Accounting Assignment 3: Fraudin AIS Student’s name: Lecturer’s name: Date of Submission:  

Introduction to the firm

Koss Corporation is a well known American based firm that also design and manufacture headphones. The firm was incorporated in 1953 by John C. Koss. The firm was primarily known as J. C. Koss Hospital Television Rental Company. After that the CEO starts looking for more boosting ideas and he jointly with Martin Lange developed a stereo headphone. In 1991 the firm was headquartered in Milwaukee, Wisconsin, USA. At that time Koss Audio and Video Electronics commenced the new project of selling consumer electronics products through a separate brand and company. It is a family owned business and almost 75% of Koss is owned by the owner family. In 1980, the firm diversified into related areas of electronics, in 1984 that comes to end with a bankruptcy filing of almost $6 million. In 1985, Koss come outofChapter 11 bankruptcy proceedings.In 1991 Michael J Koss, son of founder John C Koss, took over as president and chief executive officer.In December 2009, previous VP of account Sujata “Sue” Sachdeva was accused in government court of wire misrepresentation after the firm found her theft of $34 million amid a five-year period amid which the organization’s normal net pay was $6 million.the arraignment expressed that to cover the extortion, Sachdeva looked to control different Koss workers to make deceitful entrances. Sachdeva was later sentenced to 11 years in government jail. Professedly, to the extent that $2 million of the missing trusts were utilized to buy attire and other extravagance things that were put away unused, regularly with the labels still joined. At last, Koss was compelled to restate five years of Financials.

Firm Embezzled Case

There were many failures in the firm’s accounting system that assisted this embezzlement to last for a decade. Sue Sachdeva was the main accountant at Koss Corporation and it is estimated that she embezzled over 34 million dollars during that time. Sachdeva was able to embezzle this amount through wire transfers, checks, and credit cards (Whitehouse, 2011). The first failure was the age of the AIS. It is estimated that the system was almost 30 years old. There were two offers to purchase a new system and each time Michael Koss, the CEO, denied the request (Whitehouse, 2011). Koss was operating on an outdated accounting system and probably thought that it was okay because he had auditors come in and authenticate the work it did. It is important to have a current system in order to keep accurate reports in keeping the company operating efficiently.

Another failure was the reports that were produced by the AIS. Michael Koss never took the time to look at the financial records of the company. Even though he was the CEO of the company, he never took adequate time to read and compare the financial statements on a monthly or yearly basis. SOX

The article recounts some specific problems within Koss:

* Koss Corporation prepared materially inaccurate financial statements, book and records, and lacked adequate internal controls from fiscal years 2005 through 2009.

* Michael Koss was supposed to approve the payment of invoices greater than $5,000, but no approval was needed for wire transfers or cashier’s checks (the primary method of theft by Sachdeva).

* The computer system was more than 30 years old, and did not lock the accounting system at the end of a month to prevent later changes to the books.

* Many account reconciliations were either not prepared or were not maintained as part of Koss’s accounting records. To the extent that reconciliations were conducted, they were improperly performed by the same persons who initiated or recorded the transactions, enabling those persons to make modifications to the reconciliations to cover up fraudulent entries.

* While Sachedeva provided Michael J. Koss with reporting certifications for his review, he did not conduct an adequate review of Koss’s accounting in connection with these certifications.

Risk and Responsibilities regarding Third Party Accounting System

Outsourcing isa common practice in the contemporary corporate environment, and the accounting function is one of the important functions that is outsourced. The reason for outsourcing is the advantages as the outsourcing involves the less costs, and the training and development costs are reduced, also the management is not burdened with the accounting issues, and however the responsibility for the true and fair account remains on the shoulder of the management. The management is responsible for the true and fair accounts and not the service provider in the case of outsourcing the accounting function so the clerical tasks related to the accounting functions can be transferred, but the responsibility for these tasks cannot be transferred or outsourced.

An outside organization will have access to the extremely confidential data and the lack of appropriate internal controls or incompetency in service provider can cause material errors and fraud, any organization can outsource its functions but it cannot outsource the responsibility for implementing internal controls (Hall, 2011). The outside organization will tackle the accounts of the company, it will have the access to the potential information, which can be used for the insider trading, and the third party can personally get the benefits but selling or purchasing the shares when the prices are expected to rise or fall.

The risks related to the outsourcing the accounting function is the clash with the auditing function, and this occurs when the firm, which is providing the outsourcing services, also performs the external audit of the company’s accounts. The accounting function and the auditing function create similarities and the outsourcing firm may have personal interest when auditing the same firm with which it were in contract by providing the accounting services. The auditing function  will not be independent, and the company can hide its drawbacks in the auditing report, as the company is examining itself, and it has certain interest in enhancing its performance.

The outsourcing of the accounting function increases the risk, and the company cannot transfer the risk, responsibility by transferring the outsourcing function to the third party. (Smith, 2013) The outsourcing functions also have ethical concerns and the precious accounting service provider can provide the auditing services which raises ethical issues. The other issues related to the accounting and auditing function clash is a familiarity issue in addition to the inherent interest, and most importantly, the responsibility cannot be transferred for any discrepancy in detecting and preventing fraud. The management of the company is responsible for the prevention and detection of the fraud, the task of the accounting service provider is to provide the extension of the organization function, but it would not limit the responsibility of the company in maintaining the true and fair financial statements. The auditors are also not responsible for preventing and detecting the fraud, but they are liable to make an opinion on the financial statements regarding the truth and fairness of these reports.

Prevention From Fraud

The Koss scandal has resulted in the more strict scrutinizing of the other companies; the financial data does not disclose the true information, and the degree of disclosure varies from country to country and the true profitability and the asset values could be concealed, the data was available after 3, or 4 months after the year end (Aitel, 2011). The Koss Scandals could have been prevented if the drawbacks in the accounting system would have been detected earlier. The tighter scrutiny of the accounts and the regulations regarding the independence of auditing function may have prevented from the failure of the Koss. The auditors are liable to form opinion regarding the truth and fairness of the financial information, and the auditors’ performing their duty by providing external audit is the legal requirement, both now and at the time of Enron’s collapse. The auditor did not predict about the affairs of the company, and the disclosure regarding the going concern of the company was not published with the financial information. Presently, any issues relating to the going concern of the company must be disclosed, as they hold potential value for the investors and the shareholders.

The collapse of the failure resulted in the lack of confidence in shareholders and their interest was exploited by the company’s management and other stakeholders. Very strict regulations were implemented to restore the confidence in the people regarding the publicly listed companies and the publicly traded stock of these companies as this phenomenon had provided setback for the people. The Sarbanes Oxley Act was the immediate consequence of the corporate scandals like Koss and WorldCom etc. and this law resulted in stronger independence for auditors, and the auditors are required to be rotate every five years, requires CEO and CFOs to personally certify the statements, requires audit committees and code of ethics in place (Aitel, 2011). The Sarbanes Oxley Act has many implications and one of which is the establishment of the board that regulates the auditing function. The Sarbanes Oxley Act proposed the independence of the auditors.

The independence of the auditors has various aspects. The auditor must be a proficient person and it must be an associate of the professional accounting body, and must hold appropriate competence to form opinion on the financial statements, and secondly the auditor must not have familiarity to the company. The firm that is providing the accounting services should not provide the auditing service to the company in the context of external audit, and there must be no personal familiarity. The personal familiarity, partnership in business or acquaintance is likely to affect the professional opinion of the auditor, therefore it has been recommended that the auditor should be independent; the auditor should be competent and must possess independence.

The selection of the auditor can defeat the motive of independence and the remuneration of the auditor, and the timing of the audit fee can affect the auditing function, therefore independent audit committee is recommended. The audit committee sets the remuneration, and this remuneration must not be excessive, and also it should not include any bribe or ‘gift’ to the auditor, and it is the ethical responsibility if the auditor to leave or resign, if there are issues with the independence and the remuneration of the auditor. The company’s may put pressure on the auditor if there is significant amount is in balance regarding the remuneration of the audit.(Coenen, 2013).

Possible Changes to SOX 2002 or Current Laws

The Sarbanes Oxley Act has resulted in increased costs because it requires the establishment of different committees and the costs are increased for the compliance requirements; this act is the major factor in the decision of going a company public, and public company, this act is making more difficult to hire and retain qualified directors (Niskanen, 2007). The setting of various committees is an extra cost for business and the companies, which are converting from the private companies to public companies, will have to bear substantial costs in setting these committees and meeting the requirements of this legislation. The companies, which are public companies, tend to go private because of the burdens that this act has levied on the companies. The responsibility of the companies have been increased at the public level as they hold the investors and shareholders’ investment in the business therefore the strict regulations are the necessity for the corporate systems, and without this act the confidence of the shareholders may not have been restored.

The Sarbanes Oxley Act has made the directors and the Chief executive officers personally responsible for the financial statement and the financial affairs of the company. This act requires the CEOs to sign the financial statements and hence they are legally held responsible for the affairs of the company, and they should exercise their authority and power to prevent and detect any fraud in the company. The directors are not necessarily being committing fraud, the employees of the company may commit the frauds and they may not be the actor of the CEO in committing fraud, and they may commit fraud or misstatement for their personal benefits. However, the CEO should ensure that there are proper controls, which protect the company, form the fraudulent activities or misrepresentation.

The setting of the auditing company is helpful in maintaining the internal audit function. It helps in coordinating the internal audit function with the external audit function to ensure the objectivity and the independence. The internal audit function have to face more issues related to the independence in contrast to the external audit, but as the internal audit is not the legal requirement, therefore no strict regulations were in place in regarding to the internal audit function. The internal auditor may face the hurdles in reporting on the drawbacks in the system or reporting any misstatement or fraud, especially if the management is involved in it, but setting the audit committee helps the internal audit to function more effectively.

The audit committee in contrast to the internal audit department is not required to report to the manager, but the audit committee is required to report to the upper level employees, which are the directors of the company; therefore the manager may not exercise undue influence of the representatives of the internal audit department.

 The Sarbanes Oxley Act requires the establishment of various committees such as audit committee and the remuneration committee and these committees ensures the independence in both the audit and remuneration function. The directors can set very high pays for themselves, which may not be appropriate; however, with the establishment of such committees they may hold the shares and can get the higher incentives for their performance in addition to their salaries. The purpose of the remuneration committee is also to hire and retain the directors of the company, and this is useful making the board of directors for the company. The board of directors must include the executive and non executive directors. The executive director’s look after the day to day functioning of the company, whereas the non executive directors analyze the executive level information, however the board of directors must include a person with the required expertise in relevant field for example accountancy.

The structure of the board of the directors has the prime importance to the company, and the board of directors are both the representative of the company, employees and the shareholders; therefore the Sarbanes Oxley act applied stricter regulations to include the non executive directors in the company, as they will not have interest in the concealment of the information, as in the case of executive directors and in contrast to the executive directors, they cannot benefit from any manipulation or fraud.  The structure of the board of directors is the corporate level preventive approach in protecting the fraud and manipulation and ensuring the independence at the higher organizational level.

The element of surprise can be an efficient method to detecting fraud early on. Companies know where auditors will be checking and alter figures and entries so the predictable test won’t be alarming. This could prevent auditors from being complacent in their test and how they operate. This would involve changing the requirement from five down to three years.

Strategy to Prevent Fraud

The US congress passed the Sarbanes Oxley Act after the corporate failure of the companies like Enron, Koss etc., this law establish new Public Company Accounting Oversight Board with the power of licensing the auditing firms, and regulating accounting functions; it requires the CEO and CFOs to personally sign the financial statements, hence they are personally liable (Graham & Smart, 2011). The Sarbanes Oxley was passed in 2002 and its approach is rules based approach in contrast to the UK approach, which is the principle based approach. This act provides the regulation regarding the accounting functions and the accounting policies, and it requires the company, specifically the publicly listed companies, to include the vouching certificate with their financial statements. This act is helpful in restoring the confidence of the people in the accounting, auditing, and the overall corporate governance system. The companies, which are listed publicly, are the ultimate target of this act, as their shares are public traded, and the public at large have interest in keeping these shares. The boards of directors are responsible for the misstatement and the prevention and detection of fraud, and they may face criminal prosecution if they are found guilty of committing fraud and concealment or manipulation in the financial statements.

Internal controls are essential. (Coenen, 2013). Auditors need to plan part of their audits in analyzing internal controls. These internal controls could entail items like sign off on set money limits, dual signatures on checks over certain amounts, dual review of monthly financial reports, requiring all entries to have proper documentation, or have access logs to the accounting system.

Under the Koss embezzlement there were numerous wire transfers and checks that were over the preset $5000.00 threshold that required the CEO’s approval before proceeding. This internal approval control was not enforced by the CEO or those processing the transfers within the organization. There is a chance that if the CEO was looking at the monthly reports and compared this to the actual transfers, this discrepancy could have been caught earlier. Since the embezzlement has come to light, Koss has criticized the companies accepting payment that they should have reached out to Koss to question the big payments they were receiving (Koss, 2014).

Another failure was not requiring paperwork of bills or bill pays to be audited at a later date. This internal control would allow another person to validate the charges and bills being paid to match what was issued. In Koss scenario, the perpetrator and her assistant were able to fix the books because they knew no one was checking these items as outlined. Koss could have appointed someone to match the invoices with the bills as to check the accuracy of the outgoing charges. The auditing firm gave back money because they concluded they did not perform at their best in detecting these possible internal control errors (Airtel, 2011).

When auditors are completing their work sometimes the come across figures or documents which do not support the internal controls and these are called exceptions. It is important for companies to follow up on exceptions or missing information during audits (Coenen, 2013). The information failure may have been prevented in the Koss if the company has adopted a fair valuation of the assets and appropriate accounting policies. The accounting policies must be consistent, and they should not be adjusted according to the necessity. The accounting polices should have retrospective effect when they are changed and the concern in bringing retrospective change is the consistency in the financial statements.

The financial statements should be published timely, and the auditing function must be carried out in rather short time. The publishing of the financial statements is very lengthy process, and the auditing of these statements may also take time, therefore the information, which is brought to the people after 3 or 4 months, will not have the usefulness as if it were on time. These processes cannot be eliminated; however, their efficiency can be enhanced to provide the timely information of the stakeholders and those who have interest in the company. The disclosures for the significant events must be announced at the AGM with the financial statements and the relevant reporting criteria must be met.

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from: http://www.sequenceinc.com/fraudfiles/2013/06/escaping-detection-why-auditors-do-not-find-fraud/

Hall, J. A. (2011). Accounting Information Systems (Hall), 8th ed. Cengage Learning.

Koss website visited on 4th Oct, 2014. Retrieved from: http://www.koss.com/en

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