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Fraud Focus: Contemporary and Historical Cases
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a. Management at Koss may have placed a high level of trust in Sachdeva because they
knew her for a long period of time and she did not exhibit behaviors that caused concern.
Further, management at the company was reportedly quite relaxed in its approach to monitoring
and control. These behaviors led to a lack of professional skepticism on the part of management.
c. Sachdeva’s lavish lifestyle should have raised suspicions because her level of
conspicuous consumption far exceeded her apparent ability to pay given her relatively modest
salary. However, her lifestyle may have been explained away or ignored because of her
husband’s prominent medical practice. People likely assumed that her lifestyle was none of their
business and that she simply used her family’s joint money to fund her lavish purchases. Even
when confronted with a known fraud, individuals that know a fraudster often have difficulty
believing that it is true – denial is a common factor even in the face of seemingly obvious signs
of fraud.
d. Management and the audit committee should have been skeptical of Sachdeva because of
the weak internal controls in place, coupled with deteriorating financial conditions at the
company. The auditors should have been more skeptical of her explanations for the financial
condition of the company. The auditors should have collected more audit evidence to better
f. Whenever an organization uses corporate credit cards, there should be controls over their
use. Most typically, such controls involve review and approval of payment by a senior official. In
Sachdeva’s case, senior management allowed her to use the credit cards without review, and she
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g. Top-level managers should have been skeptical about the reasons for Sachdeva’s
behavior. In retrospect, it seems that she was purposely trying to intimidate her subordinates
through this dominating behavior. Management may have questioned why she was trying to
intimidate her subordinates. Was there something that she was trying to cover up? This tactic
was also used at Enron, whereby top-level management would explicitly indicate that any
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a. Yes, the members of the audit committee appear to be professionally qualified. They
have all held financially responsible leadership positions at large companies in industries similar
to those as Koss Corporation. The committee meets less frequently than quarterly, which is fairly
infrequent. Prior to SOX, this level of audit committee involvement was common, but it is now
more common for audit committees of public companies to meet at least bi-monthly, if not
monthly. Without frequent meetings, committee members are not able to generate sufficient
b. Lawrence Mattson is the audit committee financial expert. He is a retired president of a
large consumer products company, which should make him financially knowledgeable.
However, the fact that he has clearly been retired for quite some time (he is in his late 70’s) calls
into question whether he is currently “up to speed” on the financial reporting demands faced by a
c. Their compensation is very low given the important role that they play in the company,
and the fact that this is a public board. Further, many audit committee members at public
companies receive stock options or stock grants to align their interests with the long-term goals
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of stockholders. These audit committee members receive no stock options, and hold very few (if
any) shares.
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This exercise is based on an article in the Wall Street Journal (Dell Investors Protest CEO in
Board Vote, by: Joann S. Lublin and Don Clark, Aug 18, 2010). The article provides more
details on shareholder voting for directors if the instructor is interested in pursuing that aspect of
governance. In terms of the specific questions:
a. The following are the corporate governance principles presented in the chapter. Students
could argue that many of the principles could be in question at Dell. Of great concern is that
management has a great deal of control over the governance and there are questions about
management’s ethics and integrity. If the financial statements were intentionally misstated, this
calls into question the company’s commitment to transparency. Further, given Mr. Dell’s roles,
there are questions about the independence of the board.
• The Board’s fundamental objective should be to build long-term sustainable growth in
shareholder value for the corporation
• Successful corporate governance depends upon successful management of the company, as
management has the primary responsibility for creating a culture of performance with
integrity and ethical behavior
b. The discussion in part a. suggests that Dell’s auditors should have some concerns about
the quality of governance at Dell. And this in turn suggests that the audit might have heightened
risk.
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d. In general, having an independent board chair would improve governance. Given the
alleged behavior of Mr. Dell, it may be even more important at Dell, Inc. Recall however that no
individual or company admitted wrongdoing in this case.
Application Activities
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a. The skepticism continuum is founded on the belief that professional skepticism is related
to a questioning mind, and that an individual may range from a neutral mindset, to a presumptive
doubt mindset, to complete doubt. Complete trust would be outside the range on the continuum
of professional skepticism. The continuum then relates to evidence collection, whereby lower
skepticism is associated with less audit evidence and documentation and higher skepticism is
associated with more audit evidence and documentation.
c. Common human judgment tendencies that can weaken individual auditor professional
skepticism include the following:
• Overconfidence. The tendency of individuals to overestimate their own abilities.
Overconfidence can lead the auditor to not spend enough time critically thinking about
client-related facts that would otherwise raise red flags.
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This research question asks students to summarize the PCAOB’s concerns with respect to
problems their inspection teams have noted in auditors’ performance in each of the following
areas.
a. Auditors’ overall approach to the detection of fraud
Problems noted:
1. auditors often document their consideration of fraud merely by checking off items
2. lack of involvement by senior members of the engagement team
b. Brainstorming sessions
Problems noted:
2. Brainstorming sessions were sometimes conducted AFTER audit evidence
c. Auditors’ responses to fraud risk factors
Problems noted:
2. Auditors sometimes collect evidence, but do not tie it to specific known fraud risk
d. Financial statement misstatements
Problems noted:
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2. Failure to investigate known departures from GAAP to determine if those
departures were indicative of fraud.
3. Failure to post material items to a summary sheet indicating material
misstatements, or inappropriately netting misstatements. This causes senior
e. Risk of management override of controls
Problems noted:
2. Failure to evaluate the fraud risk potential associated with end of period journal
f. Other areas to improve fraud detection
Problems noted:
2. Failure to adequately audit accounts receivables, which are related to revenue
recognition (an area in which auditors are supposed to presume fraud)
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a. The PCAOB sets standards for audits of public companies and defines the auditing
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assuring audit quality, i.e., the threat of inspection should lead to more consistently high audit
quality on all engagements even though not all engagements will actually be inspected.
b. The rationale for the requirement was probably to get people from diverse disciplines to
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a. Shareholders would normally not know what qualifications are important for their
external auditors. If the CEO or CFO had these responsibilities, the auditor would be more likely
to bend to their wishes rather than take the hard stances that may be required for fair financial
reporting. Part of the purpose of designating the audit committee to oversee the audit is to have
an advocate for the stockholders of the company.
b. Factors to consider in evaluating the external auditor’s independence include:
• The nature and extent of non-audit services provided to the client.
c. This part of the problem will vary based upon the company that each student selected.
This is a good problem to assign if you feel that your students are unfamiliar with locating basic
public company filings using the SEC online data system.
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The purpose of this project is to get students familiar with resources related to businesses and
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This exercise illustrates that the issue of corporate governance is a global issue. The insights the
students will obtain will depend, in part, on the countries selected for research. For example, a
Academic Research Cases
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a. The issue being addressed is the role that risk, internal controls, and risk management
within a company has on external audit demand and therefore, audit fees. Much research has
been done on factors that may have an effect on audit fees. Some research has indicated that
audit fees are affected by the size of the company, inherent risks such as receivables and
litigation risk attributable to the auditor. Other research has indicated that these results are not
consistent. Specifically, this research focuses on four risk issues that may affect audit fees. The
b. The research indicated that there is a positive association between internal control/ risk
management in an organization and audit fees as well as corporate governance and audit fees. In
an organization with multiple stakeholders, the stakeholders are able to share control costs and
therefore more apt to lead to an increased voluntary demand for levels of control. Audit fees are
c. Companies with greater corporate governance and voluntary controls have an increased need
and desire for external audit assurance. This would also imply that these companies expect a
higher quality audit, but they are more willing to pay for the higher quality audit. Companies
with less corporate governance and only mandatory controls are more willing to sacrifice audit
quality to reduce audit fees for the company.
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Only 50 companies elected to provide all information necessary to complete the research. Risk
and risk-management data for these companies was hand-collected from the 2001 annual reports.
Estimation models were used to determine the effect of risk variables, governance variables, and
the joint effect of these risks. Risk variables were given a score of 1 to 5 and included disclosures
about management of financial risk, disclosures about management of compliance risk,
disclosures about management of environmental risk, disclosures about management of
e. The research is somewhat limited due to a relatively small sampling of companies being
used. Also, the risk and risk management data was retrieved from the 2001 annual reports.
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a. The issue being addressed is the need for an internal audit report (IAR) to increase
governance transparency for external stakeholders. Governance transparency is defined as the
availability and extent of governance-related disclosures. The internal audit function is critical to
The legal liability for internal auditors may increase as a result of the potential to become more
accountable for the performance of an internal audit. Additional requirements for performance of
the audit could result in loss of flexibility in determining the scope of the internal audit as
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would increase internal auditor value within the corporate world, as well as the audit profession
itself.
b. The results of the interviews that were conducted definitely indicate that an IAR has the
potential to improve external stakeholder understanding of the internal audit function and
corporate governance. As a result, corporate governance would be more transparent to the
external stakeholders. The interview results indicate that increased transparency may lead to
Increased cost considerations determined in the interviews included increased legal exposure for
internal auditors as they would be held more accountable for their performance as well as more
accountable for financial reporting failures. This increased liability could affect availability of
qualified auditors as well as their desired compensation as a result of the increased liability.
Increased information load for users is another cost concern. The corporate disclosure is already
c. An internal audit report supplied to external stakeholders could have several implications on
audit quality. The report would potentially increase the accountability of the internal auditor,
providing the auditor an incentive to apply more diligent care to the audit itself, therefore
increasing the quality of the audit. The increased accountability and public review could provide
the internal audit group with leverage for asking for critical resources and access within the
d. Data was gathered by conducting 18 semi-structured interviews, which averaged 20
minutes in length. A semi-structured interview format was used to allow new topics and
questions to be introduced by the interviewees. The interviewees were selected using a
convenience sampling. The interviewees consisted of four audit committee members (including 2
audit committee chairs), three analysts from investment firms, five internal auditors (including
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e. The research for this paper did not consider the extent to which external stakeholders
deduce adequate information about the internal audit function from current governance
disclosures. Additional research is also needed to determine the costs and benefits derived from
various wordings on an IAR within a mandatory versus voluntary environment.
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a. The authors examine newsworthy cases in the pre-SOX era to identify the correlation
between audit committee (AC) characteristics (independence and financial expertise including
both accounting and non-accounting financial expertise) and the occurrence of misappropriation
of assets. They are particularly interested in how AC financial expertise and independence relate
to the incidence of misappropriation of assets in publicly-held companies.
b. Companies whose AC members were independent and possessed non-accounting
financial expertise had a reduced likelihood for the occurrence of misappropriation of assets. The
presence of a financial expert was especially necessary (even with accounting expertise, but to a
lesser extent than non-accounting), as ACs with independence but no financial expertise were not
significant in reducing the occurrence.
Without considering AC independence, overall financial expertise (comprised of both accounting
and non-accounting financial expertise) and non-accounting financial expertise were both
c. When assessing the internal controls of a company, the auditor should not automatically
assume an increased control risk solely due to lack of accounting expertise on the AC. As shown
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by this study, non-accounting financial expertise is actually correlated with a stronger control
environment that deters instances of fraud. So, auditors need not be overly-skeptical of (nor
overly-reliant upon) the company’s internal controls based on the background of the financial
expert.
Ford and Toyota
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Note to instructor: The solutions based upon the FYE 2012 annual reports for Ford and Toyota are posted
at the Cengage web site for the 9th edition of this text. The solutions for FYE 2014 will be posted at the
Cengage web site for the 10th edition of this text.
Ford and Toyota Semester Project: Using these instructional resources based on Ford and
Toyota, students will have the opportunity to apply the concepts from each chapter within the
context of two actual companies. We have used these types of exercises in our undergraduate
and graduate auditing classes . In the undergraduate classes, the authors used these types of
FORD AND TOYOTA GROUP PAPER DESCRIPTION
The purpose of this group paper is to summarize your in-class discussions of the Ford and
Toyota materials. The case is worth 100 points and will be due the last day of class. Note the
following:
1. There is no page limit. Simply type up your answers (single space text is
appropriate, and please use 12cpi font) to each class assignment as we proceed
throughout the course. Keep them in a file and hand them in at the end of the course.
3. Start a new class day/assignment on a new page of paper.
4. The text of your responses should address the assigned questions. Assign one
group member per class day/assignment to be a note-taker, and that person will also be