IN A TYPICAL fraud, an employee, vendor, or customer profits from his or her misdeeds. This case involves a financial reporting fraud where the operating results were misstated in the income statement. The fraud had gone on for nearly a year; although all the symptoms were visible, no one did anything about it -- until the internal auditors performed a typical audit of food and beverage inventories.

* Discovery

As usual, the audit of food and beverage inventories began shortly before year end. The auditors performed and recorded the inventory counts and followed with blind test counts, agreeing their counts to the accountants' and ultimately to the perpetual inventory records. Everything looked fine -- until they made a comparison to the general ledger balance.

Food inventory normally totaled around $400,000, about what the perpetual records showed. The general ledger balance was nearly $1 million more than the perpetual records. The food and beverage controller explained that the difference had to be the result of overpayments by the accounts payable department and that investigation was needed. The financial controller, previously unaware of the problem, supported the food and beverage controller's position.

* Investigation

Professionally skeptical, the auditors called in audit management, who determined that inventory balances had been steadily increasing since January. Fearing that cost of sales could be inadvertently understated, the audit manager determined that cost of sales was 39 percent, well within industry standards. Cost of sales was always 39 percent, exactly as budgeted, winter, spring, summer, fall.

The food and beverage controller explained the consistent cost of sales by pointing to the accounts payable overpayment problem. He provided copies of his monthly analyses used to compute cost of sales. He said he didn't know which suppliers were overpaid or by how much, so he recorded a fixed amount until he could research the problem. But it was now mid-December, and time for research was running out.

The auditors tested one month's payments in the general ledger and could find no indications of overpayments to vendors. The auditors interviewed the accountant responsible for preparing the cost of sales analysis each month. He provided his analyses, which showed cost of sales averaging 44 percent, not 39 percent. Also, cost allocations were lower by $100,000 per month. The accountant knew of the differences between his figures and the food and beverage controller's but did nothing about it because he had been told the differences were caused by overpayments.

The internal audit manager was alarmed to learn that the financial controller had made an eleventh-hour unsupported adjustment to the November general ledger, transferring more than $800,000 from the food inventory account to a prepaid asset account. This was followed in December by a similar transfer of $400,000. A questionable $1.2 million resided in a prepaid asset account, and it was now time to close the books. The controllers were anxious to put the matter behind them. They had already reported preliminary income to the parent company.

Working around the clock, the internal auditors gathered enough proof to demonstrate that there was no factual evidence of overpayments. When confronted, the food and beverage controller admitted that he was coerced by the food and beverage director to record cost of sales at no more than 39 percent, the amount budgeted. By the end of the year he had convinced himself that there really were overpayments. The financial controller acknowledged that he failed to follow up on the strange increase in the inventory balance.

* The Result

The company had no choice but to take an unexpected last-minute hit to the income statement for $1.2 million in unrecorded cost of sales. This further depressed the company's already disappointing operating results. Year-end bonuses were less than anticipated. The food and beverage controller and financial controller were fired. The food and beverage director was fired for reasons unrelated to the fraud.

Within four months after the identification of the problem, real food costs had been reduced to less than 39 percent. If the food and beverage director had accepted the data originally and taken appropriate corrective action to cut waste in the kitchens and restaurants, nearly $1 million in expenses could have been avoided.

The symptoms of fraud are often obvious to anyone who cares to look. In this case the food inventory carrying value increased steadily to four times normal, and performance (constant cost of sales at 39 percent) was too good to be believed. But you have to want to see the problem.

It is tempting for auditors to document explanations provided and move on. Perpetrators will always have a reason. Auditors should verify and test explanations provided. Follow-through leads to a real understanding and eventually to the truth -- and sometimes to fraud.

Problems grow until they cannot be ignored. Refusing to admit there was a problem cost everyone in this case.

For some companies US$4 million, the amount allegedly embezzled by a financial controller at global IT services firm Wipro, is very significant. But it’s not that large for the Indian giant, which had revenues of US$4.4 billion and profits of US$732 million in the first nine months of 2009. “The company’s internal investigation concluded that, while the matter should be taken seriously, the amounts embezzled were not material from a financial reporting perspective given the size of the company and the scale of its operations,” Wipro told its shareholders last month.

True enough, but the damage to the company’s reputation and credibility is surely far greater. Among Wipro’s wide range of services is consulting and advisory on financial management, including treasury and cash management and risk management. The company also prides itself on its CMM 5 Level status – that’s the highest level in the Capability Maturity Model developed by Carnegie Mellon University, indicating that Wipro’s processes are at their optimum. People can be forgiven for wondering: Is this a case of physician, heal thyself?

Other companies should not gloat, however. If a CMM Level 5 enterprise like Wipro can be hit by fraud, how much more vulnerable are those with no such certification? Wherever there is money, unfortunately, fraud is always a possibility. There are lessons to be learned from what happened at Wipro, both on how the embezzlement was made possible and the way the company is handling the matter.

Anatomy of a Fraud
The man at the centre of this storm is a chartered accountant whose dead body was found near a railway track in Bangalore in December, a few weeks after the embezzlement came to light. According to Wipro, this “junior member of the company’s controllership team” was discovered to have been transferring company money to his personal account from November 2006 until last year. The company has not revealed exactly how much was siphoned off, but media reports say the total is in the region of Rs20 crore, or US$4 million.

“Our investigations have revealed that only this employee was involved, and nobody else in the team had any clue,” Suresh Senapaty, Wipro’s CFO, told the Economic Times. “We have recovered more than half of the amount.” The company is now “undertaking actions with respect to stricter adherence to processes,” he added. “We have to be more alert in monitoring, and we need to tighten the processes for ensuring an early warning system and make it tougher.”

In its statement to shareholders, Wipro said it had “put into place additional initiatives to help ensure Wipro’s financial controls and financial reporting remain unassailable by anyone within and outside the company.” Changes have been made to “certain key positions in the controllership team,” said the company, because their association with the late employee has “created a conflict of interest for them.” Internal and external advisors are also reviewing and enhancing internal controls and procedures.

The internal report has not been made public, but the media has been quoting unidentified Wipro officials who requested anonymity. “The employee stole the password from a colleague and used it to transfer money to his and his family members’ personal accounts,” one of them told the Economic Times. The newspaper said the transfers ranged from 100,000 rupees (US$2,174) to 1.2 million rupees (US$26,088) at a time, which are not insignificant amounts. If true, they should have raised red flags within the company and the bank, which presumably has anti-money laundering policies in place.

lagerwhenindoubt:

External Auditors[b] value their reputation[/b] because[b] that is the only reason they are in business[/b], they won't risk it for anything else. Arthur Anderson lost a huge slice of her reputation because of the ENRON Scandal

lagerwhenindoubt:

Arthur Anderson lost a huge slice of her reputation because of the ENRON Scandal

ola olabiy:

This is NOT true. They all play game.

Dis Guy:

you guys dropping number need to be a bit more professional, you are acting no different from all these Forex guys on Nairaland

You should have a company name or registered business