requirements

1.Imagine yourself in Nancy John's position. Recall that Nancy was openly critical of the previous Executive Director (ED). Using the fraud triangle as a guide, speculate on the incentives/pressures, opportunities, and attitude/rationalizations that you might contend with if you were the newly promoted ED at New Day Products. (LO2)

2.Summarize the general attributes and responsibilities of a nonprofit organization's board of directors. In what significant ways do they differ from a board of a for-profit organization? (LO1)

3.Consider the state of the organization's board of directors immediately prior to the discovery of the fraud.

a.Evaluate the board's oversight given what you now know about a board's oversight responsibilities. (LO1)

b.Identify and discuss activities that the board no longer performed or could have done differently (provide at least three specific examples) that might have prevented the fraud from occurring. In your discussion of your top three suggestions, be sure to describe what each would have accomplished. (LO3)

4.Contrast the levels of assurance provided by a financial statement audit versus a financial statement review. (LO4)

5.Assume that periodic audits rather than reviews continued for the duration of Nancy's term as Executive Director and that you were on the audit team and participating in its discussion assessing the risk of fraud.

a.Identify eight "red flags", including internal control weaknesses, that would have indicated the potential for fraud in the case (again, refer to the fraud triangle). (LO2, 3)

b.What would have been the appropriate response (i.e. changes to the audit program) to the red flags that you identified had the audit team identified them? (LO2, 3)

c.Why might a financial statement review as chosen by Nancy not have picked up on any of these "red flags"? (LO4)

6.Do you agree with the judge's ruling regarding Nancy John's culpability for the fraud?Why or why not? (LO3)

Bad Days at New Day Products ABSTRACT: This instructional case describes an embezzlement committed by the former executive director of a Southeast Idaho nonprofit organization, New Day Products. The case examines the roles that inadequate internal controls, lax board of director's oversight, and financial statement reviews rather than financial statement audits might have played in enhancing the opportunity for the fraud. The organization, New Day Products, helps people with disabilities achieve their highest economic, social, and personal potential by providing them with vocational, social, and personal services. Keywords: fraud; embezzlement; nonprofits; internal controls; separation of duties; board of directors; board oversight; governance; case studies. THE CASE Jamie Davis, the office administrative assistant to the Executive Director (ED) at New Day Products, stared at the letter from the IRS in shock and disbelief. The letter asserted that New Day Products owed over a million dollars in back payroll taxes, associated interest, and tax penalties. While Jamie suspected something amiss with how the ED managed the organization, she scarcely imagined that things were this bad. Jamie recalled past questionable expenditures and reflected on the ED's seemingly extravagant spending habits as well as those among the ED's family and friends. She realized that the management style at New Day Products, a small nonprofit organization focused on helping people with disabilities, had become increasingly secretive during the ED's tenure. Employees seemed discouraged, even afraid, to question authority; simple acts such as opening the mail were reserved for the ED. Jamie decided to open the IRS letter only because it appeared urgent and the ED was on vacation. Her decision would become the triggering event leading to the long unraveling of a devastating fraud and embezzlement scheme orchestrated by Nancy John, the ED of New Day Products. Jamie wondered how this could happen at an organization with a mission of helping people. Differences between For-Profit and Nonprofit Organizations Although for-profit and nonprofit organizations are similar in that they both comprise people working together to accomplish their organizations' missions and goals, they differ in fundamental ways. First, a primary goal of all for-profit organizations is to generate profits for their owners. In contrast, the primary goals of nonprofit organizations generally focus on providing benefits to society. Differences in the primary goals of for-profit and nonprofit organizations give rise to different funding models. For-profit organizations are generally funded by investors who expect to obtain a return on their investment. Nonprofit organizations are frequently funded by donations and government grants. Although donors and other funding sources do not usually expect to receive monetary returns from their investments of time and resources, they do expect that the nonprofit organization make measurable progress toward its mission. Although a nonprofit can generate income, it must be recycled back into the organization to achieve the organization's objectives. Second, for-profit organizations' workforces primarily consist of competitively paid managers and staff, whereas a nonprofit's workforce often includes a large portion of volunteer efforts. As a result, employee pay is frequently higher at for-profit organizations compared to nonprofit organizations, sometimes hindering nonprofit organizations from attracting equally skilled employees. However, nonprofits can sometimes counter pay disparities by attracting employees who are strongly motivated by the organization's mission. Such differences in employee motivation between for-profit and nonprofit firms can create markedly different cultures: for-profit cultures are often typified by aggressive profitoriented activities whereas nonprofit cultures are typified by their sense of community and the resulting intrinsic rewards. As a result, the public as well as the nonprofit organization's employees often assume 1 that a nonprofit organization's management and staff are serving the best interests of the organization (Mann 2006). Third, for-profit organizations pay income taxes on their taxable earnings. In contrast, organizations that are designated as nonprofit organizations by Section 501(c) of the Federal Tax Code are exempt from paying some federal and, in most cases, state income taxes. However, both types of organizations must withhold and remit any federal and state employee income, medicare, and social security taxes from employees' paychecks. Both for-profit and nonprofit organizations must also remit to tax authorities their matching contributions for employees' medicare and social security payments and any federal and state unemployment taxes. Fourth, for-profit organizations are owned by shareholders who have ownership claims to the organizations' assets and, through voting rights, control the composition of the organizations' governing boards. Nonprofit organizations have no owners; a nonprofit organization's earnings must be reinvested in the firm. Nonprofit organizations are generally considered accountable to the public that they serve and to the state agencies and tax authorities by which they are regulated. Much like for-profit organizations, nonprofit organizations rely on boards of directors for financial and strategic oversight. Boards also help to develop and maintain operational policies in support of the organization's mission. However, the responsibilities of nonprofit and for-profit boards of directors differ in key ways discussed in the next section. Board Responsibilities and Differences between For-Profit and Nonprofit Boards Except for an increased emphasis on mission, boards of directors at nonprofit organizations are much like their counterparts at for-profit firms. Boards of directors are generally responsible for the strategic and fiscal oversight of their organizations. In exchange for their time and talents, for-profit board members can be well-compensated, commonly with stock-based compensation that aligns their interests with those of shareholders. In contrast, nonprofit board members are not compensated and may be expected to directly provide or generate financial support for the organization (Epstein and McFarlan 2011). Like the board members of for-profit organizations, board members of nonprofit organizations have a legal fiduciary duty to provide independent oversight of the organization's assets and operations. While state laws vary, in general nonprofit board members are legally responsible to provide adequate strategic, operational, and financial oversight over the organization, its mission, and its senior executives (AICPA 2017). To achieve effective board governance, a nonprofit board should meet regularly to review and approve the organization's mission, strategy, budget, compensation practices, and other key financial and operations policies. A board should comprise members having diverse ethnic, gender, and racial backgrounds to provide broad perspectives and help ensure a fair and equitable review of organization policies. Boards members should also have diverse experience and expertise to provide the organizational and financial skills necessary to advance the organization's mission and provide adequate oversight. Although boards should consist of at least five members, they can often exceed 25 members for large organizations (Independent Sector 2015). As with for-profit boards, management oversight is among a nonprofit board's most important responsibilities. Boards are generally responsible for the hiring, evaluation, and firing, when necessary, of their organizations' EDs. A board of directors hires, oversees, and evaluates ED performance and any changes in ED compensation. A nonprofit board should also review and evaluate policies for approving expenditures to verify that they are consistent with the organization's mission. For example, the board should require that management prepare appropriate written policies for authorizing expenditures. Such policies should clearly establish who is authorized to approve payments, what documentation is required, and what kinds of expenditures are permitted. Although not required, nonprofit boards may wish to form an audit committee to provide stronger assurance of the organization's financial health. Audit committees are generally formed from a small 2 subset of the board, such as three to five members. Audit committees are not involved in day-to-day accounting functions but oversee the assurance process that includes the hiring and evaluation of the firm's independent auditors. Audit committees can also follow through on auditor recommendations to ensure that they are implemented. Although a nonprofit board may choose not to form an audit committee like what is required for publicly held companies, it should continue to protect its independent oversight of the organization's auditors by having the full board perform such audit committee functions (National Council of Nonprofits 2020). Differences Between Board Responsibilities and Management Responsibilities Management and boards of directors play distinctively different roles in their organizations. Whereas management is responsible for planning and executing strategy and enforcing the organization's operating procedures, boards of directors provide broader and more general oversight by reviewing and approving strategy and setting broad policy guidelines. Boards of directors are responsible for recruiting chief executives and devising their compensation contracts. They are also responsible for assessing business risk and monitoring their organizations' financial health and internal controls. In addition to monitoring financial health, boards of directors should monitor an organization's culture to assess whether it is conducive to meeting the organization's mission and goals (Grant Thornton 2016). Organization Background Founded in 1975, New Day Products is an Idaho nonprofit organization that provides comprehensive employment and social services to people with disabilities in cooperation with private and public community organizations and businesses. Its services include employment planning programs, employer and employee matching services, and in-house employment opportunities. Its employment planning programs assist participants with vocational decisions through standardized testing, situational assessments, and community-based job tryouts. Each individually tailored program culminates in a service report that details the participant's vocational strengths and developmental needs and helps the participant choose a vocation. New Day Products' matching services match participant's abilities to job requirements and provide additional assistance through on-site job coach training. Its in-house employment opportunities include jobs such as wood container manufacturing, pallet repair, bulk mailing operations, engraving, laundry, and janitorial services. New Day Products' social services include a developmental disabilities program and an adult living center. The developmental disabilities program teaches life skills that not only encompass social skills but more fundamental skills such as cooking. The program is tailored to each participant's needs, goals, preferences, and interests, and the training is often provided in context, whether at home or the workplace. Residents at New Day Products' adult living center participate in the developmental disabilities program, but the adult living center also fosters greater community interaction and involvement. In addition to participating in arts, crafts, and games at the center, residents participate in field trips to local events. When the fraud was revealed in 2009, New Day Products served seven counties in Southeast Idaho. Its funding and costs exceeded $1.3 million. Its four major funding sources were (1) the Idaho Division of Vocational Rehabilitation which helped fund its vocational training, (2) Medicaid which provided partial funding for residents of the adult living center, (3) federal and state cleaning contracts for janitorial services at local facilities including the FBI data processing center, and (4) revenues from selling goods and services like its wood pallets and trophy engravings. Profits from selling goods and services were approximately 35% of its total funding. A Brief Organization History 3 At its founding, New Day Products boasted a well-rounded board of directors consisting of 15 members with expertise in accounting, legal, financial, vocational, and social work. As some board members had relatives who were beneficiaries of the organization, the board was highly committed to the organization's success. Leading the organization, Dick Kaup, was an experienced and dedicated Executive Director. Dick believed in a highly transparent management style. He kept the board fully informed regarding all operational and financial matters. With detailed reports provided by Dick, the board monitored actual results against an annual budget and discussed significant variances. The board oversaw internal controls assuring that no one person controlled an entire financial process from beginning to end, with separation of duties enabled by the board-approved organizational structure (Figure 1). The board treasurer reviewed Dick's company credit card statement every month to ensure that all charges were reasonable and served legitimate business purposes. Regular board training, including training about financial oversight and internal controls, and annual board self-evaluation enhanced board effectiveness. Staff members were similarly well-trained and adequately supervised. A local CPA firm experienced with nonprofits performed financial statement audits every two years. Although not required by New Day's funding sources, Dick believed that a periodic independent audit provided a necessary deep dive into the processes and documentation supporting the organization's financial reporting. By all accounts, the organization operated smoothly and efficiently under Dick's leadership. When Dick retired, Steve Clark became the new ED. One board member described the next five years under Steve's directorship as \"...a period of complacency. We had been lulled into a sense of security knowing that Dick had done a wonderful job and the organization was on solid footing.\" While the board continued its monthly meetings and its bi-annual financial statement audits, its membership began to shrink. One member left due to health problems, another retired and moved out of the area, and two others left because their own businesses were taking up more of their time. With fewer resources, a lack of expertise, and reduced focus, the board relaxed or abandoned altogether many of the board practices from the Dick Kaup era. Rumors began circulating that Steve was not as committed or adept as his predecessor. The financial health of the organization had shown signs of deteriorating. Staff turnover, historically quite low, began to increase. Nancy John was openly critical of Steve's leadership and some board members shared a similar sentiment. Two additional board members left the organization to pursue other service opportunities, including the board treasurer, leaving the board with no financial expertise and nine remaining members. Filling board vacancies proved difficult. A remaining board member recalled that \"as folks left the board, we would make an initial attempt at replacing their area of expertise, but things would go on and we wouldn't find a replacement.\" In 2006, having lost confidence in Steve's ability to lead the organization, the board released Steve and appointed Nancy John as ED. The Nancy John Years Nancy John could have been two different people. To the board, she was a hardworking, engaged manager who was \"always in control\" of a situation. But to the staff, she was an intimidating micromanager who ran things \"close to the vest\