ABCABLE, INC.

ABCable, Inc. is a publicly traded cable provider. Among its current services are providing cable services, including television, Internet access and local telephone service. ABCable experienced rapid growth in all markets beginning in the late 1990s and continuing through now.

While revenues continue to grow, income is showing signs of declining to a level beneath that expected by analysts who follow the company. In an analysis of why, Sally Bens, financial vice president, discovered that maintenance of cable systems has become an increasingly large cost particularly in new cable coverage areas. She pointed out to Bill Jones, the president, that in the relatively new areas maintenance is high, particularly when viewed from the perspective that the areas currently have few customers. Jones has suggested that it doesn't seem right to face such high expenses when "everyone knows we will have a larger customer base in a few years in those areas."

Shortly thereafter, Bens and Jones decided to transfer out of Cable Maintenance Expense and into the Capitalized Cable account enough of these expenses to enable net income to meet analysts' forecasts. Documentation in some cases was created indicating a correction of an error and in some cases no documentation was created to support the entries.

Subsequently, these types of transactions were posted quarterly, on an "as needed" basis. Bens rationalized that it was indeed unfair to expense so much of the maintenance cost in rapidly growing areas. Jones didn't give it a lot of thought other than to periodically remind Bens of how important meeting EPS growth rates was.

The above scheme does not meet generally accepted accounting principles and led to materially misstated financial statements. Under generally accepted accounting principles, these transactions should have been expensed. Thus, the ABCable overstated assets and income.

1.Is this an example of fraudulent financial reporting or misappropriation of assets?

2.SAS No. 99 requires a number of inquiries of management, the audit committee, internal auditors, and others. Which, if any, individuals responding to these inquiries might be likely to reveal this scheme to the auditors?

3.This is an example of management override. What types of procedures does SAS No. 99 prescribe for management override? Which, if any, of these procedures would have a possibility of detecting the scheme?

4.Review Appendix 1 below. Which fraud risk factors are present in this case? List them and cite the example from the case.

Appendix 1: Examples of Fraud Risk Factors

Misstatements Arising from Fraudulent Financial Reporting

Incentives/Pressures

Opportunities

Attitude/Rationalization

1.Threatened financial stability or profitability

• High degree of competition
• or sales saturation
• High vulnerability to rapid
• changes (e.g., technology,
• interest rates)
• Declines in customer
• demand, business failures in
• industry
• Operating losses
• Negative cash flows from
• operations
• Rapid growth or unusual
• profitability
• New accounting, statutory,
• or regulatory requirements
• 2. Excessive pressure on management to meet requirements or third party expectations due to
• Profitability or trend level expectations
• Need for additional debt or equity financing
• Marginal ability to meet exchange listing requirements
• Likely poor financial results on pending transactions
• 3. Management or directors' financial situation threatened by
• Significant financial
• interests in company
• Significant portions of
• compensation contingent on
• results of company
• Personal guarantees of debts
• of company
• 4. Excessive pressure to meet financial target set up by directors or management

1. Industry provides opportunities for

• Related-party transactions
• beyond ordinary
• Company can dictate terms or
• conditions to suppliers or customers (may result in inappropriate transactions)
• Accounts based on significant estimates
• Significant, unusual or highly complex transactions
• Significant operations across international borders with differing business environments and cultures
• Significant bank accounts in tax haven jurisdictions
• 2. Ineffective monitoring of management allows
• Domination of management
• by a single person or small
• group without controls
• Ineffective board of director
• or audit committee oversight
• 3. Complex or unstable organizational structure
• Difficulty in determining
• organization or individuals
• with control of company
• Overly complex structure
• High turnover of senior
• management, counsel, or board members
• Internal control deficient
• Inadequate monitoring of
• controls
• High turnover rates or
• ineffective accounting, internal audit or information technology staff
• Ineffective accounting and information systems

Relating to board members, management, or employees

• Ineffective communications,
• implementation, support or
• enforcement of ethics
• Nonfinancial management
• excessive participation in selecting accounting principles or determining estimates
• Known history of violations of securities or other laws
• Excessive interest in maintaining or increasing stock price
• Aggressive or unrealistic forecasts
• Failure to correct reportable conditions on a timely basis
• Interest by management of employing inappropriate means to minimize earnings for tax reasons
• Recurring management attempts to justify marginal or inappropriate accounting based on materiality
• Strained relationship with current or predecessor auditor

Misstatements Arising from Misappropriation of Assets

Incentives/Pressures

Opportunities

Attitude/Rationalization

1. Personal financial obligations

2. Adverse relationship between company and employees

• Known or anticipated layoffs
• Changes in compensation
• Promotions, compensation or other rewards inconsistent with expectations

1. Characteristics of assets

• Large amounts of cash on
• hand or processed
• Small, high value, or high
• demand inventory items
• Easily convertible assets
• (bearer bonds, diamonds,
• computer chips)
• Small marketable fixed assets
• 2. Inadequate internal control, including inadequate:
• Segregation of duties
• Job applicant screening of
• employees with access to
• assets
• Recordkeeping for assets
• Authorization or approval of
• transactions
• Reconciliation of assets
• Documentation of transaction
• s(e.g., credits for merchandise
• returns
• Requirements for mandatory
• vacations
• Management understanding of
• information technology
• Access controls over
• automated records

Attitude or behavior of those with access to assets susceptible to misappropriation

• Disregard for need for
• monitoring or reducing risks
• Disregard for internal control
• Behavior indicating
• displeasure or dissatisfaction with company or its treatment of employees
• Changes in behavior or lifestyle that indicate assets may have been misappropriated