Identify the alternative options that Koss corporation could have done in this case. (i.e., consequences of each course of action -Pro and Con of each)

Koss Corporation Corporate Governance, Internal Controls, and Ethics: What Went Wrong? Melanie O. Anderson Slippery Rock University INTRODUCTION THE ACCOUNTING FUNCTION Koss Corporation is a Milwaukee company whose principal The accounting work was handled by Sujata "Suc" Sachdeva, business is the design, manufacture, and sale of stereo vice president of finance, secretary, and principal accounting headphones and related accessories. Michael Koss is the officer-in a small business, employees typically have more CEO: his father, John Koss, founded the company in 1958. than one responsibility. Suc, whose family was from India, The company has trademarks and patents for its products had been employed at the company for 17 years.' She was to differentiate itself from the competition. Koss Corp. has a trusted and valued employee and cared about $200,000 a six-man Board of Directors, including Michael and his per year. She had two assistants: Julic Mulvaney, senior father. John is 81 years old and serves as chairman of the accountant, and "Tracy Malone, junior accountant." Board. Michael is 57 years old and serves as vice chairman, Sue told friends and coworkers that her family was very president, CEO, COO, and CFO.' The other Board wealthy and held a very high social status in India. She members have served 25 years. Neither Michael nor the reported that she and her husband spent their wedding night other Board members have financial backgrounds. Michael in the Taj Mahal. It was important for her and her family to graduated college with an anthropology degree. live in the best arca, attend the best schools, and socialize Although Koss Corp. is a multimillion dollar company, with the recognized society members of Milwaukee. Suc it only employs 73 people, which auditors consider a "small served on several charity boards, organized lavish parties for business." Michael has worked for Koss Corp. since 1976, their events that cost millions of dollars, and purchased all and earns a base salary of $295,000; his total compensation, items that did not sell at the charity auctions she organized. including options, is over $800,000.3 Suc also had a reputation as a demanding boss: Her Selected financial data is presented in Table 1. assistants were required to help her with the charity events, Table 1: Financial Data from 2008 and 2009 and Sue took them out to lunch almost daily. Julie and Tracy also went to Sue's house to help her unpack and store the June 30, 2009 June 30, 2008 $ 46,943,293 many expensive items she purchased. Suc loved designer Net Sales $ 38,184,150 Net Income 1,976,658 4,494,289 clothing, shoes, and accessories and purchased over 20,000 items in a five-year period from 2004 to 2009. She purchased Basic Earnings per Common Share: so many items that they did not fit in her house. So, she Basic: 0.54 1.22 Diluted: 0.54 1.22 rented a storage unit and a two-office suite to store her Total Assets unused purchases. In addition, Sue made some purchases $ 28,470,352 $ 29,977.077 Cash Dividends per Common Share $0.52 that she never picked up from the retailers.' $ 1.52 IMA EDUCATIONAL CASE JOURNAL VOL. 6, NO. 1, ART. 3, MARCH 2013Suc could not pay for all of these purchases with her PAYMENTS BY CHECK OR WIRE TRANSFER $200,000 salary or her physician husband's $600,000 salary." Her job at Koss Corp. provided her with an extra opportunity Michael approved invoices of $5,000 or more for payment. to obtain the funds necessary to support her lavish lifestyle: Yet processing wire transfers and cashier's checks outside of She committed the fraud over at least a five-year period to the accounts payable system did not require his approval. fulfill her compulsive shopping disorder." This flaw in Koss Corp.'s internal control system allowed Sue and Julic to cover up the embezzlement." THE FRAUD Over the total 12-year embezzlement period, Sue wrote over 500 cashier's checks, totaling over $17.5 million, from Sue started stealing from the company with relatively small Park Bank." Julie did not have the authority to sign checks thefts that increased over the years. She partially hid the at Park Bank, although she often ordered and processed alleged theft in cost of goods sold (COGS) and indicated the checks for Sue without Michael's knowledge or the increase in COGS was due to rising material costs. She authorization." So as not to draw attention to these checks, also overstated assets and other expenses and understated they were often made payable to initials, such as "N-M," for liabilities and sales." Neiman Marcus or "S.F.A." for Saks Fifth Avenue."" Sue embezzled $34 million over a five-year period Julie helped Suc initiate and authorize wire transfers of beginning in 2004:" only the embezzled amounts from Koss Corp. funds to Suc's personal creditors for over $16.3 2005 forward were documented, even though she had been million without requiring or obtaining Michael's approval." allegedly embezzling since 1997. The fraud was uncovered when American Express notified Michael Koss about an PETTY CASH unusual, ongoing practice: Suc paid her personal credit card balances with several large wire transfers from a Koss Corp. Most organizations maintain a petty cash fund to facilitate bank account." small, incidental expenses. Petty cash balances and The following amounts represent the fund's embezzled transactions are usually small. Given the insignificance of by Sue:13 petty cash, management and auditors spend very little time 2005 - $2.195,477 reviewing these accounts. Sue used petty cash as another 2006 - $2.227,669 vehicle to obtain funds: more than $145,000 over five years." 2007 - $3,160,310 2008 - $5.040,968 COMPUTERIZED ACCOUNTING SYSTEM 2009 - $8,498,434 2010 - $10,286,988 (two quarters) A computerized accounting system and the related software were designed to prevent certain unintentional (or Suc wired an average of $500,000 per month from Koss intentional) errors. For example, entering an out of balance Corp. bank accounts to pay for her personal credit card bills." entry is not possible in most computerized accounting Suc colluded with her senior accountant Julic to embezzle systems. Koss Corp.'s computerized accounting system, the money. Julie maintained she just made the journal however, was almost 30 years old and did not have sufficient entries and cash transfers based on Suc's orders, noting that controls. Koss Corp.'s accounting system could not lock Suc was a "powerful, imperious, overbearing, determined, out changes made after the end of the month, and there and willful superior."13 was no audit trail. Suc and Julie made undetected post- closing changes to the accounting records without Michael's FRAUDULENT ACTIVITIES approval or knowledge." Julie covered up Suc's embezzlement by forging entries Koss Corp., like most businesses, had a system of internal to match the company cash account balance with the cash on controls designed to protect the company's assets. The hand balance in the bank and "holding back" receivables to fraudulent activities that occurred included large payments match the amount of the cash shortfall." In addition, Julic by check or wire transfer, misuse of petty cash, an outdated did not record Internet sales or sales from the company's computerized accounting system, unprepared account retail outlet in order to cover up the cash shortfall.34 reconciliations, and minimal management review of financial statements. IMA EDUCATIONAL CASE JOURNAL 2 VOL. 6, NO. 1, ART. 3. MARCH 2013RECONCILIATIONS DISCUSSION QUESTIONS Other checks and balances in accounting systems include 1. Review the fraudulent activities. What went wrong? account reconciliations that are prepared by the accounting Describe what internal controls were missing or staff. Account reconciliations were not prepared or maintained circumvented. Consider the Sarbanes-Oxley Act of 2002 at Koss Corp. Reconciliations that were performed were (SOX) requirements, and review the definition of internal prepared by Sue or Julic, so they were not correct; they also controls. Who is responsible for internal controls? What initiated or recorded all accounting entries." reporting is required? 2. What were the problems in the corporate governance MANAGEMENT REVIEW and/or organization structure? What are the major requirements of SOX with respect to corporate Suc provided Michael with financial statements and reports governance and/or organization structure? How would that were prepared from the fraudulent accounting records, corporate management and the accounting function be and Michael did not review them in great detail. Because better organized? he trusted Sue, Michael did not fully review the financials 3. What should Julie Mulvaney have done when Sue before approving them." Sachdeva requested her to assist in the fraud? What would the IMA* Code of Ethics, known as the IMA THE AUDITORS Statement of Ethical Professional Practice, dictate:" 4. What were the responsibilities of the following entities Grant Thornton, a national firm based in the U.S., was the or individuals for the fraudulent activities? What are the auditor for Koss Corp. at the time. Over the five-year period. possible consequences? Koss Corp. paid Grant Thornton $625,000 to audit their a. American Express financial results. Grant Thornton classified Koss Corp. as a b. Park Bank non-accelerated filer. The fraud was never detected during c. Suc Sachdeva the audit for several reasons: (1) Grant Thornton reviews the d. Michael Koss company's financials to make sure that every account balance e. Julie Mulvaney aligns with accounting standards. Because Sue and Julie were balancing the books to counteract the fraud, nothing seemed ABOUT IMA" suspicious. (2) Lax oversight ran rampant at Koss Corp. Because Michael trusted Suc, he believed all her numbers With a worldwide network of more than 65,000 professionals, were correct. "7 IMA (Institute of Management Accountants) is the world's Sue knew the questions the auditors would ask and the leading organization dedicated to empowering accounting documents they would review. Because Sue knew the July 1 and finance professionals to drive business performance. year-end would bring scrutiny to June's records, she never IMA provides a dynamic forum for professionals to advance moved any money in June. Grant Thornton viewed Koss their careers through CMA" (Certified Management Corp. as a small audit of a well-run company with low risk Accountant) certification, research, professional education, and an excellent training ground for new auditors." networking, and advocacy of the highest ethical and professional standards. For more information about IMA, CONCLUSION please visit www.imanct.org. Sue embezzled over $34 million in a five-year span. She betrayed the trust of her boss, Michael, as well as the company's employees and shareholders. Answer the discussion questions below based on your review of the Koss Corp. case