Question 3 (7 marks,)

The Ladies Apparel Corporation(TLAC) is a leader in women's legwear and intimate apparel. Their brands include fashion-forward Hua one of the most recognized and respected brands among women. While their heritage is in hosiery products, their brands have experienced tremendous sales successes with innovative designs and solutions in many other categories, including sleepwear, loungewear, panties, slippers, bras, shoe solutions, fashion legwear, and socks. TLAC is a public company, headquartered in Toronto, whos shares trade on the Toronto Stock Exchange and has a December year-end. TLAC operates four divisions in both Canada and the United States. The company also has a design studio/showroom in the heart of the fashion district in New York City.

TLAC has historically allowed its divisions to operate autonomously. Corporate intervention occurred only when planned results were not obtained. Corporate management has high integrity, but the board of directors and audit committee are not very active. TLAC has a policy of hiring competent people. The company has a code of conduct, but there is little monitoring of compliance by employees. Management is fairly conservative in terms of accounting principles and practices, but employee compensation packages depend highly on performance. TLAC Company does not have an internal audit department and it relies on your firm to review the controls in each division.

Stan Silver is the general manager of the Hosiery Division. Silver has been the general manager for the last seven years, and each year he has been able to improve the profitability of the division. His compensation is based largely on the divisions profitability. Much of the improvement in profitability has come through aggressive cost cutting, including a substantial reduction in control procedures over inventory.

During the last year a new competitor has entered Hosierys markets and has offered substantial price reductions in order to grab market share. Silver has responded to the competitors actions by matching the price cuts in the hope of maintaining market share. Silver is very concerned because he 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, his salary and bonus will be reduced.

Silver has decided that one way to make the division more profitable is to manipulate inventory because it represents a large amount of the divisions balance sheet. He also knows that controls over inventory are weak. He views this inventory manipulation as a short-run solution to the profit decline due to the competitors price cutting. Silver 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.

Required:

1. What is the risk of fraud in TLAC (unlikely, likely or highly likely). (1 mark)

2. Explain the three conditions for fraud (the fraud triangle) and describe whether or not each of these conditions was present at TLAC. (6 marks)

Use the table below on the next page to complete your answer.

Fraud Conditions	Condition Present at TLAC