud and Illegal Acts Case (True blood Case Studies- Case 08-9), which involves a questionable sales transaction made between Jersey Johnnie’s Surfboard, an SEC registrant, and Mr. Sinaloa, an independent sales representative of the company. As a simplified overview of the case, an external audit firm was hired on to perform a year-end audit of Jersey Johnnie’s Surfboards, Inc. Towards the end of the audit, the engagement partner notified the auditors that there could be a possibility of fraud and illegal acts made by the company. The engagement partner received a call from the company’s director of ethics and compliance, who stated that an anonymous employee of the company had called into the hotline questioning a sales transaction that seemed suspect. The sales transaction occurred at year-end on December 31, 2010, which seemed suspicious because of the timing of the transaction and effect the transaction had on the year-end figures. Specifically the employee noticed a sales invoice dated December 31, 2010 made out to a Mr. Sinaloa. This transaction was suspect for the employee because the company does not typically recognize revenue associated with products shipped to Mexico until Mr. Sinaloa presents the company with a confirmed sales order.
On March 15, 2011, Moore, Billings & Co., PLC was brought in to do a private investigation on the validity of the sales transactions made by Jersey Johnnie’s Surfboard and Mr. Sinaloa. On December 31, 2010, Moore, Billings & Co., PLC concluded that there were no signs of fraud from the sales transaction at year-end. The following are several findings by Moore, Billings & Co., PLC to confirm their results:
a)There was an oral agreement between Mr. Sinaloa and Jersey Johnnie’s Surfboard regarding a possible sale back in October 2010 to have the products shipped to him before any issuance of sales orders.
b)Mr. Sinaloa’s relationship with Jersey Johnnie’s Surfboard shifted from agent to distributor, which allows Mr. Sinaloa to receive his compensation in the form of commissions for his work.
c) The customer’s general manager was on vacation, therefore was not present to sign the purchase order for the transaction which took place on December 31, 2010.
Issues and Related Pronouncements
There are several issues and questions concerning this case that are to be answered in order to accurately state whether the transaction is valid or is considered fraudulent. These are also questions pertaining to those involved with the case and if their actions are legit.
Issue 1: What steps should management, the Board of Directors, or the Audit Committee of the Board of Directors take in response to allegations of possible fraud or illegal acts?
Related Pronouncements: (a) Sarbanes-Oxley Act 2002: Section 301, (b) AU Section 333: Manager Representations, and the publication of [Institute of Internal Auditors, American Institute of Certified Public Accountants and Association of Certified Fraud Examiners, Managing the Business Risk of Fraud: A Practical Guide (2008)].
Issue 2: What steps should the audit engagement team take in response to allegations of possible fraud or illegal acts?
Related Pronouncements: AU Section 316: Consideration of Fraud in a Financial Statement Audit; paragraphs .51 to .67: Responding to Assessed Fraud Risk. Paragraphs .79 to .82: Communicating about possible Fraud to Management, the Audit Committees, and others.
Issue 3: Was the scope of the independent investigation sufficient?
Related Pronouncements: The publication of PCAOB has given the specific method to the auditors. [AU Section 316A, Consideration of Fraud in a Financial Statement Audit]