Fraud in the AIS: Koss Corporation Fraud - Research Paper Example

 Fraud in the AIS: Koss Corporation Fraud Introduction Koss Corporation is a headphone and other electronic manufacturing company that was established in 1953 (Coenen, 2010). The company was faced by a major Fraud and funds embezzlement case in 2009, where it was discovered that its chief financial officer, Sujata Sachdeva had defrauded the company a total of $31.5 million for the period spanning 2004 to 2009. The fraud in Koss Corporation entailed two major accounting system misappropriations, namely fraudulent wire transfer and the insertion of fraudulent account entries in the company financial books and records (Coenen, 2010). An accounting Information System (AIS) within an organization is meant to help the organization’s accounting function, through the collection, processing, storage and then dissemination of the accounting information to the organizations stakeholders or other externally authorized and interested parties such as the auditors (Hall, 2013). In this respect, any form of fraud or embezzlement of the funds belonging to an organization occurs as a result of the failure of the organization’s accounting information system (Hall, 2013). Thus, there are various ways in which both the functions and components of the Koss Corporation Accounting information system failed, allowing for the fraud and embezzlement of the company’s funds. These failures in functions and components of the Koss Corporation AIS include: Koss Corporation’s AIS Functions Failure Failed collection and storage of financial data The major function of the AIS within any organization is the collection and storage of financial data from the original source document, recording all the transactions in the financial journal entries, and finally transferring the journal entry information into the ledger accounts for balancing (Schaeffer, 2008). This function of the Koss AIS failed, considering the fact that the fraud and embezzlement that spanned over a period of six years, spanning the period 2004 to 2009 entailed the insertion of fraudulent account entries in the company’s books and financial records (Coenen, 2010). Therefore, the process of collecting data from the source documents such as invoices and receipts was not effective, allowing for the fraudulent insertion of nonexistent accounts in the financial books and their consequent transfer to the ledger book for balancing. Thus, the balancing of the company’s ledger accounts was done based on fraudulent and nonexistent transactions. Failed supply of financial information to the decision makers The second major function of the AIS within any business organization is to supply the collected, recorded and stored financial data to the relevant authorities within the organization for subsequent decision-making (Hall, 2013). In the Koss Corporation fraud case, this function of the AIS failed completely, because the financial information collected were not submitted to the relevant top management of the organization such as the company CEO and the company auditors for investigations and analysis (Coenen, 2010). Despite the existence of a company auditor during the whole period that the fraud was being carried out, the auditor did not discover the discrepancies in the financial accounts that would have revealed the fraud, and neither did the CEO unearth the fraudulent dealings by the Chief financial officer of the company. Therefore, the information supply function of Koss’s AIS failed. Failed financial control mechanisms The last major function of AIS within any business organization is to ensure that the right control mechanisms are in place, which prevents the misappropriation of the organization’s funds, through applying the relevant checks and balance mechanisms that control the spending of the organizational funds to the relevant items of expenditure (Schaeffer, 2008). In the Koss corporation case, the financial control mechanism of the AIS absolutely failed, through allowing for enormous spending amounting to a massive $400,000 per month through a single account, all for personal expenses. The chief financial officer of the company fraudulently wired the huge amounts of money on a monthly basis to her personal credit card account for the period of 6 years, without being discovered by the company (Coenen, 2010). Therefore, the control mechanism of the company’s AIS was faulty, thus allowing for loopholes that would transfer such huge amounts of money without being detected. Koss Corporation‘s AIS Components Failure People failure People form a fundamental component of any organization’s AIS, because they are responsible for overseeing the operation of the system through initiating its major functions of collecting financial information, processing and then storing it for future use (Hall, 2013). Such people include the company accountants, auditors, financial analysts and top level managers. Thus, in the Koss corporation case, the people component of the AIS failed in its duty of seeing the system work effectively. This is because, the lower level accountants were directed to insert fraudulent account entries into the financial books and records of the company by the chief financial officer to facilitate the fraud, while the auditors and the top level management did not scrutinize the financial books and records effectively to detect the fraudulent wire transfer (Coenen, 2010). Therefore, the people component of the AIS did not only contribute to the fraud, but also facilitated the perpetration of fraud and embezzlement. Procedure failure Procedure is another major component of the AIS within any business organization, which deals with the ways financial information is collected, processed, stored and then retrieved for dissemination whenever the need arises (Schaeffer, 2008). It is through the procedure component of the AIS that any fraud can be detected, since when all the procedures are accurately followed and observed, there will be no chance for inserting fraudulent account entries in the books of accounts, since the procedures require the direct transfer of information from the source document to the financial journal entries and then to the ledger account entries (Hall, 2013). Therefore, where this procedure is accurately followed, nonexistent or inflated account entries cannot be entered in the books of account, since the journal entries and the ledger accounts will not balance as required by the accounting procedure. The fraudulent and non-existent account entries were inserted in the Koss Corporation books of accounts, while the money transfer from the company’s accounts to a personal account was not detected (Coenen, 2010). Therefore, the right accounting procedure was not followed, contributing to the perpetration of the fraud. Data failure Data is a major component of the AIS in any business organization, since it comprises of the financial information that is collected, processed and stored for future use (Coderre, 2009). Data accuracy is the fundamental requirement for the provision of accurate books of accounts. However, the books of accounts of Koss Corporation comprised of inaccurate data and nonexistent transactions. Thus, the data component of the company also displayed a failure, since it was not accurate. Software failure Software component of the AIS refers to the accounting program that is used to process data after it has been collected and entered, so that the final books of accounts can then be produced (Coderre, 2009). While the manual processing of data is prone to numerous mistakes that may lead to the inaccurate production of books of accounts, the software is applied as a foolproof method of ensuring that errors in data entries and data entry procedures are detected and corrected during the data processing (Coderre, 2009). However, the software component of the AIS proved to have failed completely, since there were numerous non-existent transactions and account entries that were entered into the data processing system, yet the software did not detect the discrepancies. This simply means that the software component of the AIS had been interfered with, making it unable to detect the discrepancies in data during it’s processing. ICT infrastructure failure The information technology infrastructure is a major component of AIS within any organization, which allows for the interconnectivity of all systems and processes within an organization, making it possible for different departments of the organization to share the relevant information. It is through the ICT infrastructure within an organization that the top management can be able to access and monitor the financial transactions of the organization, even without the need to engage the accounting department directly (Coderre, 2009). The ICT infrastructure for Koss Corporation seemed to fail, since the chief financial officer was able to perpetrate the fraudulent wire transfer of money to her personal account, with the top management such as the CEO being unable to monitor the transactions and detect the fraud (Coenen, 2010). Internal Control Failure The internal control component of the AIS provides for the security measures to be applied towards protecting the data of an organization from being interfered with (Coderre, 2009). Despite the fact that the CEO of the organization is engaged in many other functions of the organization, the financial function should be a major area of interest and concentration. This is necessary owing to the ability of the financial function to shut down the whole company even when the rest of the functions are performing well, if the financial function is faulty. Therefore, it is the duty of the CEO to periodically monitor the financial transactions of the organization, just in case a problem can be detected and addressed in good time (Hall, 2013). Thus, the internal control component of the AIS in Koss Corporation was not effective, because it allowed for loopholes exploited by the chief accounting officer to alter and doctor the financial data to suit the fraudulent transactions, through fraudulently transferring money to a personal account, and then inserting nonexistent accounting entries to cover up the fraud (Schaeffer, 2008). Assessing the failure of the Koss Corporation’s AIS to prevent the fraud The failure of the Koss Corporation’s AIS to prevent the fraud took two major dimensions. First, the fraud entailed doctoring the company’s books of accounts by the chief financial officer, through the creation of an extra account receivable within the ledgers accounts of the company (Coenen, 2010). This was a very clever move by Sujata Sachdevahad, who ensured that through the establishment of an extra account receivable, the total assets of the company remained neutral, since the account receivable created portrayed the embezzled funds as a part of the assets of the organization that the organization would receive in the future (Coenen, 2010). This way, it became difficult for the auditors and the top management of the organization to discover this discrepancy, because the assets of the organization did not seem to decrease as a result of the fraud, rather appearing to be differed payments that the organization would receive in the future. It is through this clever move that Sujata Sachdevahad was able to run away with the embezzlement for a period of 6 years without being detected (Coenen, 2010). Secondly, the failure of the Koss Corporation’s AIS was orchestrated through the booking the defrauded amounts into several account expenses of the company, where the each of the expense accounts would be inflated with small amounts of the defrauded amount, to eventually total the whole amount that was being defrauded monthly (Coenen, 2010). This is a safe method of committing fraud, considering the fact that once the expense accounts have been inflated, there is no future action required to offset the amounts, especially where such amounts are booked into the cost of goods sold expense accounts (Coenen, 2010). This way, the expense of the account are portrayed as high, while in the actual sense the top-up amounts have been consolidated and then wired to a different account. This fraud becomes very difficult to detect, since such detection requires very close monitoring of each component of the account expense. Level of responsibility a third-party accounting system In case a company is using a third party accounting system, the responsibility of the software provider is limited to the operation of the software, and not the actual mistakes of the people who are using the software (Feinman, 2007). Therefore, the software provider can only be liable to the stakeholders of the company, under circumstances where the software turns out to be faulty, and thus is not able to discharge its data processing functions appropriately. The culpability of the third party software provider emanates from the fact that the third-party owes its clients a professional duty of care (Feinman, 2007). However, if the fault emanates from the professional negligence of the accountants in operating the accounting software, then it is the accountant, as opposed to the third-party accounting system provider, who bears the responsibility for any loss incurred by the stakeholders (Feinman, 2007). Advances in accounting/ICT that could have prevented the Koss Corporation Fraud The advances in technology that entail the provision of audit-specific software such as Interactive Data Extraction and Analysis (IDEA) is an essential accounting technology, which could have been applied to prevent the Koss Corporation Fraud from occurring (Coderre, 2009). This is because, IDEA is a software program that scans and profiles accounting data into two categories; the business and the financial transactions, making it possible to compare between all the transactions that a business has made in terms of purchases and procurements against all the payments that the business has made in terms of financial payments (Coderre, 2009). Thus, the profiling of the accounting data of Koss Corporation into these two categories would have made it possible to identify the nonexistent transaction entries that were made in the company’s book of accounts, making it possible to detect the fraud that was being committed over the 6 years in the company, which entailed the insertion of fraudulent account entries in Koss’s books of account (Coenen, 2010). Secondly, IDEA is an accounting technology advancement that would have made it possible to avoid the fraud that occurred in Koss Corporation. This is because; this software is designed to be able to retain transactions in an archive, such that the archived transactions can then be run to establish relational tables that compare the transactions undertaken within a given business period to the corresponding payments done (Coderre, 2009). This way, it becomes easier to detect the fraudulent transactions that have been inserted in the account records, since they will not match any item of the purchase and payment in the tables. Necessary changes in the Sarbanes-Oxley Act of 2002 The change that should be made to the Sarbanes-Oxley Act of 2002 is amending clause 404, so as to relieve the organizations the cost burden imposed by the Act (Brite, 2013). The burden has been imposed through requiring that the publicly traded organizations should be audited by both internal and external auditors, while at the same time requiring the audit board committee of the shareholders to participate in their own independent auditing of the organization’s accounts (Brite, 2013). This requirement creates room for the organizations to compromise the auditing processes by failing to report high profits and also through compromising the auditors in a bid to reduce the auditing costs that have increased two folds since the implementation of the act (Brite, 2013). Thus, the provision should be changed to require only the external auditors and the audit committee of the board of directors to undertake independent audit investigations. This will reduce the audit cost burden for the organizations, and allow the auditing report from both the external auditors and the audit committee to reflect accurately in reporting the financial situation of the organizations. Recommend a strategy that Koss Corporation may use to prevent future business information failures The recommended strategy for Koss Corporation to avoid future business information failures is the adoption of advanced accounting software such as the IDEA (Schaeffer, 2008). This software should then be integrated with the company’s infrastructure to ensure that the top management of the company can access the books of accounts as well as all the business transaction records of the company without directly involving the accountant. This way, the top management of the organization such as the CEO can be able to monitor both the purchase/procurement and the payment transactions of the company on periodical basis (Schaeffer, 2008). The effect of this direct access is that; it will enhance the monitoring of the transactions by comparing all he purchase/procurement transactions against the payment transactions and discover any discrepancies in good time, which can then be addressed before they turn out into a major scandal. References Brite, C. (2013). Is Sarbanes-Oxley a Failing Law? University of Chicago Law Review. Coderre, D. (2009). Computer Aided Fraud Prevention and Detection: A Step by Step Guide. John Wiley & Sons. Coenen, T. (2010). Koss's $20 Million Embezzlement Should Be a Wake-Up Call to Execs. Daily Finance. Available at: http://www.dailyfinance.com/2010/01/04/koss-execs-20-million-embezzlement-should-be-a-wake-up-call-to/ Feinman, J. M. (2007). Professional liability to third parties. Chicago, IL: American Bar Association. Hall, J. A. (2013). Accounting information systems. Mason, OH: South-Western Cengage Learning. Schaeffer, S. M. (2008). Fraud in Accounts Payable: How to Prevent It. John Wiley & Sons. Read More