BILOXI BLUES"

You are an account analyst manager for Acton Accounting Firm. Your company has just landed a contract with Stephen Odom, the new owner of Biloxi Electroplating. Your firm has the honor of being the third exclusive accounting firm hired to audit Biloxi in the last three years. Biloxi Electroplating is one of the leading electroplating firms along Mississippi's Gulf Coast area, the Florida panhandle to the east, and to the west, in areas of Louisiana

The company operates diverse polishing plating facilities for original equipment manufacturers of steel and aluminum wheels, bumpers, and other automotive components. The company was founded in 1982 and now employs over 1,000 employees at its home site in Gulfport, Mississippi. The company's original owner, Spencer Burton, built the company on his vision encapsulated in the company's mission statement, "Mutual dependence toward mutual success." He believed that employee morale was integral to company effectiveness and avoided the imposition of formal procedures/protocol for employees except as they apply to the physical operations of electroplating (primarily as they relate to safety concerns). Burton sold the company in 1989, but the tradition of his mission statement lives on in the company today.

Your preliminary analysis of Biloxi paints a picture of a company on the rise in the early to mid-90s that now is experiencing some financial and morale difficulties. Your background research shows that when the company was riding high, it increased expenditures as part of management's "refinement" program. In 1995, Biloxi invested in a comprehensive program to be more self-sufficient in its use of energy. With its new power plant development, Biloxi managed to supply over 50% of its own power needs and became capable of running critical production applications during emergency power outages. During 1996, Biloxi also invested resources in an expanded plating line, new high speed coating technology, and an aggressive robotics program aimed at reducing costs.

You discover through your internal review of corporate documentation that the business had been operating well financially between 1990 through 1997, realizing handsome profits. However, the business faltered in the last few years, with the company breaking just above even in 2002 and 2003. A review of contracts for 2002 and 2003 demonstrates that the number of contracts for electroplating in the Louisiana region declined, but would not account for all the monetary losses incurred for this two-year period. Your team of analysts discover a shortfall of $86,348 for 2002 and $93,639 for 2003.

You interview CEO Edgar Hilts. While conceding that business could be better, Hilts confides that he cannot understand why the business is losing so much money. You ask him about the individuals working in the accounting department and are surprised to find that for a company of over 1,000 employees the accounting department consists of only the chief financial officer and his assistant. Mr. Hilts explains that he had to reduce the number of employees in this section (because of cost cutting) and decided to retain the two most reliable employees to handle the books. Mr. Hilts tells you that he has the utmost confidence in the two, Chief Financial Officer Roger Perkins and Financial Associate Evelyn Mason, because he has been life-long friends with Perkins and is the brother-in-law of Mason. Hilts reports to you that Perkins is an ideal worker, being the first to arrive every work day and the last to leave. He considers Perkins a real "catch" since he persuaded him to come over from working for the Pearl Casino in New Orleans where Perkins was chief financial officer for five years. Hilts not only characterizes Mason as an indispensable financial expert, but also the single person responsible for facilitating Biloxi's acquisition of Formulated Coating, a small phosphate coating company in 1994, that led to two highly lucrative years for Biloxi. Hilts added that Formulated Coating had not shown similar profits in the last few years, but according to Hilts, "Mason helped us when we needed her".

You assign your analysts to review all of Biloxi's financial records for the past three years and interview any employees they deem appropriate to interview. Their report yields the following results:

1. According to inter-office e-mail memoranda for the year 2001, CEO Hilts announced to his employees that Biloxi was embarking upon an austerity program that would include layoffs, across-the-board salary reductions, a hiring freeze and an increased shifting of manual electroplating to automated electroplating.
2. An office-wide e-mail was sent by CEO Hilts to all employees in August, 2001 announcing that all Biloxi executive staff would assume oversight responsibilities relinquished by all subordinate employees who had been laid off as a result of the austerity program.
3. Public record documentation supports the 1994 acquisition of Formulated Coating but also reveals that contracts developed through Formulated Coating's patented phosphate coating technique have never dropped since 1994 but actually have risen each year from 1994 to the present (Background research done by one of your analysts on related Dunn and Bradstreet reports in 2001 indicated that general demand for phosphate coating of metals was rapidly rising due to the efficiency and durability of the process).
4. Travel expenditures rose dramatically in 1999, 2002 and 2003 for executive staff, primarily weekend business trips to and from New Orleans.
5. CEO Hilts was also the owner of a small company named VirtuoTech (50 employees), a company that provided conference coordination services for private corporations and professional associations. The company declared bankruptcy in 2002.
6. Contacts with the three consecutive law firms used as legal counsels for Biloxi in 2001, 2002 and 2003 reveal that there were no legal improprieties detected within Biloxi during that three-year period.
7. Interviews with Biloxi personnel reveal that Perkins and Mason demonstrate two completely opposite lifestyles. Perkins is a very private person who is a "workaholic." He hardly ever takes time off from the job. Mason has lately transformed from a shrinking violet into a "live wire" at the office who brags about her vacations to exotic lands.

Discuss whether or not you believe that there is evidence of any symptoms of fraud occurring within Biloxi Electroplating. Explain in detail what types of "red flags" are present that may represent symptoms of fraud and why you consider them symptoms of fraud (supporting information). In addition, identify and explain any internal control weaknesses within the organization that may need to be corrected to prevent future fraud. Also, provide some preliminary discussion on what could have accounted for the shortfalls in 2002 and 2003. Offer recommendations on what steps might be taken by Odom to avoid experiencing the reoccurrence of such events.