Question

Case 1

John is the manager of a small computer sales and support chain. He has stores located throughout the state of California and is in strong competition with all of the major computer providers within that state. John’s company is known for providing quick support and friendly service. In the process of selling goods to customers, John’s company will often offer deals that include free service or low-priced service for the products being purchased. John’s competitors offer the same types of deals to their customers, but because of the small mobile size of John’s company, he is better able to provide quick service to his customers. John is the president of his company and has raised funding through issuing stock. He has not used external loan funding much in the past. John has approximately 50 stores located in California and is in the process of obtaining business locations outside of the state. John’s main goal is to be successful in the computer business because of the quick customer service his company provides. He believes his company will be able to charge higher prices because people will be willing to pay the initial higher price on computer components for the added customer service on the back end.

John has managers in all of the different stores who report directly to him. They do not communicate regularly with other store managers on inventory issues or customer service representative availabilities. John has found much success in the past because of the customer service he has been able to provide. In recent years, the competition has become more successful in duplicating his activities or in providing low-maintenance products. John’s company has provided financial statements on a yearly basis, so investors can follow the company’s success. With the growing success of competitors, John has found it more difficult to be successful. During the past year, John’s company recorded significant revenues from sales that will require warranty service over the next few years. However, John’s reported warranty expenses stayed the same. In addition, the reported inventory levels remained approximately the same as in previous years. No additional financing or loans were recorded on the financial statements, even though assets continued to grow. Revenue was the only financial statement amount that changed dramatically.

2. What could look like fraud but be explained by industry trends?

Answer 1

2) In the case, John has been finding it difficult to successful due to competition, but John’s company recorded significant revenues from sales. The rise in the sales the warranty services over the next few years has also risen or the warranty liability has been growing. The John’s company reported a warranty expense remains the same every year.

This industry trends of having accumulated warranty service rising high whereas the yearly warranty expense remains the same looks like a fraud, but it is not true. The every year’s sales contain warranty expenses towards a few future years, but the services provided towards a particular year in future are only some percentage of total year. We can divide the whole warranty expense in yearly percentage for the whole warranty years.

Second activity in financial reporting which could be suspected as fraud but that is due to the industry trend is the increase inventory and growth of assets without increase of additional financing or loans. As the company grows and its sales increases, the income and cash also increases. The increase in cash increases the assets and cash is converted in inventory to counter the increased sales in the coming years.