Loading presentation...

Present Remotely

Send the link below via email or IM

Copy

Present to your audience

Start remote presentation

  • Invited audience members will follow you as you navigate and present
  • People invited to a presentation do not need a Prezi account
  • This link expires 10 minutes after you close the presentation
  • A maximum of 30 users can follow your presentation
  • Learn more about this feature in our knowledge base article

Do you really want to delete this prezi?

Neither you, nor the coeditors you shared it with will be able to recover it again.

DeleteCancel

Make your likes visible on Facebook?

Connect your Facebook account to Prezi and let your likes appear on your timeline.
You can change this under Settings & Account at any time.

No, thanks

Financial

No description
by

on 15 March 2014

Comments (0)

Please log in to add your comment.

Report abuse

Transcript of Financial

The Accounting Problem in Molex
$1.25
Thursday, March 13, 2014
Vol XCIII, No. 311
Company Background
Financial Reporting Problem at Molex, Inc.
Company Management
Financial Reporting Problem
Factors influencing management’s decision
not
to raise the issue with the auditor

Deloitte would
ONLY
be able to complete their
REVIEW
of the
first quarter results
if the
CFO
Diane Bullock and
CEO
Joe King were
REPLACED
.

If you are the director of Molex, how would you respond?
We want to hear from you
Strategic Management Daily
Mid-July
Molex's corporate finance group identified the intra-group transaction inventory account was overstated in the consolidated income statement
July 21
CFO Diane discussed this matter with other top management, including CEO Joe
Year 2004
July 27
Fourth quarter results did not mention the problem
Sep 10
The management representation letter for the annual financial statements made no mention of the problem
Oct 15
Molex's management discussed the problem for the first time with Deloitte and proposed recognizing 2 million of the adjustment during the current quarter
Oct 19
Deloitte disagreed with the proposal and argued that the entire error amount should be recorded in the first quarter
Oct 20
The entire error amount was recorded in the first quarter but no disclosure was made
Q&A
Financial Problem of Molex
2002 and 2003:
No elimination of intra-group transaction

2004:
No disclosure of 8m pretax inventory valuation error in the letter of representation
Transfer of inventory
Accounting Treatment
Elimination in full:
Intra-group balances,transactions, income and expenses
Profit and losses recognized in assets
Assumptions
No tax effects
2002 :
Transfer price: P1 at cost plus 20% mark up
Inventory 100% unsold

2003:
No transfer of inventory
Inventory from intra-group transaction in 2002: 100% unsold
Correction
What Molex did:

2002 and 2003: No elimination of intra-group transactions

What should be done:

2002:
Dr. Sales P1
Cr. COGS 80%P1
Cr. Inventory 20%P1

Correction
What Molex did:

2002 and 2003: No elimination of intra-group transactions
What should be done:

2003:
Dr. R.E(beg) 20%P1
Cr. Inventory 20%P1

Correction Effect

2003:
Retained Earnings overstated by 20%P1 =5M
Inventory overstated by20%P1=5M
Assumptions
2004:
Transfer price: P2 at cost plus 20% mark up
Inventory 100% unsold
Inventory from intra-group in 2002 transaction: 100% unsold
2002:
Sales overstated by P1
Expenses overstated by 80%P1
Profit before tax overstated by 20%P1=5M
Inventory overstated by20%P1=5M
Correction
What Molex did:

2004:
Dr. Sales P2
Cr. COGS 80%P2
Cr. Inventory 20%P2=3M
Dr. R.E (beg) 20%P1=5M
Cr. Inventory 20%P1
What should be done additionally:

2004:
Disclosure of error
1. Remuneration Incentive
Source: Court document of Molex Inc. (P.65)
Possible consequences of disclosure
Revenue
Base salary increase X
Market expectation X
Public confidence
Stock price
Firm’s performance X

Bonus XX ( + )
(Performance-based bonus calculated as a % of base salary)
2. Audit Opinion
Clean audit report X
Public confidence X
Share price
3. Lack of Materiality & Expertise
Joe & Diane:
Investigation of gathered information
Financial impact of the error was
immaterial

Audit Committee:
Financial expert X
Professional judgment of “materiality” X
Consulted independent legal & accounting
advisors
Lack of Expertise of Audit Committee
After consultation
Evidence of wrongdoing? X
Management deliberately withheld
information from Deloitte? X
Disclosure? X

Molex 1st quarter financial results
Adjustment to “Operating Results”
without
disclosure
Role of Audit Committee
Discuss with the independent
auditor
their qualitative judgment about the appropriateness of the organization’s financial
disclosure
practices

Fulfillment of fundamental role? X

Section 407:
Requires company to disclose whether it has a
financial expert
on the audit committee
If not explain

Molex’s explanation:
“The BOD
believes
that the Audit Committee members can perform the audit functions as required”
Justification? X

Sarbanes-Oxley Act (SOX)
More Stringent
Auditing Environment From 2002 Onwards
Wave of corporate
Accounting Scandals

Andersen
was convicted for shredding Enron’s audit evidence and was forced to
surrender its license

PwC
was required to
pay a $5m fine
for issuing clean unqualified audit opinion in 16 misstated financial reports

Deloitte
was facing with a number of lawsuits claiming
billions of dollars in potential damages
because several of its largest clients such as Adelphia, Fortress Re, Parmalat were accused of Fraud and Accounting Misstatements

The
Impact
of
SOX
Low Reliability
of Molex's
Management Representation Letter
Deloitte
DISCOVERED
that Molex’s Top Management had
KNOWN
about the magnitude of the
MISSTATEMENT
as early in the
July 21 Meeting

CEO Joe and CFO Diane
admitted
that they decided
not to inform
Deloitte of the errors because they claimed it is an
IMMATERIAL
misstatement

Deloitte
cannot rely
on the Management Representation Letter as part of the
audit evidence
because management
lacked integrity

Personal Interests

of

Molex’s Director

Deterrence
by the Severe
Consequences
of
Enron
and
Tyco International
Scandals
Enron’s Scandal
Employed approximately
20,000 staff
and was one of the world's major electricity suppliers
Still
BANKRUPTED
on 2 Dec 2001 because of its Accounting Scandal

Tyco International’s Scandal
Top competitor of Molex
Inflating operating income
by $500m from 1998 to 2002
Required to pay
$50m civil penalty

CONCERNS
of
Board of Directors
Duty of Care
is the duty to make or delegate decisions in an informed way
Required the directors to
act prudently
in light of all available information in making informed decision
Directors are required to
monitor the reporting systems
and check for
compliance with regulation
Directors of Molex
could NOT shirk their liability
and claimed that they were not being informed with the misstatement

Concealment of misstatement is
NOT
in the
best interests
of the corporation and its shareholder
Breach the duty of good faith

Fiduciary Duty
of Directors in
US
3 Options
for the
Members of BOD
Accede
to the Deloitte’s request to
remove the CFO and CEO
as executive officers so that they would
not
have any
influence
over financial reporting or internal controls

Ignore

Deloitte’s demand
, forcing the auditor to either refuse to review the quarterly financial statements or to resign

Dismiss Deloitte
and
hire a new auditor
Real Life Situation
What should be done:

2002:
Dr. Sales P1
Cr. COGS 80%P1
Cr. Inventory 20%P1

Correction Effect
What should be done:

2003:
Dr. R.E(beg) 20%P1
Cr. Inventory 20%P1

CONCERNS
of Molex’s
EXTERNAL AUDITOR
(Deloitte & Tochue) About the Reporting Problem
The
Impact
of
SOX
Low Reliability
of Molex's
Management Representation Letter
Materiality
$8,000,000/$(283,417,000+8,000,000)x100%





= 2.75%

Personal Interests

of

Molex’s Director

4. Tight Deadline
Time limit to issue the FS

Personal Interests

of

Molex’s Director

Personal Interests

of

Molex’s Director

Loose CG
framework of Molex is attributable to the
great trust
between
BOD
and
Management

No
need to incur
extra monitory cost

Dishonest management caused the
Breach of Trust Relationship

BOD should concern
about the disclosure problem because there was
NO well-established CG
structure to
prevent
similar financial misstatements

Fiduciary Duty
of Directors in
US
Fiduciary Duty
of Directors in
US
SOX302
stated that the top management
who certified bear the responsibility
of the misstatement

But the BOD of Molex could
NOT
completely
excuse
for the misstatement

The BOD is
liable for the fiduciary duty

Fiduciary Duty
of Directors in
US
In option 1 & 2, Molex would be unable to file its quarterly results on time with the SEC and NASDAQ, violating the Exchange’s listing requirement
Source: Court document of Molex Inc. (P.4)

Overall Impact of error
$8M
$3M before 2004
$5M 2004
Full transcript