In: Accounting
Case 4
Colleen Matthews had just turned 22 when her hard work finally started to pay off. Six months earlier, Colleen had graduated from a state university with a master’s degree in accounting. Colleen graduated with honors and was one of the youngest in her class. Unlike most of the intellectuals she had studied with throughout her career, Colleen was extremely social and had great communication skills. After graduation, she took a job with a well-known regional accounting firm. The firm specialized in assisting companies with their technology problems. Colleen knew that the connections and knowledge she would gain working for the firm would be beneficial throughout her career. Now, six months after graduation, she has a full-time job offer with one of the firm’s strongest clients. Within a few days on her new job, Colleen had adapted to her new environment. Colleen and two other recent graduates were running the entire accounting department. However, it wasn’t long until Colleen began to notice that something wasn’t right. After a few weeks, Colleen realized that the firm’s executives were participating in illegal transactions. The company executives were importing expensive technological products from China and selling them under the table to contacts unknown to Colleen. Once the firm received the products at the shipping dock, the executives’ “personal employees” marked the products and took them to a separate location. The entire operation was done with little paperwork. The money received from the special products received special attention. Colleen was told to report this inflow of cash in an account called “Personal Executive Consulting Services.” This allowed the executives to personally use the money at their convenience.
1. Does Colleen have a responsibility to report the apparent fraud?
2. If so, to whom should she report the fraud?
3. Assuming that the fraud has been continuing for several years, what would be the tax ramifications to the executives of not reporting earnings on their tax returns?
4. Even though the money is from illegal sources, are the executives required to report the income on their annual tax returns?
5. Earlier in the book, we discussed the net worth method. How do you think the net worth method can help prosecutors determine the extent of these executives’ illegal income?
With reference to your questions my answer is as follows:
1. Does Colleen have a responsibility to report the apparent fraud?
Ans: Colleen Matthew was 22 , and working with accounting firm,so being an employee of the firm and was handling accounts department she should see whether accounts of company represent true and fair view of financial statements or not .Any fraud which she comes to know she has to report it. She being an employee and account department’s incharge responsible to the firm and to the management ,shareholders as well. Moreover fruad is necessary to be reported on time and its necessary to take preventing steps as it impacts the reputation,finances of firm and employee morale.
2. If so, to whom should she report the fraud?
Ans Colleen should report to her immediate reporting authority .However if executives themselves are involved she can directly report to management. Amid a growing number of scams related to corrupt practices in companies now a day’s companies have whistle blower policy in which illegal or fraud activities can be reported .So Colleen can also report to auditors of the firm who are then liable to report in their audit reports to the management and stakeholders. She can write letter to management to report same to shareholders.
3. Assuming that the fraud has been continuing for several years, what would be the tax ramifications to the executives of not reporting earnings on their tax returns?
Ans: If such fraud has been continuing for several years and not been reported then income of all past years shall be taxable .The executives will be liable to pay penalties for under reporting of income & in extreme case they might be liable for criminal charges.
4. Even though the money is from illegal sources, are the executives required to report the income on their annual tax returns?
Ans: Yes even though the money is from illegal sources, the executives should report the income on their annual tax returns. Basic reason to do so is to avoid any huge tax evasion charges imposed by government on concealing income. Tax laws requires that money acquired through illegal means be reported and taxed just like legitimate income.
5. Earlier in the book, we discussed the net worth method. How do you think the net worth method can help prosecutors determine the extent of these executives’ illegal income?
Ans: To prove an unreported income NET WORTH METHOD is used, especially when there is no circumstantial evidences available of increase in net worth that do not match an individual's reported income. In our case also there is no evidence that executives of the company executives were importing expensive technological products from China and selling them under the table to contacts unknown to Colleen.As they did liitle paperwork and did shifting of imported parts to other location hiding from Colleens.
The following are the basic steps necessary in a net worth method case:
1. Establish net worth at the end of the taxable year.
2. Establish net worth at the beginning of the same taxable year, which is then subtracted from the end of year taxable net worth.
3. Add non-deductible expenditures.
4. Subtract non-taxable receipts from income sources.
5. Compare that figure with the amount of taxable income reported by the individual to determine the amount of underreporting.
Thus net worth method can prove helpful in finding unreported income.