The Anonymous Caller

Recognizing It's a Fraud and Evaluating What to Do

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Learning Objectives
Appreciate real-world pressures for meeting financial expectations
Distinguish financial statement fraud from aggressive accounting
Identify alternative actions when confronted with suspected financial statement
fraud
Develop arguments to resist or prevent inappropriate accounting techniques
It was 9:30 A! on a !onday morning" one li#e a thousand others in the $a#ed %ity Dr
&estland was sipping his morning cup of coffee" pondering 'a#e van der (amp)s rant in the
*outh %hina !orning +ost when the call came through
,-i Dr &estland" do you have a minute.
,
,*ure", the professor replied
,I am one of your former students" /ut if you don0t mind" I would prefer to remain
anonymous I thin# it is /est for /oth of us if I not reveal my name or company to you I am
concerned that the senior executives of the company where I serve as controller 1ust
provided our local /an# fraudulently misstated financial statements I need some fast
advice a/out what to do %urrently" I am on my car phone and need help evaluating my
next step /efore I head to my office this morning !ay I /riefly descri/e what0s going on
and get some input from you., she as#ed
,2o ahead" let me see if there is some way I can help", responded Dr &estland
,I am the controller of a small start-up company that I 1oined three and one-half months
ago 3n 4riday of last wee#" the company0s chief executive officer 5%637" the vice
president of operations" and the chief financial officer 5%437 met with representatives of
the /an# that funds the company0s line of credit 3ne of the purposes of the meeting was
to provide our most recent quarterly financial statements 8he company is experiencing a
severe cash shortage" and the /an# recently halted funding the line of credit until we
could present our most recent operating results It was at that meeting" 1ust three days
ago" that our senior executive team #nowingly su/mitted financial statements to the /an#
that overstated sales and receiva/les accounts,
,6arlier on 4riday" prior to the /an# meeting" I vehemently refused to sign the com-
mitment letter required /y the /an# /ecause of my concerns a/out the inclusion of sales
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8his case was prepared /y 4ran# A :uc#less" +hD and !ar# * :easley" +hD of $orth %arolina *tate ;niversity and *teven !
2lover" +hD and Douglas 4 +rawitt" +hD of :righam <oung ;niversity" and significantly edited /y ' %hristopher &estland +hD %+A
8he names presented in this case study are fictitious" and any relation to persons living or dead is purely coincidental 8his case study is
intended as a /asis for class discussion" and is not intended to illustrate either effective or ineffective handling of an administrative
situation If you are actually reading this disclaimer" please raise your hand
transactions to customers on account that I #new did not meet revenue recognition criteria
specified /y 2AA+ I explained to the %63 and %43 that I /elieved including those
transactions in the quarterly results would constitute fraud 8hey continued to insist that the
financial statements needed to reflect the transactions" /ecause without them" the /an#
would not continue funding the line of credit 8hey accused me of living in an ,ivory
tower, and emphasi=ed that companies /oo#ed these #inds of transactions all the time
Although they acted li#e they appreciated my desires for perfection and exactness" they
made me feel li#e it was my lac# of experience in the real world that #ept me from having
a more practical perspective to a common /usiness practice ;nfortunately" none of the
senior executives have accounting-related /ac#grounds I am the top-level accounting
person at the company,
,3ver the wee#end I had time to thin# a/out the situation" and now I am even more
convinced that this is clearly fraud !y %63 and %43 have /een arm-twisting the
accounting staff to /oo# sales transactions /efore sales occur As a matter of fact" the cus-
tomers haven0t placed any #ind of orders with our company and no goods have /een
shipped to them 8he %63 and %43 noted that /oo#ing these #inds of credit sales
transactions is a common /usiness practice" even if it isn0t technically compliant with
2AA+" given that the transactions represent sales expected in the very near future" perhaps
even next wee#,
,As it turns out" the %63 even instructed the accounts paya/le cler#" while I was out of
the office for a couple of days" to record entries the %63 had handwritten on a piece of
paper 8he accounts paya/le cler# has never wor#ed with sales and receiva/les 8he %63
told the cler#" who wor#s part-time while finishing his accounting degree at your
university" to not mention the entries to me unless I specifically as#ed In that event" the
cler# was supposed to tell me that the entries related to new sales generated /y the %63
and that all was under control 4ortunately" the student cler# is currently ta#ing your
auditing course" where financial statement fraud is a topic" and he was uncomforta/le
with what had transpired -e immediately updated me on the day I returned a/out what
had happened 8hese /i=arre entries ma#e up almost half of our first quarter
0
s sales 3f
course" given that these are quarterly financial statements" they are unaudited 3ur external
auditor has not performed any #ind of interim review of them,
,Do you thin# this is limited to 1ust one quarter., Dr &estland as#ed,
,I thin# so", the caller replied ,As I mentioned" I 1oined the company three and a half
months ago 3ne of my first tas#s involved closing out the prior fiscal year and assisting
the external auditors with the year-end audit As /est I can tell" these unusual activities
/egan 1ust recently given our poor results in the first quarter of this year 3ur company is
a start-up enterprise that has /een operating at a net loss for a while 'ust last wee#" the
/an# stopped clearing chec#s drawn off the company account 8hey weren0t necessarily
/ouncing them" /ut they were not funding the line of credit until the first quarter results
were presented on 4riday Interestingly" the /an# immediately started funding the line late
4riday and" I understand /ased on phone calls with my staff this morning" the /an# is
continuing to fund the line this morning I really thin# the earnings misstatements first occurred this
quarter and that the prior year audited financial statements are not misstated ;nfortunately" I had to
sign a /an# commitment letter only two wee#s after 1oining the company 8hat commitment letter
related to funding the loan right at the close of the last fiscal year *o" my signature is on file at the
/an# related to prior-year financial results :ut" given the current events" I refused to sign the
documents delivered to the /an# on 4riday 3ne of my accounting cler#s resigned last wee# due to
similar concerns 3ur vice president of human resources 5->7 discussed the resignation with me
after learning a/out the cler#0s concern during a final exit interview I might add" however" that the
-> vice president is the wife of the %63,
,Anyway" I0m 1ust not sure what responsi/ilities I have to disclose the earnings misstatements to
outside parties I am considering all sorts of options and thought I would see what advice you could
offer &hat do you thin# I should do" Dr &estland.,
Questions for Discussion
9 &hat would you recommend to the caller if you were Dr &estland. &hat are the ris#s of
continuing to wor# with the company. &hat are the ris#s of resigning immediately. %ould
the state /oard of accountancy /e a source of advice.
? &hat responsi/ility" if any" does the caller have to report this situation directly to the /an#
involved. :efore you respond" thin# a/out the ris#s present if the caller does inform the
/an# and it later turns out that the caller0s assessment of the situation was inaccurate and" in
fact" there was no fraud
3 &hat other parties should /e notified in addition to the /an#. &hat concerns do you have
a/out notifying the external auditors.
@ Do you thin# situations li#e this 5ie" aggressive accounting or even financial statement
fraud7 are common practice. &hat pressures or factors will executives use to encourage
accounting managers and staff to go along. &hat arguments can you use to resist those
pressures. -ow does one determine whether a company is aggressively reporting" /ut still
in the guidelines of 2AA+" versus fraudulently reporting financial information.