BACKGROUND

Koss Corporation reported a misappropriation of funds amounted to approximately

$31 million directed by its Chief Financial Officer, Sujata Sacheva, when the reported
earnings were only $26 million in five-year period. These funds were used by the CFO for
personal needs such as expensive jewelry and coats. People familiar with her spending habits
thought that she used her own money considering that her husband is a prominent
pediatrician. The company provides highly technical products that were in very competitive
markets but intriguingly, the CFO is not a Certified Public Accountant while the company’s
CEO has a degree in Anthropology. Also, most of the board members had served the board
for 20-30 years.

In 2009, Sujata Sacheva defrauded the company of over $31 million in a period of five
years. Unqualified audit opinions were issued by Grant Thornton LLP in the entire period they
worked for Koss which accelerated through the years. The poor corporate governance
contributed to the fraud enabling her to conceal so much money through the use of cost-of-
goods-sold accounts. The relationship and trust by the top management to Sachdeva has also
contributed to conceal her thefts. The fraud was uncovered through American Express noticing
that Sachdeva’s large balances have wire transfers from a Koss Corporation account. Hence, it
immediately notified the FBI regarding this matter. Upon discovering the frausd, Sachdeva was
fired along with the company’s audit firm, Grant Thornton LLP. Several items of high-end goods
were also recovered from rented storage she used to conceal the items.

2. What was Grant Thornton’s obligation to uncover the fraud?

Grant Thornton, as an auditor of Koss Company, has the responsibility to

provide reasonable assurance that the financial statements taken as a whole are free
from material misstatements may it be due to fraud or error. The auditing firm has the
obligation to uncover the fraud because it has disregarded significant indicators of
fraud. This includes the poor governance and internal control of the company which
led to Sachdeva freely taking money from the company. Grant Thornton should have
further assessed the risks of fraud by obtaining sufficient evidences upon realizing
that poor internal control could be contributing factor of fraud in the company.
In addition, Thornton could have analyzed the financial condition of fraud in
the five-year period which is clearly descending based from the pre-tax income of the
company from 2007 to 2010. He should have maintained professional skepticism
recognizing that there could have been a material misstatement due to fraud given
that the company has products that are competitive in the market but its income
continued to decrease throughout the years. Hence, Grant Thornton’s unqualified
audit opinion resulted to an audit failure for it lacked to maintain professional
skepticism.

5. What was the audit committee’s responsibility in noticing that something looked
amiss in the financial statements?
Scenario

Koss Corporation, a Wisconsin-based manufacturer of stereo headphone equipment,

reported an embezzlement of funds of approximately $31 million orchestrated by its
chief financial officer (CFO) over a five-year period when the company’s reported
earnings were only $26 million. The CFO used the funds for personal goods, such as
expensive coats, jewelry, and other personal items, which were mostly kept in
storage facilities. Interestingly, the CFO was neither an accountant nor a certified
public accountant (CPA); the chief executive officer (CEO) had a college degree in
anthropology; most of the board members had served on the board for 20-30 years;
and the company made highly technical products that were in very competitive
markets.

During the fall of 2009, Koss Corporation revealed that its vice-president of finance
(Sujata “Sue” Sachdeva) had defrauded the company of approximately $31 million
over a period of at least five years. Grant Thornton LLP was the company’s auditor,
and the firm issued unqualified audit opinions for the entire period in which they
worked for Koss. According to reports, Sachdeva’s theft accelerated over a period of
years as follows:

FY 2005 $2,195,477
FY 2006 2,227,669
FY 2007 3,160,310
FY 2008 5,040,968
FY 2009 8,485,937
Q1 FY 2010 5,326,305
Q2 FY 2010 4,917,005

To give you a sense of the magnitude of the fraud, annual revenues for Koss
Corporation are in the range of $40 to $45 million annually. Previously-reported pre-
tax income for fiscal years 2007 and through Q1 2010 was as follows:

FY 2007 8,344,715
FY 2008 7,410,569
FY 2009 2,887,730
FY 2010 928,491

How could Sachdeva have stolen so much money and fooled so many people over a
long period? It is thought that Sachdeva hid the theft fin the company’s cost-of-goods-
sold accounts, and that weak internal controls and poor corporate governance and
oversight enabled her to conceal the theft from corporate officials. Certainly, there
must have been questions raised about the company’s deteriorating financial
condition. But any number of excuses could have been used by Sachdeva to explain
the missing money. For example, she might have blamed higher cost of goods sold
on a change in suppliers or rising raw materials prices. Another contributing factor in
Sachdeva’s ability to conceal her thefts was that top management of Koss had a high
degree of trust in her, so they did not monitor the accounts that she controlled at the
company.

Sachdeva’s total compensation for fiscal year 2009 was $173,734. But according to
published reports, Sachdeva was known for her unusually lavish lifestyle and
shopping sprees. It is reported that she spent $225,000 at a single Houston, Texas,
jewelry store. Another report describes a $1.4 million shopping spree at Valentina
Boutique in Mequon, Wisconsin. People familiar with her spending habits assumed
that she used family money and that her husband’s job as a prominent pediatrician
funded her extravagant lifestyle. The fraud was ultimately uncovered because
American Express became concerned when it realized that Sachdeva was paying for
large balances on her personal account with wire transfers from a Koss Corporation
account. American Express notified the FBI and relayed its concerns.

Upon learning of the fraud, Koss Corporation executives fired Sachdeva, along with
the company’s audit firm, Grant Thornton LLP. About 22,000 items, including high-
end women’s clothing, shoes, handbags, and jewelry – have been recovered to date.
Sachdeva stored the bulk of the items she purchased in rented storage units in order
to conceal the items from her husband.

Questions

1. Why might Koss management have placed so much trust in Sachdeva, along
with providing only minimal supervision and monitoring?
2. What was Grant Thornton’s obligation to uncover the fraud?
3. Why should Sachdeva’s lavish lifestyle have raised suspicions? Why might it
have been ignored or explained away by her professional colleagues?
4. How could the other members of management, the audit committee, and the
auditors have been more professionally skeptical in this situation?
5. What was the audit committee’s responsibility in noticing that something
looked amiss in the financial statements?
6. Some reports have described Sachdeva as having a very dominating
personality, and revelations were made about the fact that she would often be
verbally abusive of her subordinates in front of top-level managers at Koss.
How should top-level managers have responded to this behavior? What
actions could the subordinates have taken to respond to this behavior? Why
might this behavior be a red flag indicating a heightened risk of fraud?