Johnson Manufacturing, a diversified manufacturer, has seven divisions that operate in the United States, Mexico, and Canada. Johnson Manufacturing has historically allowed its divisions to operate independently. Corporate intervention occurs only when planned results are not obtained. Corporate management has high integrity, although the board of directors is not very active. Johnson has a policy of performing employee screenings on all employees before hiring them. Johnson feels its employees are all well educated and honest. The company has a code of conduct, but there is little monitoring of employees. Employee compensation is highly dependent on the performance of the company. During the past year, a new competitor has entered one of Johnsons highly successful markets. This new competitor has undercut Johnsons prices. Johnsons manager of this unit, Debbie Harris, has responded by matching price cuts in hopes of maintaining market share. Debbie is very concerned because she cannot see any other areas where costs can be reduced so that the divisions growth and profitability can be maintained. If profitability is not maintained, the division managers salaries and bonuses will be reduced. Debbie has decided that one way to make the division appear more profitable is to overstate inventory, since it represents a large asset on the divisions balance sheet. She also knows that controls over inventory are weak. She views this overstatement as a short-run solution to the profit decline due to the competitors price cutting. The manager is certain that once the competitor stops cutting prices or goes bankrupt, the misstatements in inventory can be corrected with little impact on the bottom line.

Questions:

1. What factors in Johnsons control environment have led to and facilitated the managers manipulation of inventory?

2. What pressures did Debbie have to overstate inventory?

3. What rationalization did Debbie use to justify her fraud?