• Defending Koss And Their Auditors: Just Loopy Distorted Feedback

    By • Jan 16th, 2010 • Category: Grant Thornton, Latest, Pure Content, The Case Against The Auditors

    It must have been fun to work for a company with an iconic product.
    LA-based DJ Medi4 gives you a little taste of the KOSS Silent Disco at the 2007 ‘Roo.

    My objective in writing this story was to handily contradict Grant Thornton’s self-serving defense to the Koss fraud.

    The defense supported by some commentators:

    Audits are not designed to uncover fraud and Koss did not pay for a separate opinion on internal controls because they are exempt from that Sarbanes-Oxley requirement.

    But punching holes in that Swiss-cheese defense is like shooting fish in a barrel.  Leading that horse to water is like feeding him candy taken from a baby. The reasons why someone other than American Express should have caught this sooner are as numerous as the acorns you can steal from a blind pig

    Ok, you get the gist.

    Listing standards for the NYSE require an internal audit function.  NASDAQ, where Koss was listed, does not.  Back in 2003, the Institute of Internal Auditors (IIA) made recommendations post- Sarbanes-Oxley that were adopted for the most part by NYSE, but not completely by NASDAQ. And both the NYSE and NASD left a few key recommendations hanging.

    In addition, the IIA has never mandated, under its own standards for the internal audit profession, a direct reporting of the internal audit function to the independent Audit Committee. The SEC did not adopt this requirement in their final rules, either.

    However, Generally Accepted Auditing Standards (GAAS), the standards an external auditor such as Grant Thornton operates under when preparing an opinion on a company’s financial statements – whether a public company or not, listed on NYSE or NASDAQ, whether exempt or not from Sarbanes-Oxley – do require the assessment of the internal audit function when planning an audit.

    Grant Thornton was required to adjust their substantive testing given the number of risk factors presented by Koss, based on SAS 109 (AU 314), Understanding the Entity and Its Environment and Assessing the Risks of Material Misstatement.  If they had understood the entity and assessed the risk of material misstatement fully, they would have been all over those transactions like _______. (Fill in the blank)

    If they had performed a proper SAS 99 review (AU 316), Consideration of Fraud in a Financial Statement Audit, it would have hit’em smack in the face like a _______ . (Fill in the blank.) Management oversight of the financial reporting process is severely limited by Mr. Koss Jr.’s lack of interest, aptitude, and appreciation for accounting and finance. Koss Jr., the CEO and son of the founder, held the titles of COO and CFO, also.  Ms. Sachdeva, the Vice President of Finance and Corporate Secretary who is accused of the fraud, has been in the same job since 1992 and during one ten year period worked remotely from Houston!

    When they finished their review according to SAS 65 (AU 322), The Auditor’s Consideration of the Internal Audit Function in an Audit of Financial Statements, it should have dawned on them: There is no internal audit function and the flunky-filled Audit Committee is a sham.  I can see it now. The Grant Thornton Milwaukee OMP smacks head with open palm in a “I could have had a V-8,” moment but more like, “Holy cheesehead, we’re indigestible gristle-laden, greasy bratwurst here! We’ll never be able issue an opinion on these financial statements unless we take these journal entries apart, one-by-one, and re-verify every stinkin’ last number.”

    But I dug in and did some additional research – at first I was just working the “no internal auditors” line – and I found a few more interesting things.  And now I have no sympathy for Koss management and, therefore, its largest shareholder, the Koss family.  Granted there is plenty of basis, in my opinion, for any and all enforcement actions against Grant Thornton and its audit partners.  And depending on how far back the acts of deliciously deceptive defalcation go, PricewaterhouseCoopers may also be dragged through the mud.

    Yes.

    I can not make this stuff up and have it come out more music to my ears. PricewaterhouseCoopers was Koss’s auditor prior to Grant Thornton. In March of 2004, the Milwaukee Business Journal reported, “Koss Corp. has fired the certified public accounting firm of PricewaterhouseCoopers L.L.P. as its independent auditors March 15 and retained Grant Thornton L.L.P. in its place.” The article was short with the standard disclaimer of no disputes about accounting policies and practices.  But it pointedly pointed out that PwC’s fees for the audit had increased by almost 50% from 2001 to 2003, to $90,000 and the selection of the new auditor was made after a competitive bidding process.  PwC had been Koss’s auditor since 1992!

    The focus on audit fees by Koss’s CEO should have been no surprise to PwC.  Post-Sarbanes-Oxley, Michael J. Koss the son of the founder, was quoted extensively as part of the very vocal cadre of CEOs who complained vociferously about paying their auditors one more red cent. Koss Jr. minced no words regarding PwC in the Wall Street Journal in August 2002, a month after the law was passed:

    “…Sure, analysts had predicted a modest fee increase from the smaller pool of accounting firms left after Arthur Andersen LLP’s collapse following its June conviction on a criminal-obstruction charge. But a range of other factors are helping to drive auditing fees higher — to as much as 25% — with smaller companies bearing the brunt of the rise.

    “The auditors are making money hand over fist,” says Koss Corp. Chief Executive Officer Michael Koss. “It’s going to cost shareholders in the long run.”

    He should know. Auditing fees are up nearly 10% in the past two years at his Milwaukee-based maker of headphones. The increase has come primarily from auditors spending more time combing over financial statements as part of compliance with new disclosure requirements by the Securities and Exchange Commission. Koss’s accounting firm, PricewaterhouseCoopers LLP, now shows up at corporate offices for “mini audits” every quarter, rather than just once at year-end.”

    A year later, still irate, Mr. Koss Jr. was quoted in USA Today:

    “Jeffrey Sonnenfeld, associate dean of the Yale School of Management, said he recently spoke to six CEO conferences over 10 days. When he asked for a show of hands, 80% said they thought the law was bad for the U.S. economy.

    When pressed individually, CEOs don’t object to the law or its intentions, such as forcing executives to refund ill-gotten gains. But confusion over what the law requires has left companies vulnerable to experts and consultants, who “frighten boards and managers” into spending unnecessarily, Sonnenfeld says.

    Michael Koss, CEO of stereo headphones maker Koss, says it’s all but impossible to know what the law requires, so it has become a black hole where frightened companies throw endless amounts of money.

    Companies are spending way too much to comply, but the cost is due to “bad advice, not a bad law,” Sonnenfeld says.”

    It’s interesting that Koss Jr. has such minimal appreciation for the work of the external auditor or an internal audit function. By virtue, I suppose, of his esteemed status as CEO, COO and CFO of Koss and notwithstanding an undergraduate degree in anthropology, according to Business Week, Mr. Koss Jr. has twice served other Boards as their “financial expert” and Chairman of their Audit Committees.  At Genius Products, founded by the Baby Genius DVDs creator, Mr. Koss served in this capacity from 2004 to 2005. Mr. Koss Jr. has also been a Director, Chairman of Audit Committee, Member of Compensation Committee and Member of Nominating & Corporate Governance Committee at Strattec Security Corp. since 1995.

    If I were the SEC, I might take a look at those two companies…Because I warned you about the CEOs and CFOs who are pushing back on Sarbanes-Oxley and every other regulation intended to shine a light on them as public company executives.

    No good will come of this.

    I don’t want you to shed crocodile tears or pity poor PwC for their long-term, close relationship with another blockbuster Indian fraudster. Nor should you pat them on the back for not being the auditor now. PwC never really left Koss after they were “fired” as auditor in 2004.  They continued until today to be the trusted “Tax and All Other” advisor, making good money filing Koss’s now totally bogus tax returns.

    Picture 41

    As cheapo as Mr. Koss Jr. seems to be when it comes to audit fees, ostensibly saving a few million on PwC and a Sarbanes-Oxley 404 audit as well as a few internal auditors, his skinflinty-ness has cost his family, and his father’s legacy, more than $30 million.  Who knows? Maybe given Mr. Koss’s progressive attitudes about technology and focus on everything but his family’s business – he has a blog and a Twitter account as well as a penchant for being interviewed in the major media like some kind of CEO idiot savant – we may find out someday, like a plot out of a Bollywood movie, that  something deeper and more spiritual was going on between him and Ms. Sachdeva

    How else to truly explain handing a non-family member the keys to the kingdom?

    Maybe, back in 2004, PwC insisted on a Sarbanes-Oxley 404 audit or additional procedures based on the control weaknesses they knew so well? Maybe Koss said no way and found Grant Thornton, an audit firm that would not insist on more work given the risks?

    Interestingly, this “problem-child” client hand off mirrors the one at Overstock, another example of paternalistic management preoccupation with everything but the real numbers.  There, PwC walked away and Grant Thornton took over less than a year ago, in spite of whatever PwC knew and could tell them about the muck they were walking into.  In the Overstock case, however, when Grant Thornton woke up and quit/was fired, KPMG, another Big 4 firm, was ready to take their place and take the idiot management’s money for however long they last.

    In this case, Koss went down another notch in the public accounting world and selected Baker Tilly, a next-next tier firm to be their next auditor and help them get out of the current mess, if possible, by restating multiple years of financial statements.  Just like Mr. Koss’s other company, Genius Products, had to restate after he stepped down as a Director and Audit Committee Chairman.

    You may say, “Who’s getting hurt here?”  After all, the family, the vast majority shareholders, took some risks and we might assume understood full well the cost/benefit equation of running a loosey-goosey shop. (We haven’t even begun to talk about their IT…)

    Well…the hundreds of employees at their factories, their vendors, their customers, and business partners, the IRS, the minority shareholders (maybe even their employees in the 401k plan) and, of course, the communities they operate in are getting hurt.

    Because it will be a miracle if Koss survives this fiasco as a going concern.

    If you cry any tears, they should be for the boutiques that counted on Ms. Sachdeva as their biggest and, I am sure, by a long shot their most lucrative customer.

    Valentina was one of 12 retailers, including seven in the Milwaukee area, where Sachdeva allegedly used the card for $4.5 million in purchases and paid the balance with Koss funds.

    “You find yourself dumbfounded,” Valentina owner Tony Chirchirillo said of the news. “We never expected anything like this.” She seemed to be “a very nice person” who placed special orders for designer gowns and garments that cost between $2,000 and $8,000, he said. “She always wanted the best — beyond our usual price range,” Chirchirillo said.

    Chirchirillo said he and his wife, Cheryl, and daughter, Gina Frakes, who run the store, assumed “she came from money” and that her job at Koss, plus her husband Ramesh Sachdeva’s position as a prominent pediatrician, provided the spending money…The Chirchirillos…are now planning the future of the business with the “devastating” loss of their biggest customer, he said.

    “It threw everything upside down,” Chirchirillo said.

    How many $1+  million shop-o-holics can there be in Mequon?

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    Post Script: In researching what has been written about Sujata Sachdeva already, especially in the Indian press, I came across several references to a classic Indian film of the same name. Here’s an excerpt from one review.  The additional link is to a storyboard of the film.

    Sujata is Bimal Roy’s classic on the social issue of untouchability..this film succeeds in making a social malaise which has been plaguing indian society for centuries into an intensely personal study.

    Seen from the POV of Nutan who plays the title role of Sujata, the film (its the irony of the highest order that a girl bearing the name of Sujata which in hindi means- a ’’good’’ caste-whatever that means!!! is deemed ’’untouchable’’) sensitively examines the impact and implications it has on the young girl’s life.

    The plot is simple: An infant from a ’’low’’ caste…untouchable’’ family is adopted by a well-educated, cultured family in the pre-independence era. She is named Sujata and she becomes a kind of companion of the newly born daughter of the family. They grow up to become Nutan and Shashikala respectively. Nutan considers this to be her own family doing all the household chores and acting as a friend and companion to the younger Shashikala.

    A distant relative of the family tries to fix the match of her grandson(Sunil Dutt) with Shashikala but instead Sunil Dutt is drawn towards the simplicity of Sujata who too after initial inhibitions reciprocates. But all hell breaks lose when the grandmother(Lalita Pawar) comes to know of it and she is further shell-shocked to learn that the girl is ’’Achoot’’.

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    23 Responses »

    1. Nice shot and not the first time this has happened by far.

      I have personnally seen the same scam pulled by the Finance Director on at least 10 different occassions (over 30 years experience). Almost always with companies with the same disregard for internal audit, internal controls and the external auditors envolvement in anything beyond signing the financial statements.

      I would guess anyone who has been in the audit profession over 5 years has also witnessed this at least once.

      In most of thecases I saw however, it never made the news, or even a police report. The victum companies were concerned about public image and were willing to accept payback to the extent the perp could make restitution.

      Personally, I am not sure any law can prevent this.

      Reporting on the lack of segregation of duties (which we did) also seems to have limited effect. “He/she is a trusted employee.”

      There is a difference though between private and public companies and your commnets on enforcement speak to perhaps the only avenue for action. Similar to horse theives in the old west – Catch’em, try’em, hang’em.

    2. […] respected colleague Francine McKenna did a great deal of research and writing about why Grant Thornton shouldn’t get a pass in the Koss case. She’s found a lot of interesting information about Koss Corp., its finance function, its […]

    3. You obviously don’t know a whole lot about auditing and the professional standards –

      SAS 109 (AU 314), Understanding the Entity and Its Environment and Assessing the Risks of Material Misstatement – based on the industry Koss is in (manufacturing), the audit team most likely would assess greatest risk of material misstatement for inventory/cost of goods sold and revenue recognition. So I don’t see how this would have helped in catching this fraud (unless of course these items were being recorded as inventory purchases).

      SAS 109 (AU 314), Understanding the Entity and Its Environment and Assessing the Risks of Material Misstatement requires auditors to make inquiries with management and outside the accounting function about their assessment of where the greatest risk of material misstatement due to fraud would occur. Things would be discussed like tone at the top, management/board oversight, etc. Again, there is no direct relationship here that would indicate that Grant didn’t perform this required procedure or something came to their attention that should have alerted them that something was wrong.

      Additionally, without obtaining and reviewing all management letters provided by Grant, it is impossible to state whether or not the internal control issues that were present had been identified by Grant and ignored by management (possibly due to cost), or whether the audit team was asleep at the wheel. Generally speaking (from my experience), smaller companies have inherent segregation of duties issues which require much greater participation at the board and management level in order to offset some of the additional inherent risks. As an outsider looking in, when you have a family owned and run business, chances are this company lacked the fresh set of eyes and discipline needed in such a work environment. You feel very vulnerable as an auditor of these types of business, because frankly, a fraud like this would be easy to perpetrate and conceal. Depending on how the fraudulent items were recorded, a perfectly planned an executed audit may have uncovered these items, but I have been a part of such few flawless audits in my career that it is unlikely this would have ever happened (usually these things get unraveled by the greed of the person committing the fraud)!

      Finally, there is a vast difference in the cost and billing structure between a Big Four firm and a national firm like Grant. And even though Grant had a lower fee than PwC, chances are there was more involvement from the partner and manager during the Grant audit than the PwC audit.

    4. @themadhacker

      Not sure why you think I don’t know about auditing or the standards…

      We don’t know yet how this fraud was perpetrated, which accounts were manipulated, or what. And Grant Thornton’s work, partner time, management letters, etc will be scrutinized in detail in any lawsuits. A class action suit has already been filed.

      In fact, it seems that you are agreeing with me. In fact, inventory and cost of sales is where Tracy Coenen the fraud expert right there in Wisconsin has been saying she thinks the fudging occurred. If you read the whole post, I’m saying that executive and board oversight was lacking, clearly segregation of duties didn’t exist, and what happened is prima facie evidence that there were no controls over the financial statements, cash, or bank activities. Add to that no internal audit and an impotent Audit Committee and I think anyone would have seen this fraud with one eye closed. In fact, I’m sure I would have because I have seen just such attitudes by executives and just such lax work by auditors.

      The jury is still out. Unless someone pays me to help the plaintiffs I probably won’t be pointing out in any detail where I think the bodies are buried, although I have very strong suspicions.

    5. I can’t imagine anyone will ever write a finer blog post.

      It seems so obvious in hindsight. I’m glad you’re here to provide that hindsight.

      Dave Albrecht

    6. Francine:
      I glanced at Koss’s financials for the last five years. Nothing seems out of line on the surface. The amounts purportedly stolen by Sue Sachdeva (SS) as reported by Going Concern on 12 January 2010 were these percentages of Koss sales for the five fiscal years ending 30 June 2009: 5.4%, 4.4%, 6.8%, 10.7% and 22.2%. These are astounding numbers if true. Had GT done a late-1970s Arthur Andersen-type “transactions flow audit” of purchases and cash disbursements, GT should have found this.
      That Koss had no internal audit function does not bother me. With about $50 million in sales, it couldn’t have one. I put no stock in the SAS 99 review. As far as I am concerned, it is a pile of self-serviing AICPA claptrap. Where SS worked from is also irrelevant as far as I am concerned.
      I have no sympathy for the Koss familiy or GT. GT didn’t charge enough in 2008 to do a proper audit. $134,000 in 2009 was a reasonable fee. Had GT spent 50 hours on the purchases/cash disbursements test, at say $150 an hour, or $7,500, it should have found this. What did GT spend its time on? Form filling to accomodate the PCAOB which likes to see lots of completed checklists?
      I agree with Jeffrey Sonnefeld and have blasted Sox as a waste of the investing public’s money for years. I’ll say again, AIG, Goldman, Freddie, Fannie, Citigroup, etc., all had internal audit groups, internal controls and audit fees of $50 million and up. So?
      If I were PWC in 2004, I would never have insisted on a Sox 404 audit. However, I would have probably done much more extensive tests than PWC likely did.
      GT should have declined this audit for $63,000. I would have. Enough. Let the lawsuit fly!

      IA

    7. @2 is an interesting link, she also writes very well but seemed to be artfully pulling punches.

      This text looks like she is trying to “tell it”;

      –I could suggest that auditors “man up” and refuse to work with clients unless they became more diligent about their internal controls, but doesn’t often happen. Some auditing firm is all too happy to accept a client recently fired by their auditors. And the auditors are reluctant to tell one another the real reasons why they quit or were fired. It’s just not good for business.–

      Almost like a Salomon Brothers without the Warren Buffet.

    8. @FranPlan – re the blogger linked @2, she was among the first writers I read on the KOSS fraud topic. My initial take was that she was being overly generous in defense of GT and supporting the AICPA party line that audits should not be expected to identify frauds, even considering the auditing standards that specifically require that auditors assess the risk of fraud in financial reporting, which apply without considering SOX compliance. Then, I linked to and read other articles she’s posted on frauds in general, as well her position on auditors and frauds as presented on her web site. My thinking now is that her blogging on KOSS is secondarily for informational purposes. Based on the way she writes it seems to be primarily a sales pitch for her services. That is – No one should think that auditors will discover frauds, so the only way a company can be sure is to hire her firm to do fraud specific audits. From info I’ve read on ACFE research on fraud detection, even fraud specific audits aren’t number one in discovering frauds. Her fraud audit and investigation credentials look very good, but her sales pitch seems to be a bit over the top.

      @themadhacker – Independent Accountant is on target for approach to discovery of what appears to be this auditable aspects of this fraud. With a total fraud of $30+ million over 5 years, average fraud over that time would have been $24,000+ per work day. As Independent Accountant pointed out in listing the fraud % per year, it would have been less than that in the beginning, but substantially higher than that in the last 2 years. The only way the fraud could have occurred and been hidden on a daily basis would be if a large number of small journal entries were being generated. After the EY failure to discover fake journal entries at Healthsouth something like that should have been a red flag for any auditor. If the fraudulent transactions were recorded based on separate payments to the credit card, rather than daily batches of smaller journal entries to create expense and an accrual, the individual payments would have run into the high 10’s of thousands and eventually into the 100’s of thousands of dollars, any of which should have been well above the threshold for payments to be specifically examined in an audit test, particularly to a vendor that was a card being used for personal purchases. I could see it being a smaller test sample if the vendor was a raw materials supplier, but AMEX, no way to ignore it. Even if the daily batches of small journal entries were being done to create fictitious expenses, there would still be the separate large payments to the credit card when they were made. I’m not clear if the AMEX card was a company card being used for personal purchases (a fraud risk red flag that should merit specific audit testing) or a personal card being paid by company funds (which should have definitely resulted in specific testing). And, the tests would not have affected the audit costs much, if at all. At most, it would be 12 AMEX payments per year. Of course, if it turns out that the fraud was multi-faceted instead of the simple, direct to AMEX approach that’s been presented in the writings so far, it would have been easier to hide from the auditor’s, although it would have required a lot more time and effort and should have generated the kinds of volume manual journal entries that are a red flag. If GT only did reasonableness tests and comparative analysis, I’m still having difficulty understanding how someone explains away amounts representing 20% of Cost of Sales or 50% of SG&A to the satisfaction of any reasonably skeptical auditor.

    9. […] contention has been made that the auditors should have found this fraud, as they are required to consider fraud in planning and performing their audits. Further, the fraud is at an estimated $31 million (my guess is it will end around $50 million), […]

    10. Hi Richard – No, none of it is a sales pitch for what you call “fraud specific audits.” I have no interest in doing that kind of work.

    11. Koss Porta Pros are great headphones for the price – recommended to all the busy season slaves out there :)

    12. If she disguised her thefts through debits to asset account or debits to liabilty accounts such as accounts payable, then the auditors should have picked up the theft. Reviewing Koss’s financials:

      (1) Accounts receivable and inventory each represent close to 3 months of sales for the fiscal year end Jun. 30, 2009. That looks high. The percentaqe of A/R to sales and inventory to sales is much higher than the prior year.
      (2) The company’s net fixed assets increased by $1.3M. This is mostly an increase in tools and dies. Why did this increase so much in 2009?
      (3) Accounts payable declined by more than $1.1M.

      If she disguised the thefts by classifying her purchases as “tools and dies” or by classifying them as purchases that go into inventory or by charging it to accounts payable, the auditors should have identified the theft.

    13. I don’t think its accurate to say that audits are not designed to uncover fraud. It would be more accurate to say that audits may not always uncover a fraud perpetrated by management when there has been collusion and that auditors are not responsible for detecting fraud when they have complied with all generally accepted auditing standards.

      The amount stolen was staggering. It was more than 5% of the firm’s gross revenues over the period of the thefts and in the last year, the thefts appear to have represented close to 20% of gross sales. In my previous post, I suggested that the perpetrator attempted to conceal this theft through bogus debits to the purchases account which affects costs of sales and inventory, the fixed assets (tools and dies) account, the accounts payable account and possibly other accounts.

      I think you would have to see why the auditors missed these items. If they failed to examine fixed asset accounts to determine the existence of those assets and the thefts were hidden partially in that account, then the auditors did not comply with GAAS. The same applies if the thefts were hidden in inventory or in reduced accounts payable. The auditors did not comply with GAAS.

    14. David:
      I don’t care how SS attempted to conceal her fraud. I assign a 99.9% probability I would have caught it, THE WAY I AUDIT, no later than 2006. Possibly in 2005. I’m serious. I know what I am doing. Had the Arthur Andersen (AA) I remember of the late 1970s, done a “TFA” audit, it would have found the fraud. In all likelihood in 2005.
      Let’s not go overboard. Assume “1978’s AA” had taken a 250-item sample of cash disbursements and selected it using “dollar-unit” sampling, that’s one item for every 0.4% of disbursements. With 5.4% of the 2005 dollars supposedly fraudulent, that’s 13 sample items which should have been questioned by 1978’s AA (5.4% / 0.4% = 13). What did the CPAs look at for from 2005-2009? How may sample items did they draw? From what? As Casey Stengel said when he managed the NY Mets in about 1962 after the NY Yankees, “Can anybody here play this game”? Do PWC or GT know how to audit anymore? Does anyone?

      Richard Archer:
      SAS 39 was adopted to require CPAs sample small items, not just look at items “above scope”. In my opinion, SAS 39 and its progeny and SAS 47 and its progeny are two of the most poorly understood SASs. This fraud should have been caught. Even if SS debited her Amex charges to purchases, the supporting documentation should have revealed that inventory items were not being bought for Koss use. Where were the receiving reports to support the disbursements?
      I agree, a Coopers & Lybrand “flux review” should have turned this up.
      Koss may be the most poorly performed audit since Coopers & Lybrand’s 1992 Phar-Mor fiasco.

      IA

    15. David – Audits are awful at finding fraud. It’s either because audits are not designed to detect fraud or the auditors are idiots. Which do you choose? Audits still are designed to detect material misstatements from errors. They are not designed to detect them from irregularities. I’d be more than happy if auditors changed their work to have a better chance of finding fraud. But that’s not where we are today. To continue to lie to ourselves and say that audits are designed to detect fraud is silly. It accomplishes nothing. We have to stop pretending and start admitting that audits aren’t useful tools.

    16. @Independent Accountant (comment 6 & 14) makes significant point about substance vs. form of auditing standards.

    17. In some news reports, there was some mention of some other employees who have been suspended/fired. It is doubtful that the VP Finance could have done this on her own. It is highly unlikely that she was posting the journal entries for these fraudulent activities or reconciling the CC account. She had to have someone help her.

      More than likely, she bullied her staff and forced them to help her carry out the fraud. Someone knew about this other than the VP, she had help. Unfortunately in instances like this, most employees don’t have a way to report this type of activity to the Board of Directors via a confidential incident reporting process.

    18. Tracy: If my hypothesis regarding how she attempted to hide the fraud is correct, then the fraud did result in a material misstatement of the balance sheet. Why would a manufacturer have 5 months of inventory on hand? (Inventory of 9.7 million divided by cost of goods sold of 24 million) Why would the inventory turns be reduced to close to 2 per year? And, why were accounts payable reduced so much from the prior year? And, what’s with the large increase in tools and dies? Even if the CPA were only doing a review and not an audit, there are red flags that should have caused this fraud to be detected.

      Independent Accountant: I am of the belief that most frauds could be detected through a thorough review of the financial statements and other analytical procedures and that most financial statement frauds could be spotted without an audit. Examples of such frauds are those at Worldcom, Global Crossing, Qwest, Sunbeam and Crazy Eddie. It sounds reasonable to me that this fraud could have been detected with a test of expenditures.

      You also have to question how management never discovered her thefts considering how much she was stealing.

    19. This highlight one reason why not all CPA’s are crazy about moving to IFRS. The current GAAP rules are rules based while IFRS is more principles based. Auditors have much more to hang their hat on when getting sued if they can prove that they have complied with the “rules” of the profession. “Principles” are much harder to hang their hat on.

    20. […] It’s easy to say that the auditors should have caught the fraud. That’s said all the time when a big fraud hits the media. But the fact is that audits rarely find fraud, and relying on the auditors to find fraud is silly. Sure, we can think of a bunch of ways that auditors could have found a fraud if they looked in the right places. But the auditors are not finding fraud. Let’s stop pretending that auditors do find fraud, because they don’t. Related Posts […]

    21. Late again. Tracey and Francine have very good points regarding Koss management and internal control structure. This is, along with understanding Koss as a business, any auditor’s first and foremost duty, that of professional competence. Pretty much all the other things regarding SASs just add to the specific areas of incompetence.

      Audits have always had the purpose of identifying errors and irregularities. The duty to report being a matter of materiality. In todays computerized records world analytics would have provided a simple path to focus audit efforts. For the remainder of areas simple statistical methods would have covered the remianing transaction base.

      Basically, an audit makes assumptions regarding the reliability of both recorded and unrecorded transactions. When management and internal controls cannot reduce audit risk the auditor needs to perform the highest level of transactional testing. Auditors’ generally have failed to make the connection to rely solely on detection (audit risk) when controls are lacking, ineffective (management override), or inoperative.

      As someone previously indicated, once you have assessed that management and the control environment are ineffective and possible even obstructive a reasonable auditor would decline the engagement or recognize the risk and plan the audit accordingly.

    22. It’s interesting (and ironic) to note that in January 2007, Koss’s external auditor, Grant Thornton LLP, was commissioned by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) to develop guidance designed to help organizations monitor the quality of their internal control systems. Their end product was to serve as a tool for effectively monitoring internal controls, as well as complying with the U.S. Sarbanes-Oxley Act of 2002 (SOX).

    23. […] month on “Ponzi’s Auditors” and I have two nice quotes. I’m talking about auditors’ responsibility for detecting fraud under SAS 99 and about the doctrine of “in pari delicto” as it relates to the AIG case against PwC […]

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