Case Study 3

Johnson Manufacturing, a diversified  manufacturer, has seven divisions that operate in the United States, Mexico, and Canada. Johnson Manufacturing has his- torically allowed its divisions to operate independently. Corporate intervention occurs only when planned re- sults are not obtained. Corporate management has high integrity, although the board of directors is not very active. Johnson has a policy of performing employee screenings on all employees before hiring them. John- son feels its employees are all well educated and honest. The company has a code of conduct, but there is little monitoring of employees. Employee compensa- tion  is  highly  dependent  on  the  performance  of the

company.

During the past year, a new competitor has entered one of Johnson’s highly successful markets. This new competitor has undercut Johnson’s prices. Johnson’s manager of this unit,  Debbie  Harris,  has  responded by matching price cuts in hopes of maintaining market share. Debbie is very concerned because she cannot see any other areas where costs can be reduced so that   the

 

 

division’s growth and profitability can be  maintained. If profitability is not maintained, the division man- agers’ salaries and bonuses will be reduced.

Debbie has decided that one way to make the divi- sion appear more profitable is to overstate inventory, since it represents a large amount of the division’s bal- ance sheet. She also knows that controls over inventory are weak. She views this overstatement as a short-run solution to the profit decline due to the competitor’s price cutting. The manager is certain that once the competitor stops cutting prices or goes bankrupt, the misstatements in inventory can be corrected with little impact on the bottom  line.

 

 

 

1.    What factors in Johnson’s control environment have led to and facilitated the manager’s manipulation of inventory?

2.    What pressures did Debbie have to overstate inventory?

3.    What rationalization did Debbie use to justify her

fraud?