Use the fraud triangle to analyze the red flags that existed in the case and ...
Question:Use the fraud triangle to analyze the red flags that existed in the case and the role and responsibilities of the auditors at Deloitte & Touche in The North Face accounting fraud.
Answer:
Pressure/incentivesManagement set overly aggressive sales goals that applied pressure on the CFO, Christopher Crawford, to financially structure the barter transactions in a way that would enable the company to record as much as revenue as possible early on in the process even though The North Face agreed to accept trade credits with a barter company in return for its purchase of merchandise and The North Face recognized profit on the trade credits. This is a common example of a high-pressure situation being created as a result of management setting overly aggressive goals.
The North face was unable to maintain the level of production that was required of them. This series of poor management decisions led to more pressure on the financial situation as well as the image of North Face. This could have contributed to the pressure the company felt to begin channel stuffing and other illegal practices.
OpportunityTop management overrode internal controls and did pretty much anything it wanted through its structured revenue transaction. It even contacted Deloitte to explain how barter revenue should be recorded and received an answer that did not conform to what the company wanted to do so it ignored Deloitte's advice. It had the barter company pay down some cash with the hope it would satisfy Deloitte about the legitimacy of revenue recorded.
Crawford was a savvy CPA and knew all about materiality criteria used by auditors. He structured the transaction in a way that was below Deloitte's materiality criteria so the firm would not question the amount of revenue being recorded based on trade credits received from the barter company. The auditors did, in fact, pass on materiality adjustments for precisely those reasons.
RationalizationThere is not much in the case about rationalizations by Crawford for why the company recorded the revenue the way it did because Deloitte was all too accommodating. We can imagine that Crawford would have insisted it was common practice to do what he did with barter transactions and trade credits received. He would probably try to convince the auditors it was standard industry practice.
Deloitte missed numerous red flags that something was amiss at The North Face. Crawford was asking for explanations of how to record barter transactions when nonmonetary assets were involved. A skeptical auditor may have wondered whether his request was motivated by finding an opening in Deloitte's logic and then using it to structure the transaction in a way that would pass muster. After all, Crawford was a CPA and should have had more knowledge of industry standards than anyone else.
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