Question

Sandra Billings, a forensic accountant, has been engaged by NewWay, a medium-sized company that has grown considerably over the years. NewWay was begun by Tom Sneethens, an entrepreneurial-minded person who has been very involved in every aspect of the business. In the last few years, however, Tom has not been able to oversee the operations of the company to the extent he has in the past and, as a result, has had to cede control over some of the more administrative tasks to others. Tom is now more involved in what he loves—creating new products and interacting with similarly-minded entrepreneurial employees on his team. Lately, NewWay has experienced fraud committed by collusion between an employee in accounting and a salesperson who also is an employee of the company. Specifically, the fraud involved entering fictitious sales in the salesperson's account so that the salesperson could earn higher bonuses in December, NewWay's year-end. Simultaneously, the accounting person increased Accounts Receivable and Sales to correspond to the sales entered for the salesperson. As a result, NewWay was defrauded of cash, and the financial statements, as of December 31, were misstated. Tom was devastated when he heard of the defalcation. To add to his misery, he wanted NewWay to apply for a loan to expand operations further. He was concerned that if the bank required an audit, the theft and financial statement misstatement would be discovered and, although the financial statements had been corrected, that the bank would not trust Tom and NewWay enough to loan the funds that Tom believed the company required. He listened carefully to Sandra as she spoke about improving the internal controls so that this type of nefarious activity would never again occur. He understood the importance of having adequate controls, but he couldn't understand the importance of something else Sandra discussed with him: corporate governance. “Why would I need this?” exclaimed Tom. “I thought this was only for huge companies that are traded on Wall Street.”

Required

How might Sandra respond to Tom's question and comment? Answer by listing a number of aspects of corporate governance that could help NewWay to operate so that it remains a profitable and viable company.

Explain how each of the pillars of corporate governance, if implemented, could benefit NewWay.

Answer 1

Yes Tom, your surprise is valid. While corporate governance is a term which you may believe is more relevant for big listed companies , it is untrue. Corporate Governance encourages accountability and helps to prevent and/ or unearth massive frauds before they can cause undue damage. In the absence of sound corporate governance principles and a well laid internal control system such instances of frauds and mistatement of financial statements may occur.

Corporate governance affects the operational risk and, hence, sustainability of a corporation. The quality of a corporation’s corporate governance affects the risks and value of the corporation. While you are involved in growing your business through leaps and bounds, you need a robust system in place to prevent such events in future.

The three pillars of corporate governance are: transparency, accountability, and security. All three are critical in successfully running a company and forming solid professional relationships among its stakeholders which include managers, employees, and most importantly, the owner.

• Transparency

The first pillar of corporate governance is transparency. Although transparency is a necessity for the whole company, its presence is even more important at the top where strategies are planned and decisions are made. In our case it is important that we document the current case of fraud and quantify the loss in actual terms. The impact on the financial statements needs to be disclosed and necessary reinstatements need to be done. This will instill confidence in the minds of the bankers about our transparent accounting practices.

• Accountability

This pillar points out as to who will take the blame if something goes wrong. In the current case the steps taken with regard to terminating the defrauding employees, informing external parties, filing legal papers etc. needs to be documented. Employees need to be sensitised that such instances are subject to zero tolerance. The audit will reveal if any other employees are involved in this fraud.

• Security

Data security is of utmost relevance in modern times. The entire system controls need to be evaluated as to how the fraud was completed without any exceptional report. Nowadays, everyone in a company has a responsibility to adhere to strict security standards. The work flow needs to be revisited and email access, account access needs to be guarded.

In short, all the aspects of corporate governance need to be implemented to prevent any such events in future and raise NewWay to new heights.