Question

The SEC issues Accounting and Auditing Enforcement Releases (AAERs) summarizing SEC actions concerning civil lawsuits brought by the SEC in federal court and related settlements from administrative proceedings. Visit the SEC’s website (www.sec.gov) and locate the link to Accounting and Auditing Enforcement Releases (AAERs) under the “Enforcement” tab. Locate AAER-3932 involving Maxwell Technologies, Inc. issued on March 27, 2018.

a. Briefly describe how the Maxwell Technologies, Inc. 2011 and 2012 financial statements were misstated.

b Describe examples of deficiencies in Maxwell Technologies’ control environment.

c. One of the inherent limitations of internal control is management override of internal control procedures. Give an example of management override from the Maxwell Technologies AAER.

d. Maintaining adequate documents and records is an important element of an entity’s control activities. How did the company’s vice president of sales and marketing violate this important element of internal control?

The risk assessment component of internal control involves a process for identifying and analyzing risks that may prevent the organization from achieving its objectives. How did the senior financial personnel exhibit deficiencies in risk assessment procedures related to red flags regarding sales and collections from the German distributor?

Answer 1

1. There were couple of ways in which the financial statements of Maxwell was misstated. However the statement from the management talks about the improper application of the guidelines related to recognition of revenue. The main issued was where the management used unethical or incorrect ways of trying to boost its revenues to paint such a misconception to its investors and other analysts that it's growth was far more successfull than reality.

The management used several improper tactics to prematurely record revenue such as having side deals with customers with contingent payment terms and full right of return, channel stuffing, extending payment terms, falsifying purchase orders and third-party confirmations and by instructing certain distributors to order products they neither wanted nor needed at quarter-end.

Even after knowing that such recognition of revenue does not meet the required principles and criteria for recognition, the management still decided to proceed in a faulty manner.

2. One of the defeciencies in the control environment of Maxwell Technologies was such the easy over ride of controls and repeated red flags that were being raised that allowed such fictitious sales to grow quarter on quarter for such a long period of time. All automated controls and red flags that should have alerted them to material revenue recognition departures were clearly overridden and gone for a toss. Credit limits were also ignored. Overall, material weaknesses in its control environment over financial reporting was mainly because of the fraudulent adjustment of the timing of recognition of revenue from sales to certain distributors.

3. One such management override of controls was the over ride of credit limits to its distributors. One such distributor, called as the german distributor, was allowed a credit of approximately 3.8m$, over and above his existing credit limit. The management did not even perform the basic due diligence required for extending such credit limit to its distributor. And this allowed Maxwell Technologies to record such revenue, not sure whether it will be received or not, and meet its growth outlook targets issued to various analysts.

4. The company's management violated the basic element of internal control i.e. to maintain adequate documentation, in numerous ways. Firstly, it did not ask for any liquidity or any other certificate that would give it evidence of the debtors capability to pay if it increased such credit limits. Also the company did not follow up diligently on the accounts receivable reports, extended payment terms, emails, etc. The main area I would say was where the management failed to request for any documentation of the German Distributor’s credit worthiness nor did it conduct any due diligence before raising the limit.

5. The senior finance personnel just over rode the controls set up to identify whether any risk exists in undertaking the actions it intended to undertake. As mentioned in earlier points, control limits were not followed, documentation was not checked or asked for, senior finance personnel colluded with the top management to adhere to whatever its requirements were. All such actions that were undertaken by the top management had only a single motive behind them and that was to acheive its growth outlook given to analysts and investors so it could boost or have a positive impact on its stock prices.

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