Week 7 Case Study: Corporate Governance, Internal Controls, and Ethics

• This is the book: https://login.vitalsource.com/?redirect_uri=https%…- It’s the Business Ethics book.
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• APA 7th Edition.
• Responses to two peers will come later.
• Corporate financial scandals for large companies have received a lot of press over the years, but financial scandals occur in companies of all sizes and in all industries. Read the case Koss Corporation Corporate Governance, Internal Controls, and Ethics: What Went WrongKoss Corporation Corporate Governance, Internal Controls, and Ethics: What Went Wrong – Alternative Formats
• In an APA-formatted paper of at least 2 – 4 pages, not including the cover page and references, discuss the following:What were the fraudulent activities in this case? Describe the internal controls that were missing or circumvented. Review the Sarbanes-Oxley Act to review appropriate internal controls and required reporting.What were the problems in the corporate governance and/or organizational structure at Koss? What are the major requirements of SOX with regards to corporate governance and/or organizational structure? How should the corporate management and accounting function at Koss have been organized?What should Julie Mulvaney have done when Sue Sachdeva requested her to assist in the fraud?Use concepts from course materials and other research you conduct to inform your paper. Be sure to cite sources that support or provide evidence for what you write.

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Koss Corporation Corporate Governance,
Internal Controls, and Ethics: What Went Wrong?
Case
Author: Melanie O. Anderson
Online Pub Date: July 12, 2017 | Original Pub. Date: 2013
Subject: Management Accounting, Business Ethics
Level: Intermediate | Type: Direct case | Length: 2200 words
Copyright: © 2013 IMA Educational Case Journal. All rights reserved.
Organization: Koss Corporation | Organization size: Small
Region: United States of America | State: Wisconsin
Industry: Manufacture of computer, electronic and optical products
Originally Published in:
Anderson, M. O. (2013). Koss Corporation corporate governance, internal controls, and
ethics: What went wrong? IMA Education Case Journal, 6(1), Article 3.
Publisher: Institute of Management Accountants
DOI: http://dx.doi.org/10.4135/9781526426819 | Online ISBN: 9781526426819
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© 2013 IMA Educational Case Journal. All rights reserved.
This case was prepared for inclusion in SAGE Business Cases primarily as a basis for
classroom discussion or self-study, and is not meant to illustrate either effective or ineffective
management styles. Nothing herein shall be deemed to be an endorsement of any kind. This
case is for scholarly, educational, or personal use only within your university, and cannot be
forwarded outside the university or used for other commercial purposes. 2018 SAGE
Publications Ltd. All Rights Reserved.
This content may only be distributed for use within Johnson .
http://dx.doi.org/10.4135/9781526426819
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Koss Corporation Corporate Governance, Internal Controls, and
Ethics: What Went Wrong?
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Abstract
The Koss Corporation, a small manufacturer of stereo headphones, suffered a $34
million corporate fraud at the hands of a trusted key executive over a five-year time
period. (The investigation only covered five years, but the total longevity of the fraud
was allegedly 12 years.) This case reviews the facts of the fraud and asks students to
evaluate the internal controls and corporate governance in place at Koss Corp. at the
time of the fraud and to make recommendations for improvements. Students are also
asked to make a recommendation as to what ethical action(s) to take if, as a
management accountant, they were faced with demands by a supervisor to make
fraudulent entries.
Case
Introduction
Koss Corporation is a Milwaukee company whose principal business is the design,
manufacture, and sale of stereo headphones and related accessories. Michael Koss is the
CEO; his father, John Koss, founded the company in 1958. The company has trademarks and
patents for its products to differentiate itself from the competition. Koss Corp. has a six-man
Board of Directors, including Michael and his father. John is 81 years old and serves as
chairman of the Board. Michael is 57 years old and serves as vice chairman, president, CEO,
COO, and CFO.1 The other Board members have served 25 years. Neither Michael nor the
other Board members have financial backgrounds. Michael graduated college with an
anthropology degree.
Although Koss Corp. is a multimillion dollar company, it only employs 73 people, which
auditors consider a “small business.” Michael has worked for Koss Corp. since 1976, and
earns a base salary of $295,000; his total compensation, including options, is over $800,000.2
Selected financial data is presented in Table 1.3
Table 1 : Financial Data from 2008 and 2009
June 30, 2009 June 30, 2008
Net Sales
$38,184,150
$46,943,293
Net Income
1,976,668
4,494,289
Basic Earnings per Common Share:
r
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Koss Corporation Corporate Governance, Internal Controls, and
Ethics: What Went Wrong?
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Basic:
0.54
1.22
Diluted:
0.54
1.22
$28,470,352
$29,977,077
Total Assets
Cash Dividends per Common Share $0.52
$1.52
The Accounting Function
The accounting work was handled by Sujata “Sue” Sachdeva, vice president of finance,
secretary, and principal accounting officer—in a small business, employees typically have
more than one responsibility. Sue, whose family was from India, had been employed at the
company for 17 years.4 She was a trusted and valued employee and earned about $200,000
per year. She had two assistants: Julie Mulvaney, senior accountant, and Tracy Malone, junior
accountant.5
Sue told friends and coworkers that her family was very wealthy and held a very high social
status in India. She reported that she and her husband spent their wedding night in the Taj
Mahal. It was important for her and her family to live in the best area, attend the best schools,
and socialize with the recognized society members of Milwaukee. Sue served on several
charity boards, organized lavish parties for their events that cost millions of dollars, and
purchased all items that did not sell at the charity auctions she organized.6
Sue also had a reputation as a demanding boss: Her assistants were required to help her with
the charity events, and Sue took them out to lunch almost daily. Julie and Tracy also went to
Sue’s house to help her unpack and store the many expensive items she purchased. Sue
loved designer clothing, shoes, and accessories and purchased over 20,000 items in a fiveyear period from 2004 to 2009. She purchased so many items that they did not fit in her
house. So, she rented a storage unit and a two-office suite to store her unused purchases. In
addition, Sue made some purchases that she never picked up from the retailers.7
Sue could not pay for all of these purchases with her $200,000 salary or her physician
husband’s $600,000 salary.8 Her job at Koss Corp. provided her with an extra opportunity to
obtain the funds necessary to support her lavish lifestyle: She committed the fraud over at
least a five-year period to fulfill her compulsive shopping disorder.9
The Fraud
Sue started stealing from the company with relatively small thefts that increased over the
years. She partially hid the alleged theft in cost of goods sold (COGS) and indicated the
increase in COGS was due to rising material costs. She also overstated assets and other
expenses and understated liabilities and sales.10
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Ethics: What Went Wrong?
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Sue embezzled $34 million over a five-year period beginning in 2004;11 only the embezzled
amounts from 2005 forward were documented, even though she had been allegedly
embezzling since 1997. The fraud was uncovered when American Express notified Michael
Koss about an unusual, ongoing practice: Sue paid her personal credit card balances with
several large wire transfers from a Koss Corp. bank account.12
The following amounts represent the fund’s embezzled by Sue:13
• 2005 – $2,195,477
• 2006 – $2,227,669
• 2007 – $3,160,310
• 2008 – $5,040,968
• 2009 – $8,498,434
• 2010 – $10,286,988 (two quarters)
Sue wired an average of $500,000 per month from Koss Corp. bank accounts to pay for her
personal credit card bills.14 Sue colluded with her senior accountant Julie to embezzle the
money. Julie maintained she just made the journal entries and cash transfers based on Sue’s
orders, noting that Sue was a “powerful, imperious, overbearing, determined, and willful
superior.”15
Fraudulent Activities
Koss Corp., like most businesses, had a system of internal controls designed to protect the
company’s assets. The fraudulent activities that occurred included large payments by check
or wire transfer, misuse of petty cash, an outdated computerized accounting system,
unprepared account reconciliations, and minimal management review of financial statements.
Payments by Check or Wire Transfer
Michael approved invoices of $5,000 or more for payment. Yet processing wire transfers and
cashier’s checks outside of the accounts payable system did not require his approval. This
flaw in Koss Corp.’s internal control system allowed Sue and Julie to cover up the
embezzlement.16
Over the total 12-year embezzlement period, Sue wrote over 500 cashier’s checks, totaling
over $17.5 million, from Park Bank.17 Julie did not have the authority to sign checks at Park
Bank, although she often ordered and processed the checks for Sue without Michael’s
knowledge or authorization.18 So as not to draw attention to these checks, they were often
made payable to initials, such as “N-M,” for Neiman Marcus or “S.F.A.” for Saks Fifth
Avenue.19
Julie helped Sue initiate and authorize wire transfers of Koss Corp. funds to Sue’s personal
creditors for over $16.3 million without requiring or obtaining Michael’s approval.20
Petty Cash
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Most organizations maintain a petty cash fund to facilitate small, incidental expenses. Petty
cash balances and transactions are usually small. Given the insignificance of petty cash,
management and auditors spend very little time reviewing these accounts. Sue used petty
cash as another vehicle to obtain funds: more than $145,000 over five years.21
Computerized Accounting System
A computerized accounting system and the related software were designed to prevent certain
unintentional (or intentional) errors. For example, entering an out of balance entry is not
possible in most computerized accounting systems. Koss Corp.’s computerized accounting
system, however, was almost 30 years old and did not have sufficient controls. Koss Corp.’s
accounting system could not lock out changes made after the end of the month, and there
was no audit trail. Sue and Julie made undetected post-closing changes to the accounting
records without Michael’s approval or knowledge.22
Julie covered up Sue’s embezzlement by forging entries to match the company cash account
balance with the cash on hand balance in the bank and “holding back” receivables to match
the amount of the cash shortfall.23 In addition, Julie did not record Internet sales or sales
from the company’s retail outlet in order to cover up the cash shortfall.24
Reconciliations
Other checks and balances in accounting systems include account reconciliations that are
prepared by the accounting staff. Account reconciliations were not prepared or maintained at
Koss Corp. Reconciliations that were performed were prepared by Sue or Julie, so they were
not correct; they also initiated or recorded all accounting entries.25
Management Review
Sue provided Michael with financial statements and reports that were prepared from the
fraudulent accounting records, and Michael did not review them in great detail. Because he
trusted Sue, Michael did not fully review the financials before approving them.26
The Auditors
Grant Thornton, a national firm based in the U.S., was the auditor for Koss Corp. at the time.
Over the five-year period, Koss Corp. paid Grant Thornton $625,000 to audit their financial
results. Grant Thornton classified Koss Corp. as a non-accelerated filer. The fraud was never
detected during the audit for several reasons: (1) Grant Thornton reviews the company’s
financials to make sure that every account balance aligns with accounting standards.
Because Sue and Julie were balancing the books to counteract the fraud, nothing seemed
suspicious. (2) Lax oversight ran rampant at Koss Corp. Because Michael trusted Sue, he
believed all her numbers were correct. 27
Sue knew the questions the auditors would ask and the documents they would review.
Because Sue knew the July 1 year-end would bring scrutiny to June’s records, she never
moved any money in June. Grant Thornton viewed Koss Corp. as a small audit of a well-run
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Ethics: What Went Wrong?
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company with low risk and an excellent training ground for new auditors.28
Conclusion
Sue embezzled over $34 million in a five-year span. She betrayed the trust of her boss,
Michael, as well as the company’s employees and shareholders.
Answer the discussion questions below based on your review of the Koss Corp. case.
Discussion Questions
1. Review the fraudulent activities. What went wrong? Describe what internal controls
were missing or circumvented. Consider the Sarbanes-Oxley Act of 2002 (SOX)
requirements, and review the definition of internal controls. Who is responsible for
internal controls? What reporting is required?
2. What were the problems in the corporate governance and/or organization structure?
What are the major requirements of SOX with respect to corporate governance and/or
organization structure? How would corporate management and the accounting function
be better organized?
3. What should Julie Mulvaney have done when Sue Sachdeva requested her to assist in
the fraud? What would the IMA® Code of Ethics, known as the IMA Statement of
Ethical Professional Practice, dictate?29
4. What were the responsibilities of the following entities or individuals for the fraudulent
activities? What are the possible consequences?
a. American Express
b. Park Bank
c. Sue Sachdeva
d. Michael Koss
e. Julie Mulvaney
About IMA®
With a worldwide network of more than 65,000 professionals, IMA (Institute of Management
Accountants) is the world’s leading organization dedicated to empowering accounting and
finance professionals to drive business performance. IMA provides a dynamic forum for
professionals to advance their careers through CMA® (Certified Management Accountant)
certification, research, professional education, networking, and advocacy of the highest ethical
and professional standards. For more information about IMA, please visit www.imanet.org.
Endnotes
1. Securities & Exchange Commission, “Koss Corporation Form 10-K,” August 26, 2009,
http://investors.koss.com/secfiling.cfm?filingID=1104659-09-51789&CIK=56701.
2 Securities & Exchange Commission, 2009.
3.Ibid.
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4. Tracy Coenen, “Koss Corp. Fires Auditor as Alleged Fraud Loss Widens to $35 Million,”
Daily Finance, January 5, 2010, www.dailyfinance.com/2010/01/05/koss-corp-fires-auditor-asalleged-fraud-loss-widens-to-31-mil/.
5. M a r y V a n d e k a m p N o h l , “ T h e D i v a , ” M i l w a u k e e M a g a z i n e , M a r c h 1 6 , 2 0 1 1 ,
www.milwaukeemag.com/article/3162011-TheDiva.
6. Van de kamp Nohl, 2011.
7.Ibid.
8.Ibid.
9. Doris Hajewski and Tom Daykin, “Former Koss Corp. Executive Sachdeva Sentenced to 11
Years in Prison,” Journal Sentinel Online, November 17, 2010,
www.jsonline.com/business/108706789.html.
10. Securities & Exchange Commission, “SEC Charges Officer and Employee of Milwaukee
Corporation in $30 Million Embezzlement,” Securities and Exchange Commission, September
1, 2010, www.sec.gov/litigation/litreleases/2010/lr21640.htm.
11. Hajewski and Daykin, 2010.
12. Securities & Exchange Commission, “Koss Corporation Form 10-K,” September 20, 2010,
http://investors.koss.com/secfiling.cfm?filingID=1104659-10-49173&CIK=56701.
13. Securities & Exchange Commission, September 20, 2010.
14. Coenen, 2010.
15. Doris Hajewski, “Koss Embezzler Feared Discovery from Start,” Journal Sentinel Online,
January 4, 2011, www.jsonline.com/business/112844064.html.
16. U.S. Securities and Exchange Commission, “SEC Files Complaint and Proposed
Settlement Against Koss Corporation and Michael J. Koss, Its CEO and Former CFO, Who
Has Agreed to Reimburse Incentive-Based Compensation,” Securities and Exchange
Commission, October 24, 2011, www.sec.gov/litigation/litreleases/2011/lr22138.html.
17. Cary Spivak, “Sachdeva to Plead Guilty to Six Felonies in Koss Case,” Journal Sentinel
Online, July 16, 2010, www.jsonline.com/business/98620864.html.
18. Hajewski, 2011.
19. Curtis C. Verschoor, “How an Embezzler Stole Millions from a Small Company,”
Accounting Web, January 6, 2011, www.accountingweb.com/topic/watchdog/how-embezzlerstole-millions-small-company.
20. Securities & Exchange Commission, 2011.
21. Cary Spivak, “Koss Embezzlement Ran in Spurts, Lawsuit Says,” Journal Sentinel Online,
July 10, 2010, www.jsonline.com/business/98152439.html.
22. Securities & Exchange Commission, 2011.
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23. Rich Kirchen, “Sachdeva Throws Mulvaney Under Train,” The Business Journal,
November 17, 2010,
www.bizjournals.com/milwaukee/blog/2010/11/sachdeva-throwsmulvaney-under-train.html?page=all.
24. Verschoor, 2011.
25. Securities & Exchange Commission, 2011.
26.Ibid.
27. Van de kamp Nohl, 2011.
28. Hajewski, 2011.
29. IMA (Institute of Management Accountants), IMA Statement of Ethical Professional
P r a c t i c e ,
M o n t v a l e ,
N . J . ,
2 0 0 5 ,
www.imanet.org/PDFs/Public/Research/SMA/IMA%20Statement%20of%20Ethical%20Professi
onal%20Practice.pdf.
http://dx.doi.org/10.4135/9781526426819
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