Case 5-6
Dunco Industries
The following two cases deal with accounting issues at Dunco Industries.
Part 1 – Marcus Yamabuto
Marcus Yamabuto graduated from Washington State University in June 2013. He began his career working
for Dunco Industries, a public company that manufactures plasma television monitors. Frank Johnson is the
chief executive officer of Dunco and Karen Gross is the chief financial officer of the company. Dunco has a
three-person audit committee and the chair is Ken Holden.
Dunco is the original equipment manufacturer (OEM) of 42- through 64-inch plasma screens. The
company sells its monitors to major manufacturers in the United States and overseas. Marcus was hired
directly by the internal audit department and reports to Francey Gordon, the director of internal auditing.
Both Marcus and Gordon are CPAs.
Marcus was assigned to review sale documents and freight bills to determine the amount of freight, the
terms of the sale, and the proper cutoff treatment. During the course of his examination, Marcus discovered
$2.4 million that was prematurely recognized as revenue by the accountants for the year ended December
31, 2013. He identified the problem by matching the invoices with corresponding freight bills and found
that the shipping date of the transaction was January 2, 201 4. However, there was a note signed by the
freight forwarder: “Picked up for shipment at Dunco warehouse on December 31, 2013.”
Marcus went to see Gordon to discuss the matter. They determined the $2.4 million was material and
should have been recorded in 2014. They were concerned about the premature revenue recognition given
the impending external audit that will begin next week.
Question
Assume that Francey Gordon goes to Karen Gross and Frank Johnson to discuss the matter. Gordon
tells Gross and Johnson that just because the freight forwarder indicates the merchandise is picked
up on December 31, that doesn’t justify reporting the revenue until the foods are on its way to
customers. Gross and Johnson disagree and instruct Gordon to leave the matter alone. What would
you do if you were Francey Gordon at this point? Be sure to include your ethical obligations in the
discussion.
The issue at hand is how to account revenue recognition when freight is involved with the delivery of the
merchandise. Freight is designed as free on board (f.o.b.) either shipping point or designation point. The
point indicates when the legal title changes hands. It is used for revenue recognition but also for insurance
purposes to determine who is responsible for a loss during shipping. With fob shipping point, the legal title
of the goods changes hands at the shipping point. This freight designation means that revenue is recognized
once the item is picked and in transit via the freight or shipping company. With fob destination point, the
legal title of the goods changes hands at the buyer’s destination or receiving point. With this freight
Part 2 – Sandy Cole
Sandy Cole is a staff auditor of Lyons & Co., CPAs. She just completed her review of various accrual
accounts during a routine audit of one of the firm’s clients, Dunco Industries. Sandy uncovered ten manual
entries made after the quarter’s close that lacked sufficient supporting documentation and that significantly
reduced the reserve balance for each account. She reviewed the entries in the system and found the same
explanation for each reduction: “reduce accrual by $1.5 million, per Jim Benson, corporate controller.” The
total amount of reductions came to $15 million, and was material to the financial statements of Dunco.
Sandy bought this information to Joan Franks, the audit manager who was in-charge of the engagement.
Franks advised Sandy to discuss the entries with the corporate controller. The controller provided verbal
support for each entry. Sandy had no reason to disbelieve the controller, so she cited the lack of supporting
documentation as an audit finding and completed the report.
Six months later, news came out that the controller was adjusting various accrual accounts to manipulate
earnings. Sandy was distraught about the situation, and questioned her conduct and the audit procedures.
Joan Franks was asked by Grace Wong, the audit partner in charge of the engagement, to explain why the
audit team did not pursue the findings and press for supporting documentation.
The controller was terminated, and the company underwent an investigation by the SEC. Sandy continued
to wrestle with her conscience: “I’m an auditor, not an investigator….right?” she thought.
Questions
1. What is the role of an external auditor? Is it to simply examine the client’s financial statements
or more – to be an investigator in conducting and completing the audit?
Although an external auditor is not meant to be purely investigator, the external auditor is supposed to be
skeptical and plan and perform the audit to detect material errors or fraud. A careful audit is an
2. Evaluate the actions taken by Sandy Cole and Joan Franks in this case. Were their actions in
accordance with ethical and professional standards? Why or why not?
Sandy Cole, as a staff auditor, is a newer employee and is still being trained. When she found the manual
entries without sufficient supporting documentation, she reacted correctly with skepticism and took the
matter to her manager. Cole then followed Franks’ instructions to talk to the corporate controller and took
him at his word as the entries were legitimate. That was her main mistake. Cole violated the due care
Joan Franks, as audit manager, has a duty to train the newer personnel and to follow up on the suspicious
entries. Franks correctly told Cole to follow-up with the company controller. However, she possibly needed
more guidance on what to ask the controller or how to follow-up depending on what the controller said.
Franks was not skeptical enough in reviewing the audit work papers to see how Cole concluded on this