Case Analyses "The authors of Case Number 1 have laid out succinctly the basic principles and parameters of analysis to be applied in uncovering and proving the fraudulent activity at TruGloss Shanghai JV. It is based on an actual and successfully investigated case of fraud involving a United States company with operations in Asia. Though unique in its particulars, the circumstances and business conditions that underlie the illegal activity uncovered are quite common and not just in the context of international business ventures."

Case Synopsis

TruGloss is a producer of high-quality paints sold to warehouse distributors and warehouse home improvement retailers throughout the United States and Canada. TruGloss recently has begun efforts to expand internationally by forming joint ventures with international distributors to help in managing operations within Europe and Asia. In countries where government restrictions dictate how such joint ventures are structured, TruGloss must alter its typical partnership strategy to operate. TruGloss believes that China possesses significant opportunities for growth and long-term viability. With the economic growth of that country, particularly in Shanghai and Hong Kong, the Company believes that many of its product lines, particularly its industrial-duty and commercial-grade products, will thrive for the next 1015 years at a minimum. However, to open operations in China, TruGloss must form a joint venture with a local governmentthe Shanghai City Government in this casein which TruGloss is a 49 percent minority owner and the government is a 51 percent majority owner. TruGloss agreed to these terms and formed the TruGloss Shanghai JV. Each party agreed to several conditions under the joint venture. As part of the agreement, TruGloss agreed to allow the joint venture to use its brand name and supply products for sale at the joint venture under several conditions. TruGloss required that the joint venture conform to all corporate policies, such that all business practices conform to United States laws and regulations for conducting business in a foreign country. The practices include internal controls, operating procedures, and external reporting issues. TruGloss also required that it supply several employees for key positions at the joint venture. These employees are employed by TruGloss but seconded (on loan) to the joint venture. The Shanghai City Government agreed to supply office space and warehousing for TruGloss products in Shanghai and several other Chinese cities and enable all TruGloss products to be imported into China. The city also required that several key executive positions be filled with individuals from its offices. The remainder of the employees at TruGloss Shanghai JV was hired locally.

Employees Seconded to TruGloss Shanghai JV.

Several key positions at TruGloss Shanghai JV are filled by seconded managers from TruGloss, Alex Richards and Grant Williams, who serve as General Manager and Finance Manager at TruGloss Shanghai JV, respectively. Both Alex and Grant speak fluent Chinese and worked for other companies with Chinese operations prior to joining TruGloss at its Philadelphia headquarters five years before the joint venture was formed. However, neither Alex nor Grant has ever actually worked in China. All employees who work under the seconded managers are from Shanghai. As part of their duties, Alex and Grant are responsible for oversight of their subordinates and are to ensure that TruGloss policies and practices are followed, including ensuring that all internal controls are in place and consistently applied.

Process for Ordering and Shipping Inventory from United States to Joint Venture.

Since all paint is purchased from the United States, Alex Richards is responsible for establishing the lowest acceptable prices to charge customers in China. However, he allows his three sales managers, Cheng Xi (Shekou), Hong Wu (Shanghai), and Jueng Chan (Yantian), to negotiate prices above the floor price and schedule delivery of orders. Before Alex will place an order for paint to be shipped from the United States to the joint venture, he complies with company policy that a 20 percent down payment be made by the customer. Also, under TruGloss policy for international sales at joint ventures, all sales are made exterminal and therefore require cash payment prior to final delivery of products. To receive inventory and release it to customers, the logistics manager at each of the three TruGloss warehouses in China requires an original bill of lading, packing list, and sales invoice. The logistics manager at each plant is also responsible for processing all customs declarations. Once documentation is appropriately handled, customers are responsible for removing their orders from the warehouse. There are three TruGloss warehouses located in Shanghai, Yantian, and Shekou that are managed by Daqing Yang, Marti Chow, and Xong Chae, respectively."

Operations at TruGloss Shanghai JV after Three Years TruGloss and Shanghai City Officials conduct a review of operations with Alex Richards and Grant Wil-liams at the end of the joint ventures third year of operations. TruGloss Shanghai JV has performed above expectations over its first three years of operations, steadily growing at sales increases of between 30 and 50 percent each year. The Shanghai government has been discussing the possibility of adding three new warehouses in other provinces with TruGloss executives during each of the next few years. Alex Richards credits much of his success on his reliance on his managers and their knowledge of local customers and customs in developing solid business relationships. Repeat sales to customers have been steadily increasing over the first three years of operations, particularly for customers in the Shanghai sales territory. Richards has been pleased with the ability of the sales managers and logistics managers to work closely to ensure that products are delivered to warehouses and customers in a timely fashion. TruGloss (U.S.) has been pleased that down payments for purchases are made on a timely basis, which enables the supply chain to work effectively. Alex has been pleased with the volume of sales by each of the sales managers. Hong Wu has been the top sales manager each year with average sales over the three years of $20 million USD per year. Cheng Xi also has performed quite well with average sales over the three years of $14 million USD per year. Wu credits his success to his ability to efficiently work with local customers to ensure timely down payments and Daqing Yang (the Shanghai logistics manager) to quickly process orders and have them available for customers in a faster time than any local competitors. Xi credits his success to the long-term relationships that he has cultivated in Shekou. Grant Williams attributes some of the success of the joint venture to his ability to effectively hedge currency risk utilizing state-of-the art derivatives that he learned about while at his prior employer, an investment banking firm in Philadelphia. He credits the employees in the joint ventures financial management business process for working well with managers in key operational processes, particularly sales and supply chain management. He has been so impressed with their work ethic and commitment to servicing those processes that he has been able to focus most of his time on the treasury side of the business. Although pleased with the performance of TruGloss Shanghai JV, the CFO of TruGloss, Jane Urley, (US) is interested in learning more about how the joint venture has been able to perform so well as a new market entrant, particularly in Shanghai, where 45 percent of its sales have been generated. To help explain their success, Alex and Grant ask Hong Wu (the sales representative in charge of Shanghai), Daqing Yang (the logistics manager in charge of the Shanghai plant), and Xiang Chu (accounting manager for Shanghai) to attend the meeting with he and Grant Williams. When asked about why the Shanghai operations were so successful, Wu discussed his ability to tap into the high demand for quality U.S. paints in the Shanghai market because all the construction occurring in and around the city. Wu noted that although there were several competitors in the area, the reputation of TruGloss gave him the competitive advantage to sell the paints at prices that were slightly higher than competitors. He noted that receiving timely down payments was the secret in turning over inventory rapidly and shortening sales cycles. Daqing Yang echoed Wus explanation by stating that customers were constantly putting pressure on him to get sales cleared through customs and into their hands. He noted that it seemed as if the customers were standing outside the warehouse door looking at their watches, waiting to give him their cash for the inventory. Xiang Chu added that Wu and Yang were excellent about informing them of customer payments and deliveries so that accounting could update its records on a timely basis. She noted that Wu personally handled sales transactions by placing orders, collecting cash down payments, and getting cash from Yang to match with invoices so that personnel in accounting could perform their duties more efficiently (e.g., deposit cash and record sales). Chus only concern was that some customers were not paying for their inventory in full when they were picking up their goods. Wu failed, on more than one occasion, to provide proper supporting documentation for sales made to customers. He was unable to present sales invoices or customs declaration forms to substantiate the sale. He also failed to present customer background check information to show the legitimacy of the customers. However, since they were continuing to buy more merchandise and make down payments, she believed that the customers probably were following up quite well. While the other sales and logistics managers were also performing well, none were doing so as efficiently as the Shanghai sales and logistics managers, according to Chu"

TruGloss CFO, Jane Urley, was satisfied by the responses of the joint venture managers, but she was a bit concerned about whether internal controls were being followed in a manner consistent with TruGloss policy. Alex Richards assured her that the joint venture was acting in the spirit of the Companys policies but that some controls were not consistently followed because of the volume of sales that had been occurring over the first three years. Further, the local culture and work practices in Shanghai are different than that of the United States, resulting in a transition period of adapting to controls designed for western cultures and work practices. Both he and Shanghai City officials assured the CFO that no serious policies were being violated (e.g., bribes, etc.); however, Alex noted that often orders were being processed ahead of proper documentation and that internal audits had occurred less often than expected by TruGloss policy. He informed the CFO that he had been so busy putting out fires that he had not been performing due diligence on new customers, but that all were making timely 20 percent down payments prior to shipment. Alex, on one occasion, manually checked a few shipments and was unable to locate the bill of lading and packing slip for the shipment. Xu referenced the fact that some of the records may not be properly documented and/or stored correctly but Xu would research the issue and get back to Alex. Alex became busy with other issues and failed to follow-up with the issue.Grant Williams is responsible for ensuring that an audit be performed, but he has been so understaffed and preoccupied with treasury operations that he has not been able to complete several audits that he had begun in each of the past two years. He informed the CFO that physical inventories had been completed at the Yantian and Shekou plants the prior year and would be performed the following year at all three plants. The Shanghai inventory was not performed because Daqing Yangs wife was in a car accident, and he was unable to be present the day it was scheduled. Since neither party could re-arrange their schedule after that time, they decided to wait until the following year. He assured the CFO that a thorough audit was scheduled for the following year, which also would include a review of all customer accounts to ensure timely payments were occurring for all paint sold and reconciliation of all cash accounts.

Step 5. Case Analyses A. Detection Analysis - Using Two- Three Slides? 1. What was taken? 2. Who had the opportunity? 3. How were the assets moved? 4. How was the theft concealed? 5. How were the assets converted? 6. What were the red flag symptoms? B. Summary of Findings Using Three- Four Slides 7. Accounting Anomalies Often Signal the Presence of Fraud What are the accounting anomalies in this case? Hint: Identify the irregularities in source documents 8. Were there faulty journal entries and inaccuracies in Ledger? 9. Identify the Internal Control weaknesses that contributed to making fraud easier to perpetrate.