SurelyCan is a producer of high-quality paints sold to warehouse distributors and warehouse home

improvement retailers throughout the United States and Canada. SurelyCan recently has begun efforts
to expand internationally by forming joint ventures with international distributors to help in managing
operations within Europe and Asia. In countries where government restrictions dictate how such joint
ventures are structured, SurelyCan must alter its typical partnership strategy to operate.

SurelyCan believes that China possesses significant opportunities for growth and long term viability.
With the country's economic growth, particularly in Tianjin, the Company believes that many of its
product lines, particularly its industrial-duty and commercial-grade products, will thrive for the next
10 – 15 years at a minimum. However, to open operations in China, SurelyCan must form a joint
venture with a local government—the Tianjin City Government in this case—in which SurelyCan is a
49 per cent minority owner, and the government is a 51 per cent majority owner. SurelyCan agreed to
these terms and formed the SurelyCan Tianjin JV.

Each party agreed to several conditions under the joint venture. As part of the agreement, SurelyCan
agreed to allow the joint venture to use its brand name and supply products for sale at the joint venture
under several conditions. SurelyCan required that the joint venture conforms to all of its corporate
policies, such that all business practices conform to United States laws and regulations for conducting
business in a foreign country. The practices include internal controls, operating procedures, and
external reporting issues. SurelyCan also required that it supply several employees for key positions at
the joint venture. These employees are employed by SurelyCan but seconded (on loan) to the joint
venture. The Tianjin City Government agreed to supply office space and warehousing for SurelyCan
products in Tianjin and several other Chinese cities and enable all SurelyCan products to be imported
into China. The city also required that several key executive positions be filled with individuals from
its offices. The remainder of the employees at SurelyCan Tianjin JV was hired locally.

Employees Seconded to SurelyCan Tianjin JV

Seconded managers from SurelyCan fill several key positions at SurelyCan Tianjin JV, Alex Richards
and Grant Williams, who serve as General Manager and Finance Manager at SurelyCan Tianjin JV.
Both Alex and Grant speak fluent Chinese and worked for other companies with Chinese operations
prior to joining SurelyCan at its Philadelphia headquarters five years before the joint venture was
formed. However, neither Alex nor Grant has ever actually worked in China. All employees who
work under the seconded managers are from Tianjin. As part of their duties, Alex and Grant are
responsible for oversight of their subordinates and ensuring that SurelyCan policies and practices are
followed, including ensuring that all internal controls are in place and consistently applied.

Process for Ordering and Shipping Inventory from the United States to Joint Venture
Since all paint is purchased from the United States, Alex Richards is responsible for establishing the
lowest acceptable prices to charge customers in China. However, he allows his three sales managers,
Cheng Xi (Shekou), Hong Wu (Tianjin), and Jueng Chan (Yantian), to negotiate prices above the
floor price and schedule delivery of orders. Before Alex places an order for paint to be shipped from
the United States to the joint venture, he complies with company policy that the customer make a 20
percent down payment. Also, under SurelyCan policy for international sales at joint ventures, all sales
are made ex-terminal and therefore require cash payment prior to final "delivery" of products.

In order to receive inventory and release it to customers, the logistics manager at each of the three
SurelyCan warehouses in China requires an original bill of lading, packing list, and sales invoice. The
logistics manager at each plant is also responsible for processing all customs declarations. Once
documentation is appropriately handled, customers are responsible for removing their orders from the
warehouse. There are three SurelyCan warehouses located in Tianjin, Yantian, and Shekou that are
managed by Daqing Yang, Marti Chow, and Xong Chae, respectively.

Operations at SurelyCan Tianjin JV after Three Years

SurelyCan and Tianjin City Officials conduct a review of operations with Alex Richards and Grant
Williams at the end of the joint venture's third year of operations. SurelyCan Tianjin JV has
performed above expectations over its first three years of operations, steadily growing at sales
increases of between 30 and 50 per cent each year. The Tianjin government has been discussing the
possibility of adding three new warehouses in other provinces with SurelyCan executives during each
of the next few years. Alex Richards credits much of his success to relying on his managers and their
knowledge of local customers and customs in developing solid business relationships. Repeat sales to
customers have been steadily increasing over the first three years of operations, particularly in Tianjin
sales territory. Richards has been pleased with the ability of the sales managers and logistics managers
to work closely to ensure that products are delivered to warehouses and customers in a timely fashion.
SurelyCan (US) has been pleased that down payments for purchases are made on a timely basis,
which enables the supply chain to work effectively.

Alex has been pleased with the volume of sales by each of the sales managers. Hong Wu has been the
top sales manager each year with average sales over the three years of USD 20 million per year.
Cheng Xi also has performed quite well with average sales over the three years of USD 14 million per
year. Wu credits his success to his ability to efficiently work with local customers to ensure timely
down payments and Daqing Yang (the Tianjin logistics manager) to quickly process orders and have
them available for customers in a faster time than any local competitors. Xi credits his success to the
long-term relationships that he has cultivated in Shekou. Grant Williams attributes some of the joint
venture's success to his ability to effectively hedge currency risk utilizing state-of-the-art derivatives
that he learned about while at his prior employer, an investment banking firm in Philadelphia. He
credits the employees in the joint venture's financial management business process for working well
with managers in key operational processes, particularly sales and supply chain management. He has
been so impressed with their work ethic and commitment to servicing those processes that he has been
able to focus most of his time on the treasury side of the business.

Although pleased with the performance of SurelyCan Tianjin JV, the CFO of SurelyCan, Jane Urley,
(US) is interested in learning more about how the joint venture has been able to perform so well as a
new market entrant, particularly in Tianjin, where 45 per cent of its sales have been generated. To
help explain their success, Alex and Grant ask Hong Wu (the sales representative in charge of
Tianjin), Daqing Yang (the logistics manager in charge of the Tianjin plant), and Xiang Chu
(accounting manager for Tianjin) to attend the meeting with him and Grant Williams.

When asked about why the Tianjin operations were so successful, Wu discussed his ability to tap into
the high demand for quality US paints in the Tianjin market because of all the construction occurring
in and around the city. Wu noted that although there were several competitors in the area, the
reputation of SurelyCan gave him the competitive advantage to sell the paints at prices that were
slightly higher than competitors. He noted that receiving timely down payments was the secret in
turning over inventory rapidly and shortening sales cycles.

Daqing Yang echoed Wu's explanation by stating that customers were constantly putting pressure on
him to get sales cleared through customs and into their hands. He noted that it seemed as if the
customers were standing outside the warehouse door looking at their watches, waiting to give him
their cash for the inventory.

Xiang Chu added that Wu and Yang were excellent about informing them of customer payments and
deliveries so that accounting could update its records on a timely basis. She noted that Wu personally
handled sales transactions by placing orders, collecting cash down payments, and getting cash from
Yang to match with invoices so that personnel in accounting could perform their duties more
efficiently
(e.g., deposit cash and record sales). Chu's only concern was that some customers were not paying for
their inventory in full when picking up their goods. On more than one occasion, Wu failed to provide
proper supporting documentation for sales made to customers. He was unable to present sales invoices
or customs declaration forms to substantiate the sale. He also failed to present customer background
check information to show the legitimacy of the customers. However, since they continued buying
more merchandise and making down payments, she believed that the customers probably were
following up quite well. According to Chu while the other sales and logistics managers were also
performing well, none were doing so as efficiently as the Tianjin sales and logistics managers.

SurelyCan' CFO, Jane Urley, was satisfied by the responses of the joint venture managers, but she
was a bit concerned about whether internal controls were being followed in a manner consistent with
SurelyCan policy. Alex Richards assured her that the joint venture was acting in the spirit of the
Company's policies but that some controls were not consistently followed because of the volume of
sales occurring over the first three years. Further, Tianjin's local culture and work practices are
different from that of the United States, resulting in a transition period of adapting to controls
designed for western cultures and work practices. Both he and Tianjin City officials assured the CFO
that no serious policies were being violated (e.g., bribes, etc.); however, Alex noted that often orders
were being processed ahead of proper documentation and that internal audits had occurred less often
than expected by SurelyCan policy. He informed the CFO that he had been so busy putting out fires
that he had not been performing due diligence on new customers but that all were making timely 20
percent down payments before shipment. Alex, on one occasion, manually checked a few shipments
and was unable to locate the bill of lading and packing slip for the shipment. Xu referenced the fact
that some of the records may not be properly documented and/ or stored correctly, but Xu would
research the issue and get back to Alex. Alex became busy with other issues and failed to follow up
with the issue.

Grant Williams is responsible for ensuring that an audit is performed, but he has been so understaffed
and preoccupied with treasury operations that he has not been able to complete several audits that he
had begun in each of the past two years. He informed the CFO that physical inventories had been
completed at the Yantian and Shekou plants the prior year and would be performed the following year
at all three plants. The Tianjin inventory was not performed because Daqing Yang's wife was in a car
accident, and he was unable to be present the day it was scheduled. Since neither party could
rearrange their schedule after that time, they decided to wait until the following year. He assured the
CFO that a thorough audit was scheduled for the next year, including a review of all customer
accounts to ensure timely payments were occurring for all paint sold and reconciliation of all cash
accounts.

Requirement
Assume the work of a forensic auditor. Provide the basic principles and parameters of analysis to be
applied in uncovering and proving the fraudulent activity at SurelyCan Tianjin JV. Structure your
analysis in the following order:
1. Culture consideration
2. Accounting anomalies
3. Internal control weaknesses
4. Unusual or unrealistic procedures and relationships
5. Your preliminary conclusion

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