NELSON BUILDING COMPANY CASE (Source: ACFE Investigating by Computer, 2nd Ed. 2011adapted for AC 473/573) This practical assignment is an interactive fraud investigation exercise that requires you to view and manipulate documents with your wordprocessing and spreadsheet programs. The other files that you will need to complete the Nelson Building Company problem are included in the Case 2 folder. You will be prompted throughout the practical problem to access particular files. If the file has a .doc extension, you should open the file in your wordprocessing program. These files have been saved in a textonly format. Most wordprocessing programs should be able to read these files. If the file has an .xls extension, then the file should be opened in your spreadsheet program. The .xls files are saved in a format that can be accessed by any program compatible with Microsoft Excel. To meet the case learning objectives, please complete the questions below in the order presented. To maximize learning, please do not read ahead until the preceding question has been completed. Once you complete a question, please do not revise your answers for that question based on, or because of, your analysis of a subsequent question. For grading purposes, I am aware that a subsequent question will sometimes give you the answer to a preceding question. Consequently, for this type of instructional resource, incorrect answers will not be penalized because the objective is progressive learning. Company History You are Sean Matthews, a CFE in Dallas, Texas. You receive a phone call from an area businessman named Bill Nelson. Nelson owns the Nelson Building Company, a Dallasbased residential and commercial construction firm. During Nelson Building Company's first five years of existence, Nelson showed keen business savvy and took advantage of every costsaving opportunity available. As the company's profit and retained earnings increased, Nelson decided to buy out a competitor, securing a loan from the National Bank of Dallas. The merger was successful, boosting the company's growth and profit margin. Over the following years, Nelson continued a handson approach to directing his company. He remained an integral part of all operational, financial, and administrative procedures. 2 By its eighth year of business, Nelson Building Company's annual revenues had grown to over $20 million. Nelson was comfortable with his company's 22percent market share. With his confidence surging and his interests straying into new projects, Nelson made the decision to relinquish control of the firm's daytoday operations to his chief operating officer, Tony Garcia. Garcia had been with the company for seven years. He knew the financial operations inside and out. Nelson gave Garcia the reins and spent the next two years focusing on investments in other companies, particularly a startup venture in Mexico City. At the beginning of 2011, Nelson Building Company employed more than 100 people and continued to enjoy sustained success. However, the company's good fortunes had produced a negative sideeffect: a national construction firm cherrypicked Tony Garcia out of Nelson's operation by offering him a salary Nelson couldn't match. This meant the top position at Nelson Building Company was up for grabs. With Nelson himself still busy with the startup business in Mexico, Garcia's departure also meant that Nelson Building had no one at the helm. But Nelson wasn't worried. He decided not to replace Garcia from within the company. Instead, he initiated a national hunt for the appropriate candidate. The company could sustain itself for several months while he carefully selected a new COO. Nelson had a handpicked team of senior officers who would report on the operations directly to him. It would all work out. Nelson said, "I hate to lose Tony, but I'm not sweating. This company is bigger than both of us." Your Relationship with Bill Nelson You've known Bill Nelson since 1996. Introduced by a mutual friend, you and Nelson played several rounds of golf together and became friendly acquaintances. He can be loud and almost incredibly brash, but he's a reliable, trustworthy businessman, someone who's never forgotten where he came from. Nelson hired you a few years ago to investigate an inventory shrinkage problem. You were able to uncover the problem without much difficulty or expense. Since then, you've played golf a couple times and remained casual friends, seeing each other at social functions. Ill Winds Bill Nelson once had his fingers on the pulse of his company. Even after Garcia took over the main operation, Nelson studied his team's reports diligently, monitoring the firm's operational and financial 3 activities. When Garcia left, Nelson didn't expect much of a change. He concentrated his efforts on getting the Mexico City project off the ground. Now eight months have gone by since Garcia's departure. It's August of 2011, and Nelson is nervous. He's promised himself that he will spend some time reviewing those monthly reports, but more often than not, they get a cursory glance at best. He became suspicious about the financial health of his company when he received the latest Nelson Building Company operational and financial reports over one month past their normal due date. He chalked this error up to the company being without a COO for more than half a year, and he vowed to speed up the search for a new chief operating officer. As he examined the report, however, Nelson became concerned about several problems with the company's income statement. The First Contact One morning, Nelson phones your office. He explains that he is beginning to worry about the financial health of Nelson Building Company, and that he wants your help in looking into the matter. "Here's the deal," he says, "If nothing else, for my peace of mind, I'd like to send over the income statements for the year ending December 2010 and for the first six months of 2011. You look them over; give them a quick analysis. It doesn't need to be anything thorough. Not now anyway. Just see if you think there is anything suspicious going on." Nelson gives you the background on Nelson Building Company's last eight months. You ask a few questions, and then beg off the call so you can get some lunch before your court date. You send Nelson a copy of your standard contract for services, which he signs and returns. Open and download the file nelson.xls, which contains the Income Statement sent to you by Bill Nelson. Review the material and answer the following questions.

Questions: 1. At first glance, how do Net Sales and Operating Income for the first six months of 2011 compare to the yearly total for 2010?

2. What weaknesses do you perceive in Nelson Building's current company structure (i.e., personnel, controls, etc.)?

3. What analyses do you plan to run as the first step in your investigation?

Up and Running By performing a quick profitmargin comparison, you can compare the numbers from Nelson

Building's monthly financial statement to see whether the profit margin has remained fairly constant from one month to the next. This quick, easy analysis allows you to show Mr. Nelson hard statistics to confirm or disprove his suspicions. Open the spreadsheet file nelson.xls. Enter the appropriate formula(s) to calculate the net profit percentage for Fiscal Year 2010 and for each month in 2011. Questions:

4. What formula did you use to have the spreadsheet calculate the net profit percentage for FY 2010?

5. What trend is obvious from these numbers?

6. What are you going to say to Bill Nelson?

Your First Report Your calculations show the profit margin dropping from around 11 to 2 percent during the first six months of 2011. The steady fall doesn't appear to be occasioned by exterior forcesthe price of materials in the Dallas region has remained fairly constant; retail prices have risen slightly, so if anything, you ought to be finding a healthier company than before. You lay out the situation in Bill Nelson's office. ''You have a profitmargin problem," you tell him "I was pretty sure of that," Nelson sighs. "Question is, why and what are we going do about it? Do you think one of my employees might be stealing from me?" "I've done some checking. Looks to me like business has been good. Market forces are still in your corner." "Then somebody's playing games with the cash flow," he blurts out. "Maybe, Bill. I'll find out if you want me to." Nelson asks you to conduct a preliminary investigation to discover where his company's money is going. Because he suspects the problem is internal, he suggests that your investigation be as covert as possible in the early stages. You should only speak with Nelson Building employees if it becomes necessary. You agree, as long as Nelson provides you with the information necessary to conduct a thorough investigation. He promises you'll have unlimited access to company files. Vertical and Horizontal Analysis of the Financial Records The only thing you know at present is that Nelson Building Company profits are shrinking. The next step is to refine these numbers. You decide the best way to uncover any red flags is to perform a vertical analysis on the financial data you have previously reviewed. You can assume there are no external conditions skewing the data, and that the values calculated for the year 2010 are consistent with previous years and can be considered the standard or average for normal operating conditions. Open the spreadsheet nelson.xls. Then perform a vertical analysis of the Income Statement, reviewing each category as a percentage of Net Sales. You should enter vertical analysis values to the right of each line 6 item.

Questions: 7. What is the percentage of 2010 New Construction to Net Sales?

8. What red flag(s) have been revealed through the percentage analysis of the financial statements?

9. Which category on the nelson.xls spreadsheet shows a significant rise over the 2010 standard?

10. What area of Nelson Building's operations should be reviewed next in your investigation?