AIM Corporation: A Business Fraud Case Study

ABSTRACT: The Association of Certified Fraud Examiners (2016) indicates that asset misappropriation is the most common form of occupational fraud. Based upon a real company, this case contains six frauds: collusions, commissions, fictitious sales, rebates, refunds, and write-offs. It also includes several asset misappropriations (e.g., theft of cash, misuse of inventory, and fraudulent reimbursement) schemes. Furthermore, four of the six frauds are not found in other published case studies. The case seeks to enhance learning by having students (1) examine multiple fraudulent schemes within a single company, (2) identify frauds after examining firm procedures and documents, (3) suggest applicable fraud protection procedures, (4) identify internal control weaknesses, and (5) apply the fraud triangle. Undergraduate and graduate students from two universities performed well on the case.

Keywords: fraud; fraudulent schemes; investigation procedures.

CASE Introduction

Commercial Products, Inc., an international home and builder hardware supplier, is in the initial stages of acquiring AIM Corporation (AIM), a U.S.-based company that designs and manufactures various tools and related accessories. At Commercial Products' request, you, as a CPA firm employee, are asked to perform a due diligence investigation to determine whether the financial information and asset valuations appear reasonable. This information will help Commercial Products establish a purchase price.

We thank Barbara Apostolou (West Virginia University), Alan Reinstein (Wayne State University), and Brian Patrick Green (University of Michigan-Dearborn) for comments on earlier drafts of this manuscript. Editor's note: Accepted by Charles D. Bailey. Submitted: October 2016 Accepted: March 2018 Published Online: April 2018 A37 During your due diligence investigation, you receive an anonymous, brief phone call on your firm's whistle-blower hotline regarding a potential fraud occurring within AIM's operations. After discussions with Commercial Products and AIM, you and your firm's forensic accounting division will accept an additional engagement to determine whether fraud has occurred and who the perpetrators might be. To begin the forensic accounting engagement, the partner asked you to gather background information about the company. From an internet search and discussion with AIM's management, you reported the following company and market information to the engagement partner.

cases, and cutting tools for the routers and planers. Sales of these accessories account for approximately 12 to 15 percent of annual revenue.

To remain competitive, AIM introduces new products, accessories, or product modifications at annual trade shows in the various sales regions. Several times a year, employees from headquarters, manufacturing, distribution, and sales offices meet at the Stockton headquarters for a weekend briefing on the new products. During the most recent meeting, the president relocated two sales personnel to different regions to provide a more even distribution of seasoned/ experienced sales staff. One individual was relocated from the Northwest region to the Southwest region, and one from the Southwest region to the Northeast region. Relocated sales personnel are no longer involved with prior customers and are to work only with customers in their new region. Neither salesperson was happy about the move, which required them to develop new customer relationships to obtain their standard 3 percent commission. Both were overheard complaining to James Allison, the corporate credit manager, about the relocation.

Market

While AIM is the market leader in the power tool industry, with about $3 billion in annual sales, the market for AIM's products is unpredictable because of fluctuations in the economy. For example, housing starts in the construction industry create demand for tools and accessories. AIM sells its products to thousands of hardware stores, but 60 percent of its sales are to the 12 largest retailers and discount stores that negotiate extremely competitive prices. Although AIM's primary markets are in the western states (55 percent of its sales are from the Northwest and Southwest regions), it divided the country into five sales regions (see Table 1 for list of states and sales representatives in each region): (1) Northeast, (2) Southeast, (3) Central, (4) Northwest, and (5) Southwest. Distribution centers are in Tucson, Chicago, and Dallas.

Weirich and Churyk A38 Journal of Forensic Accounting Research 2018 To obtain operations information, you decided to interview the operations manager and controller. Based on discussions, the following information was gathered.

Operations

AIM's business operations are typical in its industry. Corporate accounting is centralized, and each manufacturing facility is electronically connected through Electronic Data Interchange (EDI) to corporate headquarters. At the end of each day, manufacturing and sales activities are electronically transferred to headquarters. Table 2 contains a partial list of customers, customer addresses, dates of first sales order, and account balances as of the date of your investigation. The last column indicates the change in sales to these customers over the prior year. As mentioned previously, your CPA firm recently received an anonymous tip. The caller said that certain segments of the overall operations are causing concern as rebates and billing adjustments appear unreasonable. This tip was further discussed with AIM's internal auditor who also was perplexed by this issue. Thus, Commercial Products, in discussion with AIM management, has requested your forensics accounting division to investigate the possibility of fraud. The specific focus of the investigation centers on the operations described below.

TABLE 2

Weirich and Churyk A39 Journal of Forensic Accounting Research 2018

Demo Accounts/Kits and Stock Transfers

AIM has a large sales force that calls on customers throughout the U.S. Within each sales region, the sales manager establishes a ''demo tools'' account for each salesperson, allowing each salesperson to obtain tools from a distribution center to use as demos when calling on current and potential customers. Corporate headquarters maintains a demo log, which it periodically reconciles to the tools in the salesperson's demo account.

When the demo products have served their use or another salesperson needs them for demonstration purposes, the salesperson can sell the products as ''used,'' return them to AIM for reconditioning and resale or transfer them to another salesperson. If a product is sold as ''used,'' or transferred to another salesperson, a Billing Adjustment Form (BAF) is created to record the TABLE 2 Customer Data Weirich and Churyk A40 Journal of Forensic Accounting Research 2018 sale/transfer. The BAF results in the generation of a credit memo for the original salesperson's demo account and a debit memo to the customer or second salesperson. Likewise, a salesperson can complete a BAF for demo products that are, for example, returned to the distribution center when a new product modification occurs, or the salesperson returns the old product for the new one to be placed into the demo kit.

A regional sales manager could also process a BAF to transfer products among a region's customers, such as when one customer needs a distribution center's out-of-stock product. The sales manager checks for a customer that has the needed product and is willing to receive a sales credit, then transfers the product to the customer that needs the item. The customer receiving the product receives a debit memo and the customer giving the product receives a credit. Credits can remain in the customer's account or the customer can request a refund. While past history reveals that most customers prefer credits for future purchases, certain customers have chosen to obtain large refunds for their accumulated credits. When customers request a refund, the salesperson who sold the product creates the check request for the sales manager of the appropriate region to sign. The check request is then sent to corporate headquarters for James Allison's approval. Figure 1 shows the check requests for refunds, which reference the invoice(s) involved.

At corporate headquarters, James Allison authorizes the regional sales managers' BAFs, and can authorize bad debt write-offs. Table 3 shows several actual BAFs. As previously mentioned, authorized BAFs and write-offs are sent to corporate accounting, which records the transaction and issues a check if requested. For those BAFs that do not have customer names, the salesperson should return the demo products to AIM.

Order Processing

Corporate Headquarters' Customer Service Department via EDI receives and logs in orders and sends them to one of three distribution centers for filling and bill-of-lading generation. Both documents, the order and bill-of-lading, are sent to the Trafficking Department for matching, routing, and creation of shipping labels. The labels and documentation are sent to the Shipping/ Packaging Department.

Since shipment amounts are reported to major truck carriers as ''shipper loading counts reports,'' the carrier normally does not count the order before it takes the products for shipment. The shipping department is responsible for accurate counting. Trailers are normally dropped off one day for loading and picked up the next day for delivery. When shipments are loaded, a copy of the order and the bill-of-lading is sent to the Billing Department to generate invoices for James Allison to review before they are issued to customers.

Customers that change their minds about a product, receive an incorrect product, or receive an incorrect quantity are to contact their salesperson to request an adjustment. The merchandise is either returned to the distribution center or, if possible, sold to another customer without returning to the distribution center. In either case, the salesperson creates a BAF crediting the original customer's account and debiting the new purchaser's account or inventory. Table 4 contains BAFs for several customer returns.

Miscellaneous

While AIM is the market leader, sales were slow the first half of the current year due to declining new housing starts. To increase sales revenue, AIM's six-month promotional campaign had regional salespeople notify customers of a 2 percent cash rebate on all new purchases.

CASE REQUIREMENTS

As a second-year senior at the CPA firm, you already had some familiarity with AIM from your due diligence work preceding the anonymous tip and the internal auditor's concerns about AIM's operations and from the background information you gathered for the engagement partner. The engagement partner has asked you to assist the forensic accounting division's investigation. Prepare report APA Style to your forensic team manager addressing each of the following tasks.

you may use the ACFE Fraud Examiners Manual located in LEO/Content/Learning Resources/Books &

Other Learning Resources

Task 2: Evaluate whether the possible issues (red flags) identified in Task 1 are indicative of fraud.

Choose any two of these potential frauds. For each of these two potential frauds, draw a basic flowchart showing what should happen and what happens.

Task 3: Describe the three elements of the fraud triangle. Categorize each potential issue (red flag) identified in Task 2 under the corresponding element of the fraud triangle.

Task 4: For each of the potential fraud issues marked on the list in Task 2, provide detailed instructions for investigation techniques that could be used to verify whether a fraudulent activity is taking place. Include factors that might limit the team's ability to gather evidence for the investigation.

Task 5: Based on the evidence given in the case, identify and explain any internal control weaknesses. provide detailed suggestions for controls that may mitigate the weaknesses that you have identified.

Task 6: Conclude your report to the forensic team manager with a list of recommendations to mitigate or prevent further frauds in the organization.