Case 11 our Corporatio 2 Mherent Risk and Control Risk Factors ; Comptro; Identifyin —__ Mark S. Be: Steven at ailey, Frank A. Buckless, Glover, Douglas F, Prawitt LEARNING OBJECTIVES After completin #€ and discussing this case, you should be able to * Understand how Heneeratnd how managers can fraudulently manipulate financial * Recognize key in! 4 toring « key inherent risk factors that inerease the potetial for nena = Recognize ki ee potential for financial * Understand the i i - importance of effective corporate governance for Ceaeligttacimatipacaice ” f INTRODUCTION All appeared well at Comptronix Corporation, a Guntersville, Alabams based electronics company, until word hit the streets ‘November 25, 1992 that there had been § fraud. When reporis surfaced that three of the company’s top executives had inflated ‘company eamings for the past three years, the ‘company’s stock price plummeted 72% in one day, closing at $6”* a share down from the previous day's closing at $22 ¢ ‘The Securities and Exchange Commission's (SEC) subsequent investigation determined that Comptronix’s chief executive officer (CEO), chief operating officer (COO), and the controller/treasurer all colluded to overstate assets and profits by recording fictitious transactions. The three executives ‘overrode existing internal a ‘Source: “Company's profit data were false,” The New York Times, November 26, 1992, D:1 prepared by Matk S. Beasley, PhD. and Frank A. Buckless, Ph.D. of North oon Site ee and Steven M. Glover, Ph.D. and Douglas P. Prawit PhD. of University, as 2 basis for ‘class discussion. It is not intended to illustrate handling of an administrative situation. Upper Saddle River, N5 07458.eS i Samer od ass Ora their GUL, ginst the company an, they ad ioral st ee were Be reformed 8 speci conn ction Heys Boar executive tea ite thin y's fn interim teat Within eeiately, the COMPS crting fraud $4 10 conduct a deta PP rivesigate te allened SMAI raen, LLP Om Baa in to take charge, and Arthur vow were stoned: HOW SOUL fa soa Alnbame of ouble that Were 'EMOTS . invenigaton. *erchens of esl! AS RONIX CORPORATION so close to home? Were ‘ABOUT cOMPT! 1 operations Oe A Comptronix based its princip®l SP ites southeast Of vn originale. Te 7,000 residents located abOw “T Cggoturing SetViCrS ee rveuit Pe company provided contact Mit" Ther primary Product was circuit Beard ‘manufacturers inthe elect OW eT ment, Neighboring Hurisvitls DEA Presence personal computers and medics! ed¥iPr ix a local base of customers for its in the electronics industry provis« ‘ebama facility, the company also mainainct iifonia and Colorado Springs, Colorado + people at the three locations, and was BACKGROUND boards. In addition to the Al manufacturing facilities in San Jose, Cal total, Comptronix employed about 1600 the largest employers in Outre in the early 1980s by individuals who met waa, working Se eee industry in nearby Huntsville. Three of those founder Forking in oe Shears of the company. William J. Hebding became Compra chairman and CEO, Allen L, Shifflet became Comptronix’s president and COO, ang Paul Medlin served as the controller and treasurer. Prior to creating Comptronix, 3 three men worked at SCI Systems, a booming electronics maker, Mr. Hebding joine; SCI Systems in the mid-1970s to assist the chief financial officer (CFO). While in tt role, he met Mr. Shifflet, the SCI Systems operations manager. Later, when M, Hebding become SCI Systems’ CFO, he hired Mr. Medlin to assist him. Along with « few other individuals working at SCI Systems, these three men together formed Comptronix in late 1983 and early 1984." The local townspeople in Guntersville were excited to attract the startup Company to the local area. The city enticed Comptronix by providing it with an empty ‘kanitting mill in town. As additional incentive, a local bank offered Com - ir cative, iptronix an Attractive credit arangement. Comprronixin tum appointed th local bart directors. ‘Town business leaders were excited to have new employes opportunities and looked forward toa boost to the local evonomy. ee The early years were difficult, with g Local enthusiasm for theAccord ing to the public in SEC's alien 1989 and was Greed nse td be Shien ne nl, 1P company executives, Mi ching halen Potions Of power and ntoes ne hes oe aca fidwn te see tere earie e an ae soled ee le ee ee eee SURI suh WC ponte tld an ene oan Tike to inventory accounts. This ott oversta en ‘aly gross margin and net ine g just at querer ama! Joural, entries, ne for the period. The three ay Geietter te 909 ree . with the largest adjustments Th Ba aca Some allege that he fad was motivated by the loss of " Ae executives ‘executives’ former ae ¢ loss of partial! s were 5 t r employer, SCL ly because the successful in manipulat if Si ttcduamce ee tek ae Te Gack ote’ gatas an Deeaber a ase - Seti. “To Hide the racipuisionn hom fre a eee al mi i . at-end_ financial up the inappropriate he manipulations on the matios e ceneeiaailantoresiet Beis inventory scoot Sie ‘They decided to remove the transferred costs Ippatiidiclosely extmine the i fore year-end, because they feared the auditors Brest inventory account as of December 31, 1989, r es oe Se eo amet poeal Be i each transfer s ywever, ile sail a ines a of goods sold, the fraud team booked « fititions sale of er eccivables. ‘ous accounts receivable. That, in tum, overstated revenues ‘The net effect of these activites was that interim fi Fnancial statements included understated cost of goods sold and overstated inventories, while the annual financial statements contained overstated sales and receivables. Once they had tasted success in their manipulations of year-end sales ‘and receivables, they later began recording fictitious quarterly sales in @ similar fashion. To convince the auditors thet the fictitious sales and three company executives recorded cash payments on the bogus ix. In order to do this, they developed a relatively . ded fictitious purchases of equipment on overstated equipment ‘and accounts payable. ‘Then, Hebding, controller and treasurety Cot checks to the and Medlin, ated with the fake purchases of equipment. But in Comptronix’s receivables wereSEC eevesagenee 1999, 1990, and 1991 8eE Sales (G2 000s) ‘Reporsnd Seles ‘Ressuand SulesCase 11 - Comprronix years affected? The poration: Wdentifying inherent Risk end Control Risk Factors property, plant, and faud scheme also inflated ‘equipment ‘the balance sheet by overstating, ecciy + sotinamavarpdantlyerse= of 1991, by 111%. ‘overstated by over 90%, with 7 HE COMPANY'S INTERNAL CONTROLS* purchases journals Pgow eats manny” Oh ‘oy the existing intemal control, and recorded the ee te bctioed nf Ge fuel ty ‘were exchided from the manipulations *° ois aerongigter ‘SEC's sumenary of he investigation, Comptronix ™OPIO TES purchase orders and 1 exicunive paper til for equipment purchases, cial’ Preated for the seceiving reports. However, none of these Gocumenss Wat bogus purchases. Approval for cash dé was typically nnd vendor invoice WET report, epson ee Shifflett or Mr. Medlin could approve paymenss ee invoice. hy, Socom wns ce to ype woes COSTS ——— They saoply showed fcitious vendor Moles © 6 ee whe ven ep cnt meus sens insufficient to detect the manipastion of sales end it clerk would enter ‘the customer into the qutomatically produced & ShiPPans was shipped to the customer, Sing controler and ledger. sacl en the Nop Tanks of AN Semeutives st Compronix, directed periodic oversight from these. Directors With these Kindy op se ge ide” a pepnjectiviy: THe ment. One of the Temaining bg ranges at OWS 575.978 shares ¥ Bigs no apparent pe venture capital HN eviously @ partner in « 4+) pare 0 te Yt director WO orate boards. A secon’ ri rectors was pare Ps Comptronix’s 07 nmon ‘on two = ‘currently serving the local bank originally loaning ,, i law firm and was and CEO of th T° board of another loa oe director was the vice ¢! airman ol as cl the company. He also imvas president of af Intemational com nearby town. The td art ae ‘members a on the C me my supplier based in Taiwan tal partner who joined the boar caer singe 1984, except for she venture CAL card in 1990 ard in Igy) and the president of the key eae si an oak lah i ee on ‘granted each director an option to purc ng sede, The mre cxacive price that equaled the market price ‘on the date thatthe option was granted. A an os ore four times during 1991, The board had an audit con, that was charged with recommending outside auditors, reviewing the mope- are ith the external auditors, reviewing the result, "> audit engagement, consulting wil liaison between the board and the internal g,.,°% Auditor, audit examination, and acting as 8 The audit commitice was also charged with reviewing various comp; including those related 10 accounting and internal control matters. Twos directors and one gray director made up the three-member audit committee. GN re of those members was an attorney, and the other two served as president and Cpe O of the companies where they were employed. There was no indication of whethe of these individuals had accounting or financial reporting backgrounds The pe dit Committee met two times during 1991 MANAGEMENT. BACKGROUNDCas se 1 ~Comy Ptronix © joined the co, maifacturing on’ Sees Compe nih manager pongo hoa Inherent. Virginia’ Paige: Shitnetr deuee’ being empla ot Horses inic intine et 1981 uni nstinut 1981 unt Aprit 191 Paul Me ? on oe peavitusly works < University of Ane 992 on prox ah ; rate equal = " Medlin Hebding, $148 granted performance Ate been present reputations in the Ic reputations. Mr. Hebding P neers ‘