The Molex Inc Case Study Introduction The Molex Corporation is an electronic connector manufacturing firm, which is based in Illinois. This company is facing a financial reporting problem in which the financial statements were overstated. Joe King ,the CEO of the company, was appointed in July of 2001, and was responsible for managing and inventory control, among other very important duties. Diane Bullock was hired in 2003, to replace the previous CFO. Both Bullock and King were being accused of what? by the external auditors, Deloitte & Touche, for not disclosing an 8 million pre-tax inventory valuation error. Financial reporting Problem The financial reporting problem at Molex was that, “the profit on inventory sales that the company made between its subsidiaries but which had not yet been sold to external customers had not been excluded from the company's consolidated earnings and also in the company's inventory (Palepu & Healy, 2008).” Basically, Molex reported additional inventory and earnings from the internal inventory sales. As a result, the company’s earnings, net income, and inventory were overstated “by $8 Million before taxes and $5.8 million after taxes, with $3 million before taxes and $2.2 million after-taxes was from year ended June 30, 2004.” As it was stated on page 12-27 of the Business Analysis and Valuation applications, “The main problem came from the CEO and CFO decision to not disclose this error on the financial statements that were released on July 21, 2004 (Palepu & Healy, 2008).” The auditors were not thrilled about the poor (of) decision of King and Bullock to withholding this information from them. As a result, the auditors no longer have trust on the CEO and CFO and requested that they should be fired and replaced. Problem Correction The error should’ve been reversed when it occurred. The mistake was an overstatement of 8 million before taxes and 5.8 after tax with 3 million before tax and 2.2 million after tax happened in the previous year, which ended on June 30, 2004. The error would’ve been correct on the current
period first quarter results. To correct the overstatement of 8 million in inventory, a credit or decrease for $8 mill should’ve been done on the inventory account, and the retained earnings should’ve been debited for the same amount: Retained Earnings…………………………………………$8,000,000 Inventory……………………………………………………………………. $8,000,000 When an error of overstatement like this one happens, the financial statements have to be restated in order(ed) to bring net income to the correct amount. The Cost of goods sold should’ve been increased by $8 million and the same $8 mill needed to be deducted from net income on the income statement. They should have followed (Following) with disclosure notes to describe why this error occurred and how it impacted the statement and accounts that it touched. For instance, the notes would describe the presence of the correction on the current period of beginning inventory, and retainED earnings. Role of Top Management, The Audit committee and The External Auditor in Financial Reporting The audit committee’s role in financial reporting is to ensure that accurate and transparent disclosure is being presented to the public, investors, and shareholders. The role of top management in financial reporting is to make sure that the financial statements and disclosures are in accordance to GAAP, and that everything disclosed is truthful, while not hurting the business. The role of an external auditor is to ensure that the financial statements are presented fairly and without material misstatements in accordance to GAAP; basically, auditors guarantee the SEC that the company did in fact follow(ed) the rules and is in compliance with GAAP, or if the company is trying to, or has already, committed fraud. Given that the error of Molex was believed to be immaterial, the CEO and CFO decided not to take the issue to the auditors, since the error wouldn’t have affected the financial performance of the company. Management assumed that since no(t) harm was caused to financial performance or “earnings” the
auditor didn’t need to be informed. But the manager had not analyzed the magnitude of the error at the time of its occurrence. The issue was taken to the auditors when managers saw a huge overstatement of $8 mills on net income and inventory. Auditors Concern about the Problem The external auditors were very concerned about the error because they were not informed until after the fourth quarter results were released and prior to releasing the first quarter results on September 30, 2004. They were very concerned that they, as external auditors, didn’t see the error, and that the corporate finance group of Molex were the ones who caught it. This made the external auditors look bad because it can seem as if they didn’t carefully test(ed) the financial results, which were presented to them by Molex on July 27, 2004, in order to detect if an error had occurred in the financial statements. Good point. Besides looking inept, the auditors were concerned about the corporate issues affecting accounting and specially the audit profession. During that time, a couple a big fortune 500 companies, such as Enron, had fallen due to scandals and fraud(s) revolving(involving) misstated financial statements and reports, which resulted in huge losses to investors and added to the recession. As a consequently(consequence), the Sarbanes Oxley Act of 2003 was created to regulate auditing, especially the independency of audit firms and the company they served. As stated on page 12-26 of Business Analysis and Valuation applications, “a lot of Deloitte & Touches’ clients were involved in fraudulent accounting and misstatements of financial statements,” therefore, Deloitte and Touche was concerned with their reputation being in jeopardy once again because of the Molex error (Palepu & Healy, 2008). Should the CFO and CEO Be Replaced The requests of the auditors to replace both the CEO and CFO are silly and bad for business. There are a number of important reasons that would let me to say no to that request. Mainly, I would say no because it would look really bad for the company to fire their CEO and CFO while an error is being fixed. Additionally, an error is not intentional and it is obvious that the CEO and CFO truly believed that the error was not material, that is why external auditors exist. The external auditors passed the financial results
for the previous year (fourth quarter), and the auditors failed to discover the error. Therefore, I would force the auditor to forget about the idea of firing my employee, and I would have asked them to resign(ed) on the basis of their fault to detect the error. This would violate the SEC’s listing requirements of filing the quarter results on time, and force the auditors to approved the error fixes and leave my employees along(alone). I would definitely have bonuses and some benefits cut off from the CFO and CEO. Additionally, I would make them take audit and ethics mandatory courses. They would have to go on a long trial period before they can get a raise and bonuses again.
