John C. Koss started his first company, J.C. Koss Hospital Television Rental Company, in 1953, based in Milwaukee, Wisconsin, but John had greater ambitions. Eventually he partnered with Martin Lange, an engineer, and by 1958 the two had founded Koss Electronics, Inc. Their first product, the SP/3 Stereophone (the world’s first high-fidelity headset) wasn’t even intended to be a major product. Rather, the two business partners built it simply as an accessory to demonstrate the superior high-fidelity stereo sound of the portable stereo phonograph they had developed (if you don’t know what a phonograph is, search the Internet or ask a parent or grandparent). The high-fidelity headset debuted at a convention in Milwaukee where Koss and Lange demonstrated their new phonograph. What was novel about the instrument was a privacy switch that allowed people to plug in and listen through the headset without disturbing others around them. The phonograph with the privacy switch was intended to be Koss’s and Lange’s big innovation. But the headset stole the show.

The high-fidelity sound provided by the Koss headset was vastly superior to other headsets in use at the time; plus, the Koss headset, called a “private listening unit,” was the first to be commercially available to the public. The market was ripe for these “private listening units” because just two years earlier, Elvis Presley had released his first hit single, “Heartbreak Hotel” and Rock ’n’ Roll was just taking off. These headsets allowed teens to listen to their radically different music without annoying their parents! Over the years, Koss attempted to expand their business by developing other products. None of these products proved successful, and the company eventually stuck to the business of designing, producing, and selling high-fidelity headsets.

REQUIRED

[1] Describe management’s responsibilities in implementing effective internal control over financial reporting in a public company. What responsibilities did Koss Corporation’s management have to prevent or detect the embezzlement and accounting fraud? 

[2] In what ways did Koss management fail in its responsibilities relating to internal control over financial reporting? Note: Please be brief but be specific—consider organizing your response in accordance with the components (and principles) of COSO’s 2013 Internal Control: Integrated Framework (which can be found at www.coso.org). 

[3] As Koss Corporation’s financial statement auditor, what responsibilities did Grant Thornton have to detect the embezzlement and accounting fraud? List and briefly describe at least three red flags that could have alerted the auditor to the fraud. What audit procedures might the auditor have used to address those red flags in order to discover the accounting fraud and the embezzlement? 

[4] Based on the information presented in the case, do you believe Grant Thornton failed in its responsibilities to provide reasonable assurance that Koss Corporation’s financial statements were presented fairly in all materials respects? Justify your answer using specific arguments and examples. Include in your answer an assessment as to whether you believe an $8.5 million embezzlement in a single year at Koss would typically be considered material by most auditors, and why. 

[5] Assume the role of an expert witness who has been asked by a court of law to assess whether and to what extent Koss management and Grant Thornton were responsible for failing to prevent or detect the embezzlement and accounting fraud. Write a two-page professional opinion summarizing what you believe went wrong, and whether and how Koss management and Grant Thornton failed in their responsibilities. Cite specific examples to support your conclusion. Conclude your report with an assessment of whether Koss management and Grant Thornton should be held at least partly responsible for failing to prevent or detect the fraud. 

[6] List and briefly justify three or four specific steps that you believe would be most important for Koss Corporation to move forward after discovery of the fraud.

PROFESSIONAL JUDGMENT QUESTION 

It is recommended that you read the Professional Judgment Introduction found at the beginning of this book prior to responding to the following question. 

[7] Define the “overconfidence” bias and indicate how it may have played a role in the failure of Koss management and Grant Thornton to prevent or detect the fraud.