Morne Enterprises Ltd has experienced sustained growth in recent years under the leadership of the last two CEOs, both of whom were promoted from within the business. The company began by making steel, but has now diversified into manufacturing and supplying all types of packaging, including metal, plastic and paper-based products. It has also diversified into a range of other businesses including household appliances in Europe, the United States and Asia.

At the beginning of last year, the incumbent CEO died of a heart attack and the board took the opportunity to appoint a new CEO from outside the company. Despite the company’s growth, returns to shareholders have not increased during the last decade. The new CEO has a reputation of turning around struggling businesses by making tough decisions. The new CEO has a five-year contract with generous bonuses for improvements in various performance indicators, including sales/assets, profit from continuing operations/net assets, and share price.

During the first year, the new CEO disposed of several segments of the business that were not profitable.

Very large losses on the discontinued operations were recorded and most non-current assets throughout the business were written down to recognise impairment losses. These actions resulted in a large overall loss for the first year, although a profit from continuing operations was recorded. During the second year, recorded sales in the household appliances business in the United States increased dramatically, and, combined with various cost-saving measures, the company made a large profit.

The auditors have been made aware through various conversations with middle management that there is now an extreme focus on maximising profits through boosting sales and cutting costs. The attitude towards compliance with accounting regulations has changed, with greater emphasis on pleasing the CEO than taking care to avoid breaching either internal policies or external regulations. The message is that the company has considerable ground to make up to catch up with other companies in both methods and results. Meanwhile, the share price over the first year and a half of the CEO’s tenure has increased 80 per cent, and the board has happily approved payment of the CEO’s bonuses and granted the CEO additional options over the company’s shares in recognition of the change in the company’s results.

Required

(a) Discuss the incentives, pressures and opportunities to commit financial report fraud, and attitudes and rationalisations to justify a fraud in the above case.

(b) What financial report frauds would you suspect could have occurred at Morne?