As you read about SenseLess Company below, give some thought to the ways that possibly financial statement fraud could be occurring inside of the company.

Senseless Company designs, develops, manufacturers, sells, and services high-technology CCTV (closed circuit television) systems to small retailers in the US. The company started business in 2010 right at the end of the financial crisis in the US, and at a time when retail losses from internal (employee) and external (customer and supplier) theft were at their height. The companys business has grown dramatically since 2010, doubling its revenues every year since 2010, and the company is now considering going public with an initial public offering (an IPO) sometime with the next year.

To maintain the tremendous revenue growth in the period leading up to the IPO, management has decided to double the amount of sales commissions paid on each order received for these CCTV systems, and bypass the normal credit approval process that especially new customers normally go through before an order is accepted and processed for shipment, delivery, and installation. Also, the company has changed the terms of shipment of customer orders from FOB-Shipping Point to FOB-Destination. You drive by the warehouse at the end of the latest financial year end, and notice that the shipping department is still shipping as the clock strikes midnight.

The companys CEO, CFO, and Head of Sales are all blood or related by marriage. The CEO and the CFO are brothers, and the Head of Sales is married to the sister of the brothers. All 3 key management members started the business with their own personal money in 2010, each taking out second mortgages on their homes to generate the start-up capital required to get the business started.

Senseless has been audited each year by a local CPA firm which is owned by one partner, the audit partner, who went to high school and college with the brothers. However, in the last year, the 3 key management members decided to change auditors due to a disagreement with the audit partner over the appropriate recognition of revenue in accordance with GAAP.

In anticipation of the IPO coming, Senseless formed an independent Board of Directors and an Audit Committee two years ago, both of which meet twice per year in the first year to review the status of the business and an agenda prepared by the 3 key management members. The CEO is also on the Board of Directors. In the past year, with the IPO date approaching potentially soon, the Board decided to meet 4 times per year to get prepared and to discuss all the issues facing the company with regards to the potential IPO. The Board members have grown very close, personally, to each of the 3 key management members over the past two years, and has awarded each management members many stock options to reward them for the extraordinary growth of the Company since 2010.

Identify at least two red flags that may indicate that some type of financial statement fraud may be occurring at Senseless Company based upon the information you have been provided. Find two that have not already been identified by your classmates.

Then, once you list the two red flags, explain in detail why it is a potential red flag, and what the potential financial statement fraud could be related to the red flag. Which financial statements? Which accounts in which of the financial statements?