Question

1. How could this fraud have been prevented? Why is this a difficult fraud to prevent?

1. What factors in Johnson’s control environment have led to and facilitated the manager’s manipulation of inventory?

2. What pressures did Debbie have to overstate inventory?

3. What rationalization did Debbie use to justify her fraud?

. How could this fraud have been prevented? Why is this a difficult fraud to prevent?

Answer 1

1.

This case is difficult to prevent because it involves “collusion.” That is, an insider was working with outsiders. While internal controls are quite helpful in preventing and detecting fraud committed by single individuals, they are much less effective in preventing collusive frauds. Nevertheless, because of the large size of the transfers, there should have been some secondary approval required. In addition, telephone transfers are usually only authorized to go to certain accounts. The Lord Investments account should not have been an approved transfer account. Banks understand the huge risks involved with wire transfers and generally are very careful to use transfer keys and codes and require secondary approvals on large transfers. They also require the clients to sign transfer agreements in advance and specify into which accounts money can be transferred.

1. Johnson Manufacturing does not have a very active board of directors, and there is little monitoring of employees.

1. Employee compensation is dependent on the performance of the unit. If the division doesn’t do well, salaries and bonuses will be cut.

1. Harris’s rationalization was that she was providing a short-run solution to the profit decline resulting from the competitor’s price-cutting, and the decline would be only temporary.