Gray's Home Electronics and Car Audio Store Background Joe and Mary Gray started their multimillion-dollar home electronics and car audio store chain in Texas in the late 1970s. By mid-1983, their company had grown to 10 stores in 3 states with 500 employees and gross sales of $30 million. The decline of the oil industry in the mid1980s led to the company losing almost half of their employees. Additionally, as people moved to more economically viable states, employee turnover continued to increase. The company maintains a small internal audit department. The directors feel that the team needs to increase in size and specialist skills are required, but they are unsure whether to recruit more internal auditors, or to outsource the whole function to their external auditors, PWC. Joe is the chairman of is unsure if he needs to add some non-executive directors as there are currently no nonexecutive directors out of the five board members.

He is considering appointing one of his close friends, who is a retired chief executive of a manufacturing company, as a non-executive director. Additionally, the Grays needed to fill a recently vacated Controller position in their main office. The position was crucial and required a person who was highly motivated and knowledgeable of operations. After interviewing several candidates, they decided to give Jeff Smith the position.

The Financial Controller Jeff was nothing like the previous Controller. He was quickly labeled a "maverick" and was completing tasks that had been languishing for months. Many of the employees noticed Jeff in the office working early in the morning, late at night, and on weekends. On many occasions, Jeff stayed at the office all night and through the next day. He was eager to fill in for people away from the office due to illness, vacation, or business travel. He was improving the efficiency of the office and the Grays were elated at his performance. Within six months of Jeff's arrival, the Grays expanded the Controller duties to include many office operations, and transferred these responsibilities to Jeff. Jeff's charismatic personality and work ethic motivated many in the office to improve their work habits and efforts. The general consensus was that Jeff was an "inspired" choice for the position and had brought about a complete renewal of the business. Controls Issues and Fraud Approximately one year after Jeff was hired, Joe Gray noticed some anomalies after completing the physical inventories and year-end closing of the books. He met with Jeff on numerous occasions to try to resolve the discrepancies, but to no avail. Jeff and Joe worked on identifying the anomalies for about a month, meeting at the main office one Sunday afternoon to continue their search.

Only Jeff and Joe were in the office that day. They took advantage of Joe's extra long meeting table to lay out all of the ledgers and journals on the table in preparation for their search. After several hours, Joe began to make headway for the first time that afternoon. Jeff  excused himself to take a smoking break while Joe continued to close in on the problem. Twenty minutes went by and Joe noticed that Jeff had not yet returned. He waited a few minutes and then went to see where Jeff had gone. Not finding him anywhere in the building, Joe checked outsideJeff's car was gone. Joe tried to call Jeff's house later that day, but there was no answer. 

The following day, Jeff didn't show up for work. Joe tried to contact him again at home, but he had moved, leaving no forwarding address. As it turned out, Jeff had a long history of embezzling from companies—police and federal agencies had been looking for him for some time. Some of the ways Jeff was able to steal over $2 million included: • Printing checks and making the necessary reversing entries and using backup files to cover his tracks. • Setting himself up as a vendor with a P.O. Box address, with checks mailed to that address every few weeks. The amounts on the checks were small, so they did not require a second signature.

• Jeff handled the cash collections, disbursements, and account reconciliations.

• Jeff was able to divert some of the checks received as payments on invoices by using the company's check endorsement stamp, signing the checks over to himself, and depositing them in his personal account. When Joe came too close to the truth that Sunday afternoon, Jeff realized he was caught and left town. The authorities were contacted, but Jeff got away one more time by befriending everyone, having exemplary performance for the time he was with the company, and gaining everyone's trust he was the "perfect employee." Other Controls Issues under Jeff's Leadership In May 2007 three months after Jeff was recruited, chemicals leaked from a gas holding tank and seeped onto the parking lot. A number of employee vehicles were damaged and required repainting. 

The company agreed to reimburse employees for the cost of these repairs. Employees were instructed to submit their bills for the repairs to the Controller, Jeff. Jeff would then issue a check to the employee for the amount of the bill. While the new Internal Auditor questioned the controller about the monitoring of the reimbursements during a meeting a month after the accident, the Committee determined that procedures in place were adequate. Nine months later, at a full board meeting, someone made a remark about the fact that bills were still being turned in for reimbursement. By this time, the total of the damages reimbursed to employees had reached nearly $150,000. After making inquiries, it was discovered that some of the "repairs" were for expensive paint jobs, upgrades, buffing, body repairs, and waxing.

Further investigation revealed that thousands of dollars were reimbursed for paint jobs on cars that were damaged prior to the  accident. Moreover, some employees had turned in bills for similar jobs just a few months apart—in other words, some cars were reimbursed for the same repair twice. Although this appeared suspicious, no one caught it until the internal auditors came in one year after the accident _in response to the board's inquiry_ and reviewed the invoices and compared them with the employee list and cars repainted. 

 

 

Questions:

1. What were some of the factors that contributed to this situation? What internal controls could have been in-place to prevent this from happening? 

2. Use the COSO framework to assess the impact of the control risks outlined in the case? 

3. Compare the benefits and risks of outsourcing the internal audit function with those of inhouse provision?

4. Explain four weaknesses relating to the structure and governance of the company?

5. What steps should have been taken by the company to prevent fraudulent activity relating to the gas spill from occurring? 

6. How could information already in the accounting system have been used to minimize the opportunity for fraud?