Virtually There Technologies: A Case Study of Earnings Management and Fraud
DiGregorio, Dean W., Stallworth, H. Lynn, Braun, Robert L., Journal of the International Academy for Case Studies
The primary subject matter of this case concerns recognizing and correcting earnings management and fraud. Secondary issues include helping students to develop professional judgment and to become aware of typical reporting problems experienced by growing companies. The case has a difficulty level of three and is appropriate for junior-level students in intermediate financial accounting courses. It could also be used at level four in a senior-level auditing class. The case is designed to be taught in 2.5 class hours and is expected to require 4 hours of outside preparation by students. Alternatively, the case can be assigned as a project that requires minimal classroom time.
Earnings management has received a great deal of publicity by the press and increased scrutiny by the SEC. However, many students do not understand how earnings management and frauds are perpetrated, the extent to which "gray" areas exist in accounting practice, and the role that professional judgment plays in determining the correct course of action. This instructional case is designed to help students learn to recognize earnings management and fraud, to develop professional judgment, and to become aware of typical reporting problems experienced by growing companies. Students are required to identify problem situations and differentiate between unintentional errors and omissions, aggressive accounting practices and fraud. They must also propose adjusting journal entries and determine the effect on income. The case is based on a fictional fast-growing high tech company, Virtually There Technologies, which manufactures and markets virtual reality game systems. In the wake of the abrupt departures of the CFO and controller, students assume the role of the new controller. Their job is to get the financial records in order before the annual audit of the company financial statements begins.
Recommendations for Teaching Approaches
This case can be discussed in class or assigned as a project to be completed outside of class. The requirement to prepare a memorandum of their findings was designed to improve written communication skills and professional judgement. The requirements to prepare adjusting journal entries and determine the effect on income were designed to improve the students critical thinking skills and to reinforce the necessity of being aware of how proposed journal entries effect income per the books.
The case may also be used to improve analytical and verbal communication skills by requiring students to present or discuss in class, the problems encountered, their proposed corrections, and the effect on income. For example, students can be required to make a presentation to the company's Board of Directors to discuss their investigation and explain their findings.
Versions of this case have been used for the last two years in one of the author's Intermediate Financial Accounting II classes. The vast majority of the students felt that the case helped them integrate and apply the materials covered in the course. The case was distributed approximately three-quarters of the way through the course and collected on the last day of class. It was weighted at approximately 7% of the final grade for the course.
The basic methods of manipulating income were discussed in class. Students were expected to complete the requirements of the case outside of class. However, they were also strongly urged to have their journal entries reviewed before handing in the case. This gave the instructor the opportunity to meet with the students, evaluate their reasoning processes, and reinforce critical concepts. In cases where several students had difficulties with the same journal entry, the issue was discussed in class. This required students to logically express their reasoning process and to develop their verbal communication skills. An additional benefit was that the students were exposed to audit procedures that would be covered later in their course work. …