6-32 Koss Corporation:
Where were the internal controls? (Refer back to Problem 4-33 for the basic facts on the Koss Corporation
embezzlement reprinted below.)
How $34 Million Disappeared. Koss Corporation is a publicly traded company that designs and sells stereo headphones.
The Koss family controls a majority of the Company's stock. On November 17, 2010, Sujata “Sue” Sachdeva, the former
Vice-President of Finance was sentenced to 11 years in prison for embezzling $34 million from the Company. Her
attorney claimed that she was a shopaholic. From 1992 to 2009, Sachdeva was the Principal Accounting Officer,
Secretary, and Vice-President of Finance at Koss. As a result of the embezzlement, Koss Corporation was required to
restate its financial statements for 2008, 2009, and the first quarter of 2010.
Sachdeva used the embezzled funds to sustain a lavish lifestyle including purchasing a vacation ownership interest in
Hawaii, a Mercedes Benz, and other automobiles. She also used the proceeds to pay for luxury travel and numerous
personal items, including luxury clothing, furs, designer shoes, jewelry, and art. One neighbor stated that packages
delivered to her front porch would sometimes reach 6 feet high! Sachdeva also maintained a large household staff. Such
purchases were well beyond her Koss salary (approximately $175,000). She explained her life style by stating that her
husband earned a couple of million dollars a year and that they both came from wealthy families.
The massive misappropriation was ultimately discovered when American Express notified the Company that funds were
being wired from a Company bank account to pay for expenses on Sachdeva's personal credit card. According to the SEC,
Sachdeva authorized at least 206 wire transfers of funds from Koss bank accounts to pay for her American Express credit
card bills and issued more than 500 cashier's checks from company accounts to pay for personal expenses. Sachdeva
used the cashier's checks to make direct payments to retailers, such as Neiman Marcus and Saks Fifth Avenue. Sachdeva
attempted to conceal the identities of the recipients of the checks by using acronyms on the checks such as “S.F.A. Inc.”
for Saks Fifth Avenue, “N.M. Inc.” for Neiman Marcus, and others. Sachdeva was able to conceal the fraud by directing
other Koss employees to make numerous fraudulent entries in Koss's books and records. Julie Mulvaney, the Company's
senior accountant who was responsible for making journal entries, reconciling accounts receivable, reconciling the
Company's bank statements, ordering cashier's checks, processing wire transfers, and checking the daily bank account
balances assisted Sachdeva in covering up the fraud.
Other information about the Company:
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Michael Koss simultaneously held 5 senior management positions: Vice Chairman, Chief Executive, Chief
Operating Officer, President, and Chief Financial Officer. Koss had little or no educational background or
experience in the areas of accounting or finance and allegedly delegated important responsibilities typically
performed by the CFO to Sachdeva on a regular basis.
Koss did not have an internal audit function.
Koss Corporation's control environment appears to have been remarkably relaxed and its corporate board rarely
changed. Excluding a member added in 2006 and founder John Koss, board members had an average tenure of
27 years.
Unlike the proxy statements of typical public companies, Koss made no mention of any accounting expertise
among audit committee members.
Because it was a small company, Koss was not subject to a section of the Sarbanes-Oxley Act that requires
outside auditors to evaluate a company's internal controls over financial reporting.
During the embezzlement, Koss's audit fees were reduced by half from $114,900 in 2007 to $63,600 in 2008.
In 2006, Sachdeva co-chaired a fundraising gala for Big Brothers Big Sisters with one of Koss's outside auditors.
On September 2, 2010, the Securities & Exchange Commission brought an action against Sujata Sachdeva, vice president
of finance, and Koss senior accountant and subordinate, Julie Mulvaney, who allegedly helped her cover up the
fraudulent scheme. The SEC alleged that Sachdeva and Mulvaney caused Koss to submit false and misleading financial
statements. Sachdeva regularly relied on Mulvaney to reconcile the cash shortfalls and to balance the books.
Sachdeva and Mulvaney primarily hid the embezzlement by making false entries on the Company's general journal. For
example, the false journal entries disguised the theft by overstating assets, expenses, and cost of sales, and understating
liabilities and sales. Mulvaney maintained binders that detailed numerous false journal entries that were made to the
Company's accounting books and records. With those entries, Mulvaney reclassified Company funds­with no supporting
documentation and no legitimate explanation. Mulvaney also maintained a series of folders that included
documentation of over 100 fraudulent transactions that were included in the Company's accounting books and records.
Sachdeva and Mulvaney were able to hide the substantial embezzlements in part because the Company did not
adequately maintain internal controls to reasonably assure the accuracy and reliability of financial reporting. Koss's
internal controls policy required Michael Koss to approve invoices of $5,000 or more for payment. However, Koss
allegedly delegated duties typically done by the CFO to Sachdeva on a regular basis. Koss also had little or no educational
background or experience in accounting or finance. Many of the cashier's checks exceeded $5,000, and some exceeded
$100,000. However, its controls did not prevent Sachdeva and Mulvaney from processing large wire transfers and
cashier's checks outside of the accounts payable system to pay for Sachdeva's personal purchases without seeking or
obtaining Michael Koss's approval. In addition, many account reconciliations were not prepared, maintained, or
reviewed as part of Koss's accounting records. Koss's computerized accounting system was almost 30 years old.
A. List the major internal controls that were absent within Koss Corporation’s internal control system.
B. What internal controls should have been implemented or applied to ensure proper controls over the Company's
recorded transactions?