Chapter 3 Homework

12. Required Information Refer to Question 10. A tobashi scheme involves which of the following? A. Selling investments and buying them back disguised as advisory fees B. Using special purpose entities (SPEs), a la Enron, to offload losses to another entity C. Issuing high yield debt via junk bonds to obtain funds to cover the losses D. Creating numerous new divisions that accept the underwater securities, and then selling them to nonexistent entities

A. Selling investments and buying them back disguised as advisory fees

8. Natalie got the call she had been waiting for over six long months. Her complaint to the human resources department of Franklin Industries had been dismissed. It was HR's conclusion that she was not retaliated against for reporting an alleged embezzlement by the Accounting Department manager. In fact, HR ruled there was no embezzlement at all. Natalie had been demoted from assistant manager of the department to staff supervisor seven months ago after informing Stuart Masters, the controller, earlier in 2018 about the embezzlement. Her blood started to boil as she thought about all the pain and agony these past six months without any level of satisfaction for her troubles. Natalie Garson is a CPA who works for Franklin Industries, a publicly-owned company and manufacturer of trusses and other structural components for home builders throughout the U.S. Six months ago she filed a complaint with HR after discussing a sensitive matter with her best friend and co-worker, Roger Harris. Natalie trusted Harris, who had six years' experience at Franklin. The essence of the discussion was that Natalie was informed by the accounting staff of what appeared to be unusual transactions between Denny King, the department manager, and an outside company no one had ever heard of before. The staff had uncovered over $5 million payments, authorized by King, to Vic Construction. No one could find any documentation about Vic so the staff dug deeper and discovered that the owner of Vic Construction was Victoria King. Further examination determined that Victoria King and Denny King were sisters. Once Natalie was convinced there was more to it than meets the eye, she informed the internal auditors who investigated and found that Vic Construction made a $5 million electronic transfer to a separate business owned by Denny King. One thing lead to another and it was determined by the internal auditors that King had funneled $5 million to Vic construction, which, at a later date, transferred the money back to King. It was a $5 million embezzlement from Franklin Industries. Natalie met with Roger Harris that night and told him about the HR decision that went against her. She was concerned whether the internal auditors would act now in light of that decision. She knew the culture at Franklin was "don't rock the boat." That didn't matter to her. She was always true to her values and not afraid to act when a wrongdoing had occurred. She felt particularly motivated in this case - it was personal. She felt the need to be vindicated. She hoped Roger would be supportive. As it turned out, Roger cautioned Natalie about taking the matter any further. He had worked for Franklin a lot longer than Natalie and knew the board of directors consisted mostly of insider directors. The CEO of Franklin was also the chair of the board. It was well known in the company that whatever the CEO wanted to do, the board rubber-stamped it. Natalie left the meeting with Roger wondering whether she was on her own. She knew she had to act but didn't know the best way to go about it. Even though Roger cautioned against going to the CEO or board, Natalie didn't dismiss that option. Assume you are in Natalie's position. Answer the following questions. In deciding what to do next, Natalie as a CPA should consider the ____________. A. Ethical Responsibilities of a CPA Professional Code of Conduct 102-4 B. Ethical Responsibilities of a CPA under AICPA Professional Code Conduct 201-1 C. Ethical Responsibilities of a CPA Professional Code of Conduct 203 D. Ethical Responsibilities of a CPA Professional Code of Conduct 301

A. Ethical Responsibilities of a CPA Professional Code of Conduct 102-4

3. [The following information applies to the questions displayed below.] Bowen H. McCoy Reprinted with permission from "The Parable of the Sadhu," by Bowen H. McCoy, Harvard Business Review. Copyright © Harvard Business Publishing. Last year, as the first participant in the new six-month sabbatical program that Morgan Stanley has adopted, I enjoyed a rare opportunity to collect my thoughts as well as do some traveling. I spent the first three months in Nepal, walking 600 miles through 200 villages in the Himalayas and climbing some 120,000 vertical feet. My sole Western companion on the trip was an anthropologist who shed light on the cultural patterns of the villages that we passed through. During the Nepal hike, something occurred that has had a powerful impact on my thinking about corporate ethics. Although some might argue that the experience has no relevance to business, it was a situation in which a basic ethical dilemma suddenly intruded into the lives of a group of individuals. How the group responded holds a lesson for all organizations, no matter how defined. The Sadhu The Nepal experience was more rugged than I had anticipated. Most commercial treks last two or three weeks and cover a quarter of the distance we traveled. My friend Stephen, the anthropologist, and I were halfway through the 60-day Himalayan part of the trip when we reached the high point, an 18,000-foot pass over a crest that we'd have to traverse to reach the village of Muklinath, an ancient holy place for pilgrims. Six years earlier, I had suffered pulmonary edema, an acute form of altitude sickness, at 16,500 feet in the vicinity of Everest base camp—so we were understandably concerned about what would happen at 18,000 feet. Moreover, the Himalayas were having their wettest spring in 20 years; hip-deep powder and ice had already driven us off one ridge. If we failed to cross the pass, I feared that the last half of our once-in-a-lifetime trip would be ruined. The night before we would try the pass, we camped in a hut at 14,500 feet. In the photos taken at that camp, my face appears wan. The last village we'd passed through was a sturdy two-day walk below us, and I was tired. During the late afternoon, four backpackers from New Zealand joined us, and we spent most of the night awake, anticipating the climb. Below, we could see the fires of two other parties, which turned out to be two Swiss couples and a Japanese hiking club. To get over the steep part of the climb before the sun melted the steps cut in the ice, we departed at 3.30 a.m. The New Zealanders left first, followed by Stephen and myself, our porters and Sherpas, and then the Swiss. The Japanese lingered in their camp. The sky was clear, and we were confident that no spring storm would erupt that day to close the pass. At 15,500 feet, it looked to me as if Stephen was shuffling and staggering a bit, which are symptoms of altitude sickness. (The initial stage of altitude sickness brings a headache and nausea. As the condition worsens, a climber may encounter difficult breathing, disorientation, aphasia, and paralysis.) I felt strong—my adrenaline was flowing—but I was very concerned about my ultimate ability to get across. A couple of our porters were also suffering from the height, and Pasang, our Sherpa sirdar (leader), was worried. Just after daybreak, while we rested at 15,500 feet, one of the New Zealanders, who had gone ahead, came staggering down toward us with a body slung across his shoulders. He dumped the almost naked, barefoot body of an Indian holy man—a sadhu—-at my feet. He had found the pilgrim lying on the ice, shivering and suffering from hypothermia. I cradled the sadhu's head and laid him out on the rocks. The New Zealander was angry. He wanted to get across the pass before the bright sun melted the snow. He said, "Look, I've done what I can. You have porters and Sherpa guides. You care for him. We're going on!" He turned and went back up the mountain to join his friends. I took a carotid pulse and found that the sadhu was still alive. We figured he had probably visited the holy shrines at Muklinath and was on his way home. It was fruitless to question why he had chosen this desperately high route instead of the safe, heavily traveled caravan route through the Kali Gandaki gorge. Or why he was shoeless and almost naked, or how long he had been lying in the pass. The answers weren't going to solve our problem. Stephen and the four Swiss began stripping off their outer clothing and opening their packs. The sadhu was soon clothed from head to foot. He was not able to walk, but he was very much alive. I looked down the mountain and spotted the Japanese climbers, marching up with a horse. Without a great deal of thought, I told Stephen and Pasang that I was concerned about withstanding the heights to come and wanted to get over the pass. I took off after several of our porters who had gone ahead. On the steep part of the ascent where, if the ice steps had given way, I would have slid down about 3,000 feet, I felt vertigo. I stopped for a breather, allowing the Swiss to catch up with me. I inquired about the sadhu and Stephen. They said that the sadhu was fine and that Stephen was just behind them. I set off again for the summit. Stephen arrived at the summit an hour after I did. Still exhilarated by victory, I ran down the slope to congratulate him. He was suffering from altitude sickness—walking 15 steps, then stopping, walking 15 steps, then stopping. Pasang accompanied him all the way up. When I reached them, Stephen glared at me and said, "How do you feel about contributing to the death of a fellow man?" I did not completely comprehend what he meant. "Is the sadhu dead?" I inquired. "No," replied Stephen, "but he surely will be!" After I had gone, followed not long after by the Swiss, Stephen had remained with the sadhu. When the Japanese had arrived, Stephen had asked to use their horse to transport the sadhu down to the hut. They had refused. He had then asked Pasang to have a group of our porters carry the sadhu. Pasang had resisted the idea, saying that the porters would have to exert all their energy to get themselves over the pass. He believed they could not carry a man down 1,000 feet to the hut, reclimb the slope, and get across safely before the snow melted. Pasang had pressed Stephen not to delay any longer. The Sherpas had carried the sadhu down to a rock in the sun at about 15,000 feet and pointed out the hut another 500 feet below. The Japanese had given him food and drink. When they had last seen him, he was listlessly throwing rocks at the Japanese party's dog, which had frightened him. We do not know if the sadhu lived or died. For many of the following days and evenings, Stephen and I discussed and debated our behavior toward the sadhu. Stephen is a committed Quaker with deep moral vision. He said, "I feel that what happened with the sadhu is a good example of the breakdown between the individual ethic and the corporate ethic. No one person was willing to assume ultimate responsibility for the sadhu. Each was willing to do his bit just so long as it was not too inconvenient. When it got to be a bother, everyone just passed the buck to someone else and took off. Jesus was relevant to a more individualistic stage of society, but how do we interpret his teaching today in a world filled with large, impersonal organizations and groups?" I defended the larger group, saying, "Look, we all cared. We all gave aid and comfort. Everyone did his bit. The New Zealander carried him down below the snow line. I took his pulse and suggested we treat him for hypothermia. You and the Swiss gave him clothing and got him warmed up. The Japanese gave him food and water. The Sherpas carried him down to the sun and pointed out the easy trail toward the hut. He was well enough to throw rocks at a dog. What more could we do?" "You have just described the typical affluent Westerner's response to a problem. Throwing money—in this case, food and sweaters—at it, but not solving the fundamentals!" Stephen retorted. "What would satisfy you?" I said. "Here we are, a group of New Zealanders, Swiss, Americans, and Japanese who have never met before and who are at the apex of one of the most powerful experiences of our lives. Some years the pass is so bad no one gets over it. What right does an almost naked pilgrim who chooses the wrong trail have to disrupt our lives? Even the Sherpas had no interest in risking the trip to help him beyond a certain point." Stephen calmly rebutted, "I wonder what the Sherpas would have done if the sadhu had been a well-dressed Nepali, or what the Japanese would have done if the sadhu had been a well-dressed Asian, or what you would have done, Buzz, if the sadhu had been a well-dressed Western woman?" "Where, in your opinion," I asked, "is the limit of our responsibility in a situation like this? We had our own well-being to worry about. Our Sherpa guides were unwilling to jeopardize us or the porters for the sadhu. No one else on the mountain was willing to commit himself beyond certain self-imposed limits." Stephen said, "As individual Christians or people with a Western ethical tradition, we can fulfill our obligations in such a situation only if one, the sadhu dies in our care; two, the sadhu demonstrates to us that he can undertake the two-day walk down to the village; or three, we carry the sadhu for two days down to the village and persuade someone there to care for him." "Leaving the sadhu in the sun with food and clothing—where he demonstrated hand-eye coordination by throwing a rock at a dog—comes close to fulfilling items one and two," I answered. "And it wouldn't have made sense to take him to the village where the people appeared to be far less caring than the Sherpas, so the third condition is impractical. Are you really saying that, no matter what the implications, we should, at the drop of a hat, have changed our entire plan?" The Individual versus the Group Ethic Despite my arguments, I felt and continue to feel guilt about the sadhu. I had literally walked through a classic moral dilemma without fully thinking through the consequences. My excuses for my actions include a high adrenaline flow, a superordinate goal, and a once-in-a-lifetime opportunity—common factors in corporate situations, especially stressful ones. Real moral dilemmas are ambiguous, and many of us hike right through them, unaware that they exist. When, usually after the fact, someone makes an issue of one, we tend to resent his or her bringing it up. Often, when the full import of what we have done (or not done) hits us, we dig into a defensive position from which it is very difficult to emerge. In rare circumstances, we may contemplate what we have done from inside a prison. Had we mountaineers been free of stress caused by the effort and the high altitude, we might have treated the sadhu differently. Yet isn't stress the real test of personal and corporate values? The instant decisions that executives make under pressure reveal the most about personal and corporate character. Among the many questions that occur to me when I ponder my experience with the sadhu are: What are the practical limits of moral imagination and vision? Is there a collective or institutional ethic that differs from the ethics of the individual? At what level of effort or commitment can one discharge one's ethical responsibilities? Not every ethical dilemma has a right solution. Reasonable people often disagree; otherwise there would be no dilemma. In a business context, however, it is essential that managers agree on a process for dealing with dilemmas. Our experience with the sadhu offers an interesting parallel to business situations. An immediate response was mandatory. Failure to act was a decision in itself. Up on the mountain, we could not resign and submit our résumés to a headhunter. In contrast to philosophy, business involves action and implementation—getting things done. Managers must come up with answers based on what they see and what they allow to influence their decision-making processes. On the mountain, none of us but Stephen realized the true dimensions of the situation we were facing. One of our problems was that as a group, we had no process for developing a consensus. We had no sense of purpose or plan. The difficulties of dealing with the sadhu were so complex that no one person could handle them. Because the group did not have a set of preconditions that could guide its action to an acceptable resolution, we reacted instinctively as individuals. The cross-cultural nature of the group added a further layer of complexity. We had no leader with whom we could all identify and in whose purpose we believed. Only Stephen was willing to take charge, but he could not gain adequate support from the group to care for the sadhu. Some organizations do have values that transcend the personal values of their managers. Such values, which go beyond profitability, are usually revealed when the organization is under stress. People throughout the organization generally accept its values, which, because they are not presented as a rigid list of commandments, may be somewhat ambiguous. The stories people tell, rather than printed materials, transmit the organization's conceptions of what is proper behavior. For 20 years, I have been exposed at senior levels to a variety of corporations and organizations. It is amazing how quickly an outsider can sense the tone and style of an organization and, with that, the degree of tolerated openness and freedom to challenge management. Organizations that do not have a heritage of mutually accepted, shared values tend to become unhinged during stress, with each individual bailing out for himself or herself. In the great takeover battles we have witnessed during past years, companies that had strong cultures drew the wagons around them and fought it out, while other companies saw executives—supported by golden parachutes—bail out of the struggles. Because corporations and their members are interdependent, for the corporation to be strong, the members need to share a preconceived notion of correct behavior, a "business ethic," and think of it as a positive force, not a constraint. As an investment banker, I am continually warned by well-meaning lawyers, clients, and associates to be wary of conflicts of interest. Yet if I were to run away from every difficult situation, I wouldn't be an effective investment banker. I have to feel my way through conflicts. An effective manager can't run from risk either; he or she has to confront risk. To feel "safe" in doing that, managers need the guidelines of an agreed-upon process and set of values within the organization. After my three months in Nepal, I spent three months as an executive-in-residence at both the Stanford Business School and the University of California at Berkeley's Center for Ethics and Social Policy of the Graduate Theological Union. Those six months away from my job gave me time to assimilate 20 years of business experience. My thoughts turned often to the meaning of the leadership role in any large organization. Students at the seminary thought of themselves as antibusiness. But when I questioned them, they agreed that they distrusted all large organizations, including the church. They perceived all large organizations as impersonal and opposed to individual values and needs. Yet we all know of organizations in which people's values and beliefs are respected and their expressions encouraged. What makes the difference? Can we identify the difference and, as a result, manage more effectively? The word ethics turns off many and confuses more. Yet the notions of shared values and an agreed-upon process for dealing with adversity and change—what many people mean when they talk about corporate culture—seem to be at the heart of the ethical issue. People who are in touch with their own core beliefs and the beliefs of others and who are sustained by them can be more comfortable living on the cutting edge. At times, taking a tough line or a decisive stand in a muddle of ambiguity is the only ethical thing to do. If a manager is indecisive about a problem and spends time trying to figure out the "good" thing to do, the enterprise may be lost. Business ethics, then, has to do with the authenticity and integrity of the enterprise. To be ethical is to follow the business as well as the cultural goals of the corporation, its owners, its employees, and its customers. Those who cannot serve the corporate vision are not authentic businesspeople and, therefore, are not ethical in the business sense. At this stage of my own business experience, I have a strong interest in organizational behavior. Sociologists are keenly studying what they call corporate stories, legends, and heroes as a way organizations have of transmitting value systems. Corporations such as Arco have even hired consultants to perform an audit of their corporate culture. In a company, a leader is a person who understands, interprets, and manages the corporate value system. Effective managers, therefore, are action-oriented people who resolve conflict, are tolerant of ambiguity, stress, and change, and have a strong sense of purpose for themselves and their organizations. If all this is true, I wonder about the role of the professional manager who moves from company to company. How can he or she quickly absorb the values and culture of different organizations? Or is there, indeed, an art of management that is totally transportable? Assuming that such fungible managers do exist, is it proper for them to manipulate the values of others? What would have happened had Stephen and I carried the sadhu for two days back to the village and become involved with the villagers in his care? In four trips to Nepal, my most interesting experience occurred in 1975, when I lived in a Sherpa home in the Khumbu for five days while recovering from altitude sickness. The high point of Stephen's trip was an invitation to participate in a family funeral ceremony in Manang. Neither experience had to do with climbing the high passes of the Himalayas. Why were we so reluctant to try the lower path, the ambiguous trail? Perhaps because we did not have a leader who could reveal the greater purpose of the trip to us. Why didn't Stephen, with his moral vision, opt to take the sadhu under his personal care? The answer is partly because Stephen was hard-stressed physically himself and partly because, without some support system that encompassed our involuntary and episodic community on the mountain, it was beyond his individual capacity to do so. I see the current interest in corporate culture and corporate value systems as a positive response to pessimism such as Stephen's about the decline of the role of the individual in large organizations. Individuals who operate from a thoughtful set of personal values provide the foundation for a corporate culture. A corporate tradition that encourages freedom of inquiry, supports personal values, and reinforces a focused sense of direction can fulfill the need to combine individuality with the prosperity and success of the group. Without such corporate support, the individual is lost. That is the lesson of the sadhu. In a complex corporate situation, the individual requires and deserves the support of the group. When people cannot find such support in their organizations, they don't know how to act. If such support is forthcoming, a person has a stake in the success of the group and can add much to the process of establishing and maintaining a corporate culture. Management's challenge is to be sensitive to individual needs, to shape them, and to direct and focus them for the benefit of the group as a whole. For each of us, the sadhu lives. Should we stop what we are doing and comfort him; or should we keep trudging up toward the high pass? Should I pause to help the derelict I pass on the street each night as I walk by the Yale Club en route to Grand Central Station? Am I his brother? What is the nature of our responsibility if we consider ourselves to be ethical persons? Perhaps it is to change the values of the group so that it can, with all its resources, take the other road. Burchard's Ethical Dissonance Cycle Model suggests this was a failure of which of the following? A. Low Organization Ethics, Low Individual Ethics Low Low B. High Organizational Ethics, Low Individual Ethics High Low C. Low Organizational Ethics, High Individual Ethics Low High D. None of these

C. Low Organizational Ethics, High Individual Ethics Low High

4. [The following information applies to the questions displayed below.] Occupational fraud comes in many shapes and sizes. The fraud at Rite Aid is one such case. In February 2015, Findling pleaded guilty to charges of conspiracy to commit wire fraud. Foster pleaded guilty to making false statements to authorities. On November 16, 2016, Foster was sentenced to five years in prison and Findling, four years. Findling and Foster were ordered to jointly pay $8,034,183 in restitution. Findling also forfeited and turned over an additional $11.6 million to the government at the time he entered his guilty plea. In sentencing Foster, U.S. Middle District Judge John E. Jones III expressed his astonishment that in one instance at Rite-Aid headquarters, Foster took a multimillion dollar cash pay-off from Findling, then stuffed the money into a bag and flew home on Rite Aid's corporate jet. The charges relate to a nine-year conspiracy to defraud Rite Aid by lying to the company about the sale of surplus inventory to a company owned by Findling when it was sold to third parties for greater amounts. Findling would then kick back a portion of his profits to Foster. Foster's lawyer told Justice Jones that, even though they conned the company, the efforts of Foster and Findling still earned Rite Aid over $100 million "instead of having warehouses filled with unwanted merchandise." Assistant U.S. Attorney Kim Daniel focused on the abuse of trust by Foster and persistent lies to the feds. "The con didn't affect some faceless corporation, Daniel said, "but harmed Rite Aid's 89,000 employees and its stockholders." Findling's attorney, Kevin Buchan, characterized his client as "a good man who made a bad decision." "He succumbed to the pressure. That's why he did what he did and that's why he's here," Buchan said during sentencing. Findling admitted he established a bank account under the name "Rite Aid Salvage Liquidation" and used it to collect the payments from the real buyers of the surplus Rite Aid inventory. After the payments were received, Findling would Page send lesser amounts dictated by Foster to Rite Aid for the goods, thus inducing Rite Aid to believe the inventory had been purchased by J. Finn Industries, not the real buyers. The government alleged Findling received at least $127.7 million from the real buyers of the surplus inventory but, with Foster's help, only provided $98.6 million of that amount to Rite Aid, leaving Findling approximately $29.1 million in profits from the scheme. The government also alleged that Findling kicked back approximately $5.7 million of the $29.1 million to Foster. Assume you are the director of internal auditing at Rite Aid and discover the surplus inventory scheme. You know that Rite Aid has a comprehensive corporate governance system that complies with the requirements of Sarbanes-Oxley, and the company has a strong ethics foundation. Moreover, the internal controls are consistent with the COSO framework. Explain the steps you would take to determine whether you would blow the whistle on the scheme applying the requirements of AICPA Interpretation 102-4 that are depicted in Exhibit 3.11. In that regard, answer the following questions. A whistleblower is defined as a person who provides information to the _________ about a violation of the securities law. A. PCAOB B. Audit committee of the firm involved C. SEC D. External audit firm

C. SEC

5. [The following information applies to the questions displayed below.] Occupational fraud comes in many shapes and sizes. The fraud at Rite Aid is one such case. In February 2015, Findling pleaded guilty to charges of conspiracy to commit wire fraud. Foster pleaded guilty to making false statements to authorities. On November 16, 2016, Foster was sentenced to five years in prison and Findling, four years. Findling and Foster were ordered to jointly pay $8,034,183 in restitution. Findling also forfeited and turned over an additional $11.6 million to the government at the time he entered his guilty plea. In sentencing Foster, U.S. Middle District Judge John E. Jones III expressed his astonishment that in one instance at Rite-Aid headquarters, Foster took a multimillion dollar cash pay-off from Findling, then stuffed the money into a bag and flew home on Rite Aid's corporate jet. The charges relate to a nine-year conspiracy to defraud Rite Aid by lying to the company about the sale of surplus inventory to a company owned by Findling when it was sold to third parties for greater amounts. Findling would then kick back a portion of his profits to Foster. Foster's lawyer told Justice Jones that, even though they conned the company, the efforts of Foster and Findling still earned Rite Aid over $100 million "instead of having warehouses filled with unwanted merchandise." Assistant U.S. Attorney Kim Daniel focused on the abuse of trust by Foster and persistent lies to the feds. "The con didn't affect some faceless corporation, Daniel said, "but harmed Rite Aid's 89,000 employees and its stockholders." Findling's attorney, Kevin Buchan, characterized his client as "a good man who made a bad decision." "He succumbed to the pressure. That's why he did what he did and that's why he's here," Buchan said during sentencing. Findling admitted he established a bank account under the name "Rite Aid Salvage Liquidation" and used it to collect the payments from the real buyers of the surplus Rite Aid inventory. After the payments were received, Findling would Page send lesser amounts dictated by Foster to Rite Aid for the goods, thus inducing Rite Aid to believe the inventory had been purchased by J. Finn Industries, not the real buyers. The government alleged Findling received at least $127.7 million from the real buyers of the surplus inventory but, with Foster's help, only provided $98.6 million of that amount to Rite Aid, leaving Findling approximately $29.1 million in profits from the scheme. The government also alleged that Findling kicked back approximately $5.7 million of the $29.1 million to Foster. Assume you are the director of internal auditing at Rite Aid and discover the surplus inventory scheme. You know that Rite Aid has a comprehensive corporate governance system that complies with the requirements of Sarbanes-Oxley, and the company has a strong ethics foundation. Moreover, the internal controls are consistent with the COSO framework. Explain the steps you would take to determine whether you would blow the whistle on the scheme applying the requirements of AICPA Interpretation 102-4 that are depicted in Exhibit 3.11. In that regard, answer the following questions. To encourage various groups to come forward and report fraud, Dodd-Frank extended whistle-blowing privileges and rewards to which of the following? A. Internal auditors B. External auditors C. The CEO D. All of these are correct.

C. The CEO

10. [The following information applies to the questions displayed below.] Summary of the Case* On September 25, 2012, Japanese camera and medical equipment maker Olympus Corporation and three of its former executives pleaded guilty to charges related to an accounting scheme and cover-up in one of Japan's biggest corporate scandals. Olympus admitted that it tried to conceal investment losses by using improper accounting under a scheme that began in the 1990s. The scandal was exposed in 2011 by Olympus's then-CEO, Michael C. Woodford. As the new President of Olympus, he felt obliged to investigate the matter and uncovered accounting irregularities and suspicious deals involving the acquisition of UK medical equipment manufacturer Gyrus. He called the company's auditors, PwC, to report it. The firm examined payments of $687 million related to financial advice on the acquisition paid to a non-existent Cayman Islands firm. A fraud of $1.7 billion emerged, including an accounting scandal to hide the losses. Along the way, the Japanese way of doing business came under attack by Woodford. Olympus initially said that it fired Woodford, one of a handful of foreign executives at top Japanese companies, over what it called his aggressive Western management style. Woodford disclosed internal documents to show he was dismissed after he raised questions about irregular payouts related to mergers and acquisitions. Without any serious attempt by management to investigate, he went behind the board's back and commissioned a report by PwC into the Gyrus deal, including the unusually high advisory fee and apparent lack of due diligence. On October 11, 2011, he circulated the report to the board and called on chair of the board, Tsuyoshi Kikukawa, and executive vice president, Hisashi Mori, to resign. Three days later, the board fired Woodford. Ultimately, the accounting fraud was investigated by the Japanese authorities. "The full responsibility lies with me and I feel deeply sorry for causing trouble to our business partners, shareholders, and the wider public," Kikukawa, told the Tokyo district court. "I take full responsibility for what happened." Prosecutors charged Kikukawa, Mori, and a former internal auditor, Hideo Yamada, with inflating the company's net worth in financial statements for five fiscal years up to March 2011 due to accounting for risky investments made in the late-1980s bubble economy. The three former executives had been identified by an investigative panel, commissioned by Olympus, as the main suspects in the fraud. In December 2011, Olympus filed five years' worth of corrected financial statements plus overdue first-half results, revealing a $1.1 billion hole in its balance sheet. On April 28, 2017, following six years of scandal-ridden disclosures, a Tokyo court found Kikukawa and five others liable for $529 million. Kikukawa and two other executives who pleaded guilty never went to jail. Instead, they were given suspended sentences of up to three years. Olympus Spent Huge Sums on Inflated Acquisitions, Advisory Fees to Conceal Investment Losses Olympus's cover-up of massive losses has shed light on several murky methods that some companies employed to clean up the mess left after Japan's economic bubble burst. Many companies turned to speculative investments as they suffered sluggish sales and stagnant operating profits. The company used "loss-deferring practices" to make losses look smaller on the books by selling bad assets to related companies. To take investment losses off its books, Olympus spent large sums of money to purchase British medical equipment maker Gyrus Group PLC and three Japanese companies and paid huge consulting fees. Olympus is suspected of having deliberately acquired Gyrus at an inflated price, and in the year following the purchases, it booked impairment losses as a result of decreases in the companies' value. To avert a rapid deterioration of its financial standing, Olympus continued corporate acquisitions and other measures for many years, booking impairment losses to improve its balance sheet. Losses on the purchases of the three Japanese companies amounted to $34.5 billion. With money paid on the Gyrus deal included, Olympus may have used more than $62.5 billion in funds for past acquisitions to conceal losses on securities investments. The previous method that recorded stocks and other financial products by book value—the price when they were purchased—was abolished. The new method listed them by market value (mark-to-market accounting). Under this change, Olympus had to report all the losses in its March 2001 report. However, Olympus anticipated this change a year in advance and posted only about $10.6 billion of the nearly $62.5 billion yen as an extraordinary loss for the March 2000 settlement term. The company did not post the remainder as a deficit; rather, it deferred it using questionable measures. Olympus's Tobashi Scheme At the heart of Olympus's action, was a once-common technique to hide losses called tobashi, which Japanese financial regulators tolerated before clamping down on the practice in the late 1990s. Tobashi, translated loosely as "to blow away," enables companies to hide losses on bad assets by selling those assets to other companies, only to buy them back later through payments, often disguised as advisory fees or other transactions, when market conditions or earnings improve. Tobashi allows a company with the bad assets to mask losses temporarily, a practice banned in the early 2000s. The idea is that you pay off the losses later, when company finances are better. Olympus appears to have pushed to settle its tobashi amounts from 2006 to 2008, when the local economy was picking up and corporate profits rebounding, in an effort to "clean up its act." Business was finally strong enough to be able to withstand a write-down. It was during those years that the company engineered the payouts that came under scrutiny: $687 million in fees to an obscure financial adviser over Olympus's acquisition of Gyrus in 2008, a fee that was roughly a third of the $2 billion acquisition price, more than 30 times the norm. Olympus also acquired three small Japanese companies from 2006 to 2008 with little in common with its core business for a total of $773 million, only to write down most of their value within the same fiscal year. Olympus Scandal Raises Questions about the "Japan Way" of Doing Business The scandal rocked corporate Japan, not least because of the company's succession of firings, denials, admissions, and whistleblowing. It also exposed weaknesses in Japan's financial regulatory system and corporate governance. "This is a case where Japan's outmoded practice of corporate governance remained and reared its ugly head," according to Shuhei Abe, president of Tokyo-based Sparx Group Company. "With Olympus's case, it will no longer be justifiable for Japan Inc. to continue practicing under the excuse of the 'Japan way of doing things.'" On the surface, Olympus seemed to have checks on its management. For example, it hired directors and auditors from outside the company, as well as a British president who was not tied to corporate insiders. In reality, however, the company's management was ruled by former chairman Kikukawa and a few other executives who came from its financial sections. The company's management is believed to have been effectively controlled by several executives who had a background in financial affairs, including Kikukawa and Mori, both of whom were involved in the cover-up of past losses. Olympus's board of auditors, which is supposed to supervise the board of directors, includes full-time auditor Hideo Yamada, who also had financial expertise. After Woodford made his allegations, he was confronted by a hostile board of directors that acted based on the premise that whistleblowing offended their corporate culture. Subsequently, the board fired him saying that he had left because of "differences in management styles." Employees were warned not to speak to them or jeopardize their careers. One problem with corporate governance in Japan is truly independent non-executive directors are unusual. Many Japanese do not see the need for such outside intervention. They question how outsiders can know enough about the company to make a valuable contribution. Moreover, how could they be sensitive to the corporate culture? They could even damage the credibility of the group. Accounting Explanations Olympus hid a $1.7 billion loss through an intricate array of transactions. A one paragraph summary of what it did appears in the investigation report: The lost disposition scheme is featured in that Olympus sold the assets that incurred loss to the funds set up by Olympus itself, and later provided the finance needed to settle the loss under the cover of the company acquisitions. More specifically, Olympus circulated money either by flowing money into the funds by acquiring the entrepreneurial ventures owned by the funds at the substantially higher price than the real values, or by paying a substantially high fees to the third party who acted as the intermediate in the acquisition, resulting in recognition of large amount of goodwill, and subsequently amortized goodwill recognized impairment loss, which created substantial loss. Here is a more understandable version of the event: Olympus indirectly loaned money to an off-the-books subsidiary and then sold the investments that had the huge losses to the subsidiary at historical cost, eventually paying a huge premium to buy some other small companies and writing off the underwater investments as if they were goodwill impairments. A more detailed bookkeeping analysis of the complicated transactions appears in Exhibit 1. Auditor Responsibilities Arthur Andersen was the external auditor through March 31, 2002, after which Andersen closed its doors for good in the post-Enron era. Then KPMG AZSA LLC was the auditor through March 31, 2009. The 2010 and 2011 fiscal years were audited by Ernst & Young ShinNihon LLC. The investigative report noted that the fraud was hidden quite well. Three banks were involved in hiding information from the auditors. The summary report said that all three of them agreed not to tell auditors the information that would normally be provided on an audit confirmation. KPMG did come across one of the tobashi schemes carried out through one of the three different routes that had been set up. According to the investigative report: Not everything was going smoothly. The report said that in 1999, Olympus's then-auditor, KPMG AZSA LLC, came across information that indicated the company was engaged in tobashi, which recently had become illegal in Japan. Mori and Yamada initially denied KPMG's assertion, but the auditor pushed them that same year to admit to the presence of one fund and unwind it, booking a loss of $10.5 billion. The executives assured KPMG that that was the only such deal, the report said. One KPMG audit team did find part of the scheme in 1999. Management lied by denying that it even existed. After agreeing to write it off, Olympus senior management lied again, saying that it was the only one. But the scheme expanded, without detection, for another six years or so and was in place, without detection, until the last component was unwound at the end of fiscal year 2010. The last part of the bad investments was finally written off in March 2011. Olympus Finally Had Enough of the Deception Olympus removed KPMG AZSA as its group auditor in 2009 after a dispute over how to account for some controversial acquisitions. The camera-maker decided not to disclose this to the stock market. Instead, Olympus told investors at the time that KPMG's audit contract had expired and it was hiring Ernst & Young. Mori and Yamada had finally decided to unwind and write off the underwater financial assets and repay the loans that it had made through its unconsolidated subsidiary. Of course, by then, the financial press had gotten wind of what was going on at Olympus. *The facts of this case are drawn from: Michael Woodford, Exposure: Inside the Olympus Scandal: How I went from CEO to Whistleblower, (NY: Penguin Books, 2012). EXHIBIT 1 Detailed Bookkeeping Analysis of Olympus's Accounting Fraud* PHASE 1 Transaction 1: This is a summary of a complex move—it involved making a CD deposit at several banks that were asked to loan the money back to an unrelated entity, with the CD as collateral, so the subsidiary can buy investments from Olympus. Note: According to the investigative committee's report, three banks were involved through the course of the whole project: Commerzbank, LGT, and Société Générale. The committee's report indicates that all three banks agreed to Olympus's request not to tell the auditors about the CDs being collateral for a loan. (Olympus books) DR Certificate of depositCR Cash(CD purchase at banks; banks loan it to unconsolidated subsidiary) (Unconsolidated subsidiary books) DR CashCR Note payable to banks(Cash from banks; collateralized by Olympus) Transaction 2: (Olympus books) DR CashCR Financial assets (Investments)(Proceeds from selling underwater investments to unconsolidated subsidiary; may have triggered gain on sale) (Unconsolidated subsidiary books) DR Financial assets (Investments)CR Cash(To buy underwater investments from Olympus) PHASE 2 Eventually the CDs would have to be rolled over and brought back. In addition, the unrealized losses would have to be written down eventually, so the second phase was launched. Transaction 3: Olympus bought some tiny (startup) companies. They paid significantly more than they were worth and paid large amounts for consultants for their service as finders and intermediaries. (Olympus books)DR Investments (startup subsidiary)DR Goodwill—(cash paid less fair market value of subsidiary net assets)CR Cash(Investments in new subsidiaries) Note: The investment in the consolidated subsidiary shows a large amount of goodwill, which could then be written down. (Entries by the newly formed consolidated subsidiary)DR CashCR Common stock(Cash investment from Olympus) Transaction 4: The effect of these transactions was to transfer money into the newest consolidated subsidiary, which used the money to buy the bad investments from the older, unconsolidated subsidiary. The unconsolidated subsidiary then repaid the note payable to the bank and Olympus liquidated its CD. (Entries by the newly formed consolidated subsidiary)DR Financial assets (Investments)CR Cash(Buy underwater investments from unconsolidated subsidiary at book value) (Unconsolidated subsidiary books) DR Cash (from consolidated subsidiary).CR Financial assets (Investments)(Proceeds received from consolidated subsidiary from sale of underwater investments)DR Note payable to banksCR Cash(Repay loan to banks) Entries by OlympusDR CashCR Certificate of deposit(CD liquidated) A good video that discusses the basic facts of the case, the role of Michael Woodford, corporate governance, and efforts of PwC is at: https://www.youtube.com/watch?v=bXawS6pYt0g An update of the legal settlement by Olympus of the fraud can be found at: http://www.law360.com/articles/638729/olympus-to-pay-investors-92m-over-alleged- Perhaps the most unusual thing about this case is that _______________. A. The fraud went undetected for so long B. Three sets of different external auditors were involved during the fraud C. The CEO turned whistleblower D. The fine was relatively light: only $92 million to settle with institutional investors

C. The CEO turned whistleblower

7. Natalie got the call she had been waiting for over six long months. Her complaint to the human resources department of Franklin Industries had been dismissed. It was HR's conclusion that she was not retaliated against for reporting an alleged embezzlement by the Accounting Department manager. In fact, HR ruled there was no embezzlement at all. Natalie had been demoted from assistant manager of the department to staff supervisor seven months ago after informing Stuart Masters, the controller, earlier in 2018 about the embezzlement. Her blood started to boil as she thought about all the pain and agony these past six months without any level of satisfaction for her troubles. Natalie Garson is a CPA who works for Franklin Industries, a publicly-owned company and manufacturer of trusses and other structural components for home builders throughout the U.S. Six months ago she filed a complaint with HR after discussing a sensitive matter with her best friend and co-worker, Roger Harris. Natalie trusted Harris, who had six years' experience at Franklin. The essence of the discussion was that Natalie was informed by the accounting staff of what appeared to be unusual transactions between Denny King, the department manager, and an outside company no one had ever heard of before. The staff had uncovered over $5 million payments, authorized by King, to Vic Construction. No one could find any documentation about Vic so the staff dug deeper and discovered that the owner of Vic Construction was Victoria King. Further examination determined that Victoria King and Denny King were sisters. Once Natalie was convinced there was more to it than meets the eye, she informed the internal auditors who investigated and found that Vic Construction made a $5 million electronic transfer to a separate business owned by Denny King. One thing lead to another and it was determined by the internal auditors that King had funneled $5 million to Vic construction, which, at a later date, transferred the money back to King. It was a $5 million embezzlement from Franklin Industries. Natalie met with Roger Harris that night and told him about the HR decision that went against her. She was concerned whether the internal auditors would act now in light of that decision. She knew the culture at Franklin was "don't rock the boat." That didn't matter to her. She was always true to her values and not afraid to act when a wrongdoing had occurred. She felt particularly motivated in this case - it was personal. She felt the need to be vindicated. She hoped Roger would be supportive. As it turned out, Roger cautioned Natalie about taking the matter any further. He had worked for Franklin a lot longer than Natalie and knew the board of directors consisted mostly of insider directors. The CEO of Franklin was also the chair of the board. It was well known in the company that whatever the CEO wanted to do, the board rubber-stamped it. Natalie left the meeting with Roger wondering whether she was on her own. She knew she had to act but didn't know the best way to go about it. Even though Roger cautioned against going to the CEO or board, Natalie didn't dismiss that option. Assume you are in Natalie's position. Answer the following questions. If Natalie Garson assumes someone else will report the apparent authorized transfer to Vic Construction, she would be subject to _____________. A. The whistleblower effect B. The tone at the top effect C. The bystander effect D. The Sherron Watkins effect, named for the whistleblower at Enron

C. The bystander effect

6. [The following information applies to the questions displayed below.] Occupational fraud comes in many shapes and sizes. The fraud at Rite Aid is one such case. In February 2015, Findling pleaded guilty to charges of conspiracy to commit wire fraud. Foster pleaded guilty to making false statements to authorities. On November 16, 2016, Foster was sentenced to five years in prison and Findling, four years. Findling and Foster were ordered to jointly pay $8,034,183 in restitution. Findling also forfeited and turned over an additional $11.6 million to the government at the time he entered his guilty plea. In sentencing Foster, U.S. Middle District Judge John E. Jones III expressed his astonishment that in one instance at Rite-Aid headquarters, Foster took a multimillion dollar cash pay-off from Findling, then stuffed the money into a bag and flew home on Rite Aid's corporate jet. The charges relate to a nine-year conspiracy to defraud Rite Aid by lying to the company about the sale of surplus inventory to a company owned by Findling when it was sold to third parties for greater amounts. Findling would then kick back a portion of his profits to Foster. Foster's lawyer told Justice Jones that, even though they conned the company, the efforts of Foster and Findling still earned Rite Aid over $100 million "instead of having warehouses filled with unwanted merchandise." Assistant U.S. Attorney Kim Daniel focused on the abuse of trust by Foster and persistent lies to the feds. "The con didn't affect some faceless corporation, Daniel said, "but harmed Rite Aid's 89,000 employees and its stockholders." Findling's attorney, Kevin Buchan, characterized his client as "a good man who made a bad decision." "He succumbed to the pressure. That's why he did what he did and that's why he's here," Buchan said during sentencing. Findling admitted he established a bank account under the name "Rite Aid Salvage Liquidation" and used it to collect the payments from the real buyers of the surplus Rite Aid inventory. After the payments were received, Findling would Page send lesser amounts dictated by Foster to Rite Aid for the goods, thus inducing Rite Aid to believe the inventory had been purchased by J. Finn Industries, not the real buyers. The government alleged Findling received at least $127.7 million from the real buyers of the surplus inventory but, with Foster's help, only provided $98.6 million of that amount to Rite Aid, leaving Findling approximately $29.1 million in profits from the scheme. The government also alleged that Findling kicked back approximately $5.7 million of the $29.1 million to Foster. Assume you are the director of internal auditing at Rite Aid and discover the surplus inventory scheme. You know that Rite Aid has a comprehensive corporate governance system that complies with the requirements of Sarbanes-Oxley, and the company has a strong ethics foundation. Moreover, the internal controls are consistent with the COSO framework. Explain the steps you would take to determine whether you would blow the whistle on the scheme applying the requirements of AICPA Interpretation 102-4 that are depicted in Exhibit 3.11. In that regard, answer the following questions. Whistleblowers who meet the criteria are eligible to receive an award based on what was collected as a result of the monetary sanctions. This can vary from ___________. A. 1 to 10 percent B. 10 to 30 percent C. 15 to 35 percent D. 1 to 50 percent, depending on the magnitude of the fraud

B. 10 to 30 percent

15. Required Information Refer to Question 13. Halliburton provided a flow chart on revenue recognition known as the ______________. A. Channel Stuffing Tree B. Bill-and-Hold Decision Tree C. Mark-to-Market Tree D. Revenue Allocation Tree

B. Bill-and-Hold Decision Tree

20. In the Loyalty to the Boss case, what is the primary ethical issue? A. Recording sales that lack economic substance B. Capitalizing expenses as inventory C. Bill and hold revenue recognition D. Releasing cookie jar reserves to smooth income

B. Capitalizing expenses as inventory

11. Required Information Refer to Question 10. Olympus attempted to cover up the losses by writing investments off as ___________. A. Market-to-market trading securities B. Goodwill impairments C. Discontinued operations D. Deferred taxes due to countries outside Japan

B. Goodwill impairments

9. Natalie got the call she had been waiting for over six long months. Her complaint to the human resources department of Franklin Industries had been dismissed. It was HR's conclusion that she was not retaliated against for reporting an alleged embezzlement by the Accounting Department manager. In fact, HR ruled there was no embezzlement at all. Natalie had been demoted from assistant manager of the department to staff supervisor seven months ago after informing Stuart Masters, the controller, earlier in 2018 about the embezzlement. Her blood started to boil as she thought about all the pain and agony these past six months without any level of satisfaction for her troubles. Natalie Garson is a CPA who works for Franklin Industries, a publicly-owned company and manufacturer of trusses and other structural components for home builders throughout the U.S. Six months ago she filed a complaint with HR after discussing a sensitive matter with her best friend and co-worker, Roger Harris. Natalie trusted Harris, who had six years' experience at Franklin. The essence of the discussion was that Natalie was informed by the accounting staff of what appeared to be unusual transactions between Denny King, the department manager, and an outside company no one had ever heard of before. The staff had uncovered over $5 million payments, authorized by King, to Vic Construction. No one could find any documentation about Vic so the staff dug deeper and discovered that the owner of Vic Construction was Victoria King. Further examination determined that Victoria King and Denny King were sisters. Once Natalie was convinced there was more to it than meets the eye, she informed the internal auditors who investigated and found that Vic Construction made a $5 million electronic transfer to a separate business owned by Denny King. One thing lead to another and it was determined by the internal auditors that King had funneled $5 million to Vic construction, which, at a later date, transferred the money back to King. It was a $5 million embezzlement from Franklin Industries. Natalie met with Roger Harris that night and told him about the HR decision that went against her. She was concerned whether the internal auditors would act now in light of that decision. She knew the culture at Franklin was "don't rock the boat." That didn't matter to her. She was always true to her values and not afraid to act when a wrongdoing had occurred. She felt particularly motivated in this case - it was personal. She felt the need to be vindicated. She hoped Roger would be supportive. As it turned out, Roger cautioned Natalie about taking the matter any further. He had worked for Franklin a lot longer than Natalie and knew the board of directors consisted mostly of insider directors. The CEO of Franklin was also the chair of the board. It was well known in the company that whatever the CEO wanted to do, the board rubber-stamped it. Natalie left the meeting with Roger wondering whether she was on her own. She knew she had to act but didn't know the best way to go about it. Even though Roger cautioned against going to the CEO or board, Natalie didn't dismiss that option. Assume you are in Natalie's position. Answer the following questions. Natalie's next step should probably be to _____________. A. Continue employment as though nothing has happened B. Report to the external auditors C. Report to the SEC D. Seek legal advice

B. Report to the external auditors

19. Which of the following is NOT a component of an effective internal control environment in COSO Internal Control - Integrated Framework? A. The control environment B. Risk abatement C. Control activities D. Information and communication

B. Risk abatement

14. Required Information Refer to Question 13. Menendez was excluded from a meeting on accounting for a potential joint venture arrangement. This is a violation of which of the following? A. Dodd-Frank B. Sarbanes-Oxley C. The RICO Racketeer Influenced and Corrupt Organizations Act D. The CPA Code of Professional Conduct

B. Sarbanes-Oxley

13. Required information Skip to question [The following information applies to the questions displayed below.] In 2005, Tony Menendez, a former Ernst & Young LLP auditor and director of technical accounting and research training for Halliburton, blew the whistle on Halliburton's accounting practices. The fight cost him nine years of his life. Just a few months later in 2005, Menendez received an email from Mark McCollum, Halliburton's chief accounting officer, and a top-ranking executive at Halliburton, that also went to much of the accounting department. "The SEC has opened an inquiry into the allegations of Mr. Menendez," it read. Everyone was to retain their documents until further notice. What happened next changed the life of Menendez and brought into question how such a large and influential company could have such a failed corporate governance system. Further, the role of the auditors, KPMG, with respect to its handling of accounting and auditing matters, seemed off, and independence was an issue. Exhibit 1 summarizes some of the relevant accounting and auditing issues in the case. Nature of Halliburton's Revenue Transactions in Question During the months following the "leaked" email, Menendez waited and watched to see if Halliburton would act on his claims that the company was cooking the books. The issue was revenue recognition as discussed below. Halliburton enters into long-term contracts with energy giants like Royal Dutch Shell or BP to find and exploit huge oil and gas fields. It sells services - the expertise of its geologists and engineers. Halliburton also builds massive and expensive machinery that its professionals use to provide those services. Then, the company charges its customers for that equipment, which has particularly high profit margins. The company's accountants had been allowing the company to count the full value of the equipment right away as revenue, sometimes even before it had assembled the equipment. But the customers could walk away in the middle of the contracts. Menendez realized that if the equipment were damaged, Halliburton, not the customer, was on the hook. Menendez accused Halliburton of using so-called bill-and-hold techniques that distort the timing of billions of dollars in revenue and allowed Halliburton to book product sales before they occurred. Menendez explained Halliburton's accounting this way. "For example, the company recognizes revenue when the goods are parked in company warehouses, rather than delivered to the customer. Typically, these goods are not even assembled and ready for the customer. Furthermore, it is unknown as to when the goods will be ultimately assembled, tested, delivered to the customer and, finally, used by the company to perform the required oilfield services for the customer.'" Based on Menendez's claims, Halliburton's accounting procedures violated generally accepted accounting principles. For companies to recognize revenue before delivery, "the risks of ownership must have passed to the buyer,'" the SEC's staff wrote in a 2003 accounting bulletin. There also "must be a fixed schedule for delivery of the goods," and the product "must be complete and ready for shipment," among other things. Shortly after joining Halliburton in March 2005, Menendez said he discovered a "terribly flawed'' flow chart on the company's in-house Web site, called the Bill and Hold Decision Tree. The flow chart, a copy of which Menendez included in his complaint, walks through what to do in a situation where a "customer has been billed for completed inventory which is being stored at a Halliburton facility." First, it asks: Based on the contract terms, "has title passed to customer?'' If the answer is no -- and here's where it gets strange -- the employee is asked: "Does the transaction meet all of the 'bill and hold' criteria for revenue recognition?'' If the answer to that question is yes, the decision tree says to do this: "Recognize revenue." The decision tree didn't specify what the other criteria were. In other words, Halliburton told employees to recognize revenue even though the company still owned the product. Ironically, the accelerated revenue for financial statement purposes led to higher income taxes paid to the IRS. "The policy in the chart is clearly at odds with generally accepted accounting principles," said Charles Mulford, a Georgia Institute of Technology accounting professor, who reviewed the court records. "It's very clear cut. It's not gray." According to the accounting rules, it is possible to use bill-and-hold and comply with the rules. But it's hard. The customer, not the seller, must request such treatment. The customer also must have a compelling reason for doing so. Customers rarely do. Top Halliburton accounting executives had agreed with Menendez's analysis, including McCollum, the company's chief accounting officer. But according to Menendez, they dragged their feet on implementing a change that was certain to slow revenue growth. In an email response to detailed questions, a Halliburton spokeswoman wrote, "The accounting allegations were made by Mr. Menendez almost nine years ago and were promptly reviewed by the company and the Securities and Exchange Commission. The company's accounting was appropriate and the SEC closed its investigation." This seems curious when we examine the SEC's own rules for recognition. Hocus Pocus Accounting- Bill-and-Hold Schemes The proper accounting for Halliburton's bill-and-hold transactions was not lost on its external auditors, KPMG. In fact, in early 2005, KPMG published an article entitled: Bill and Hold Transactions in the Oilfield Services Industry, which made it clear that oilfield services companies had to comply with all four of SEC Staff Accounting Bulletin (SAB 101) to recognize revenue early. These include: Persuasive evidence of an arrangement exists Delivery has occurred or services have been rendered The seller's price to the buyer is fixed or determinable, and Collectibility is reasonably assured. KPMG went on to recognize that it would be rare for an oilfield service company to actually meet the necessary criteria. The impact to Halliburton was highlighted by KPMG's recognition that bill and hold transactions for oilfield service companies were "common" and "involve very large and complex products and equipment that carry significant amounts of economic value." KPMG went on to state that "perhaps no area of revenue recognition has received as much scrutiny as bill-and-hold." Menendez's Complaint to the DOL Menendez's allegations are part of a 54-page complaint he filed against Halliburton with a Department of Labor (DOL) administrative-law judge in Covington, Louisiana, who released the records to Menendez in response to a Freedom of Information Act request. Menendez claimed Halliburton retaliated against him in violation of the Sarbanes-Oxley Act's whistleblower provisions after he reported his concerns to the SEC and the company's audit committee. According to a company spokesperson, Halliburton's audit committee "directed an independent investigation" and "concluded that the allegations were without merit." She declined to comment on bill-and-hold issues, and Halliburton's court filings in the case don't provide any details about its accounting practices. Menendez filed his complaint shortly after a DOL investigator in Dallas rejected his retaliation claim. His initial claim was rejected by the court and subsequently appealed after many years, and the decision was ultimately overturned but not until after he and his family had endured a nine-year ordeal during which time he was an outcast at Halliburton. The Final Verdict is in: Accountant takes on Halliburton and Wins! The appeals process went on for three years. In September 2011, the administrative law appeals panel ruled. It overturned the original trial judge. After five years, Menendez had his first victory. But it wasn't over. Halliburton appealed to the Fifth Circuit Court of Appeals. There were more legal filings, more hours of work, more money spent. Finally, in November of 2014, almost nine years after Menendez received "The Email," he prevailed. The appeals panel ruled that he indeed had been retaliated against for blowing the whistle, just as he had argued all along. Because he had wanted only to be proven right, he'd asked for a token sum. The administrative law panel, noting the importance of punishing retaliations against whistleblowers, pushed for an increase and Menendez was awarded $30,000. To say that the outcome stunned experts is something of an understatement. "Accountant beats Halliburton!'' said Thomas, the attorney and expert on whistleblower law. "The government tries to beat Halliburton and loses." Post-Decision Interview about Whistleblowing In an interview with a reporter, Menendez offered that Halliburton had a whistleblower policy prior to this incident as required under Sarbanes-Oxley. It was required to be confidential and Halliburton's policy promised confidentiality while at the same time discouraging anonymous complaints on the basis that if you didn't provide your identity they may not be able to properly investigate your concern. Menendez added that it was absolutely central to my case and I relied on this policy but it was Halliburton that blatantly ignored its own policy and betrayed my trust. He was asked how the whistleblowing policy of the SEC might be improved. He said that all too often it is almost impossible for a whistleblower to prevail and that there needs to be more protections and a more balanced playing field. "It shouldn't take nine years and hundreds of thousands of dollars to even have a remote chance of prevailing." The Human Aspect of the Case Menendez felt he had to leave Halliburton because of the retaliation and how everyone treated him differently after the email. During the appeals process, as Menendez and his wife waited for vindication and money got tight, Menendez finally caught a break. Through the accounting experts he had met during his legal odyssey, he heard that General Motors was looking for a senior executive. He agonized over whether to tell interviewers about his showdown with Halliburton. Ultimately, he figured they would probably find out anyway. When he flew up to Detroit and met with Nick Cypress, GM's chief accounting officer and comptroller, he came clean. Cypress had heard good things about Menendez from Doug Carmichael, the accounting expert who had been Menendez's expert witness at trial. After telling him, he asked Cypress, "Does this bother you? "Hell no!" the GM executive replied. This was not the typical reaction top corporate officers have to whistleblowers. The interviewer asked Cypress about it: "I was moved by it," he explained. "It takes a lot of courage to stand tall like that and I needed that in the work we were doing. I needed people with high integrity who would work hard who I could trust" to bring problems directly to senior management. Today, Menendez still works at GM. His job is overseeing how GM recognizes about $100 billion worth of revenue, the very issue underlying his struggle with Halliburton. In the meantime, Halliburton has thrived. The SEC never levied any penalty for the accounting issue raised by Menendez. In 2014, the company generated $3.5 billion in profit on $33 billion in revenue. It's not possible to tell if the company maintains the same revenue recognition policy from its public filings, says Mulford. But since the SEC passed on an enforcement action on the issue, the company likely feels it is in accordance with accounting rules. (Mulford believes that Menendez was right back then and that the SEC should have looked harder at the issue initially.) Many of the Halliburton and KPMG officials involved in the accounting issue or the retaliation have continued to prosper in the corporate ranks. One is now Halliburton's chief accounting officer. McCollum is now the company's executive vice president overseeing the integration of a major merger. The KPMG executive who disagreed with Menendez is now a partner at the accounting firm. Menendez did not tell his friends and family of his legal victory. He's more cautious than he used to be. "I changed a lot. It was almost 10 years where everything was in question. Wondering what would people think of you." He and his wife still worry that disaster could arrive in the next email. "It can really weaken a soul and tear apart a family or a marriage, if you aren't careful. Because of the enormous powers of a company," said his wife. If people asked her advice, "I'd probably say don't do it." Recently, Menendez finally explained the story to his son, Cameron, who is now 13 and old enough to understand. Cameron's response: "You should have asked for more money, Dad," the teenager said. "We could use it." Years ago, Menendez and his wife bought a bottle of champagne to celebrate his eventual victory. They still haven't opened it. EXHIBIT 1 Issues Related to the Sarbanes-Oxley Act, SEC, and KPMG Menendez contacted the audit committee because he believed it was in the best interest of the employees and shareholders if he made himself available to the committee in their efforts to investigate the questionable accounting and auditing practices and properly respond to the SEC. It was discovered that Halliburton did not have in place, as required by Section 301 of SOX, a process for "(1) the receipt and treatment of complaints received by the issuer regarding accounting, internal controls, or auditing matters; and (2) the confidential, anonymous submission of employees of the issuer of concerns regarding questionable accounting or auditing matters." After waiting for the company to take action to no avail, Menendez felt there was no alternative to blowing the whistle and on November 4, 2005, he contacted the SEC and PCAOB stating in part: "As a C.P.A. and the Director of Technical Accounting Research and Training for Halliburton, I feel it is my duty and obligation to report information that I believe constitutes both a potential failure by a registered public accounting firm, KPMG, to properly perform an audit and the potential filing of materially misleading financial information with the SEC by Halliburton." Two weeks later, at the agencies' request, he met with SEC enforcement staff at their Fort Worth office. On November 30, 2005, he• approached members of top management of Halliburton. On February 4, 2006, Menendez provided what he believed would be a confidential report to Halliburton's audit committee, giving the company yet another opportunity for self-examination. However, on the morning of February 6, 2006, Menendez's identity was disclosed to McCollum and less than an hour after finding out that Menendez had reported the questionable accounting and auditing practices to the SEC, McCollum distributed information about Menendez's investigation and identity. The disclosure was followed by a series of retaliatory actions. Halliburton management stripped Menendez of teaching and researching responsibilities, ordered subordinates to monitor and report on his activity, excluded him from meetings and accounting decisions, and ordered financial and accounting personnel to pre-clear any conversations about accounting issues before discussing them with Menendez. In May 2005, Menendez filed a civil whistleblower complaint under SOX. In July 2006, Halliburton told the Department of Labor handing the case that KPMG had insisted that Menendez be excluded from a meeting concerning accounting for a potential joint venture arrangement called "RTA." Halliburton indicated it acceded to KPMG's demand and excluded Menendez from the meeting. SOX prohibits an employer from discriminating against an employee, contractor, or agent and prohibiting such party from engaging in activity protected under the Act, and the SEC stated that the assertion by the company that KPMG's presence was mandatory was misleading. In fact, the SEC opined that KPMG's presence was not even advisable since KPMG was supposed to be an independent auditor in both appearance and in fact. The RTA meeting was scheduled to determine whether or not Halliburton would be required to consolidate the proposed joint venture. Senior management explicitly stated that the division management would not receive approval to proceed unless Halliburton could both avoid consolidation and maintain control over the joint venture activities. Earlier in the development of the accounting position regarding this joint venture, KPMG told management that they would allow the company to avoid consolidation and FIN 46R's Anti-Abuse criteria on the basis that the determination required professional judgment, and indicated that they would be willing to support a conclusion that Halliburton was not significantly involved in the joint venture activities, when clearly the facts and circumstances did not support such a conclusion. Menendez had vehemently objected to KPMG and management's proposed conclusion on the basis that such a position was absurd. According to the SEC, given KPMG's previous guidance to the company regarding RTA, and their willingness to accommodate unsupportable conclusions, continued input by KPMG on RTA was inappropriate and, once again, put KPMG in the position of auditing its own recommendations and advice. In the end, the concerted failures of management and the external auditor underscored the lack of independence between company and KPMG which is a root cause of the accounting violations Menendez fought to correct and, at last, had to report. Halliburton was violating revenue recognition rules by recognizing revenue _____________. A. Before assembling the product B. Before delivering the product C. Before the risks of ownership had passed to the buyer D. All of these are correct.

D. All of these are correct.

1. [The following information applies to the questions displayed below.] Bowen H. McCoy Reprinted with permission from "The Parable of the Sadhu," by Bowen H. McCoy, Harvard Business Review. Copyright © Harvard Business Publishing. Last year, as the first participant in the new six-month sabbatical program that Morgan Stanley has adopted, I enjoyed a rare opportunity to collect my thoughts as well as do some traveling. I spent the first three months in Nepal, walking 600 miles through 200 villages in the Himalayas and climbing some 120,000 vertical feet. My sole Western companion on the trip was an anthropologist who shed light on the cultural patterns of the villages that we passed through. During the Nepal hike, something occurred that has had a powerful impact on my thinking about corporate ethics. Although some might argue that the experience has no relevance to business, it was a situation in which a basic ethical dilemma suddenly intruded into the lives of a group of individuals. How the group responded holds a lesson for all organizations, no matter how defined. The Sadhu The Nepal experience was more rugged than I had anticipated. Most commercial treks last two or three weeks and cover a quarter of the distance we traveled. My friend Stephen, the anthropologist, and I were halfway through the 60-day Himalayan part of the trip when we reached the high point, an 18,000-foot pass over a crest that we'd have to traverse to reach the village of Muklinath, an ancient holy place for pilgrims. Six years earlier, I had suffered pulmonary edema, an acute form of altitude sickness, at 16,500 feet in the vicinity of Everest base camp—so we were understandably concerned about what would happen at 18,000 feet. Moreover, the Himalayas were having their wettest spring in 20 years; hip-deep powder and ice had already driven us off one ridge. If we failed to cross the pass, I feared that the last half of our once-in-a-lifetime trip would be ruined. The night before we would try the pass, we camped in a hut at 14,500 feet. In the photos taken at that camp, my face appears wan. The last village we'd passed through was a sturdy two-day walk below us, and I was tired. During the late afternoon, four backpackers from New Zealand joined us, and we spent most of the night awake, anticipating the climb. Below, we could see the fires of two other parties, which turned out to be two Swiss couples and a Japanese hiking club. To get over the steep part of the climb before the sun melted the steps cut in the ice, we departed at 3.30 a.m. The New Zealanders left first, followed by Stephen and myself, our porters and Sherpas, and then the Swiss. The Japanese lingered in their camp. The sky was clear, and we were confident that no spring storm would erupt that day to close the pass. At 15,500 feet, it looked to me as if Stephen was shuffling and staggering a bit, which are symptoms of altitude sickness. (The initial stage of altitude sickness brings a headache and nausea. As the condition worsens, a climber may encounter difficult breathing, disorientation, aphasia, and paralysis.) I felt strong—my adrenaline was flowing—but I was very concerned about my ultimate ability to get across. A couple of our porters were also suffering from the height, and Pasang, our Sherpa sirdar (leader), was worried. Just after daybreak, while we rested at 15,500 feet, one of the New Zealanders, who had gone ahead, came staggering down toward us with a body slung across his shoulders. He dumped the almost naked, barefoot body of an Indian holy man—a sadhu—-at my feet. He had found the pilgrim lying on the ice, shivering and suffering from hypothermia. I cradled the sadhu's head and laid him out on the rocks. The New Zealander was angry. He wanted to get across the pass before the bright sun melted the snow. He said, "Look, I've done what I can. You have porters and Sherpa guides. You care for him. We're going on!" He turned and went back up the mountain to join his friends. I took a carotid pulse and found that the sadhu was still alive. We figured he had probably visited the holy shrines at Muklinath and was on his way home. It was fruitless to question why he had chosen this desperately high route instead of the safe, heavily traveled caravan route through the Kali Gandaki gorge. Or why he was shoeless and almost naked, or how long he had been lying in the pass. The answers weren't going to solve our problem. Stephen and the four Swiss began stripping off their outer clothing and opening their packs. The sadhu was soon clothed from head to foot. He was not able to walk, but he was very much alive. I looked down the mountain and spotted the Japanese climbers, marching up with a horse. Without a great deal of thought, I told Stephen and Pasang that I was concerned about withstanding the heights to come and wanted to get over the pass. I took off after several of our porters who had gone ahead. On the steep part of the ascent where, if the ice steps had given way, I would have slid down about 3,000 feet, I felt vertigo. I stopped for a breather, allowing the Swiss to catch up with me. I inquired about the sadhu and Stephen. They said that the sadhu was fine and that Stephen was just behind them. I set off again for the summit. Stephen arrived at the summit an hour after I did. Still exhilarated by victory, I ran down the slope to congratulate him. He was suffering from altitude sickness—walking 15 steps, then stopping, walking 15 steps, then stopping. Pasang accompanied him all the way up. When I reached them, Stephen glared at me and said, "How do you feel about contributing to the death of a fellow man?" I did not completely comprehend what he meant. "Is the sadhu dead?" I inquired. "No," replied Stephen, "but he surely will be!" After I had gone, followed not long after by the Swiss, Stephen had remained with the sadhu. When the Japanese had arrived, Stephen had asked to use their horse to transport the sadhu down to the hut. They had refused. He had then asked Pasang to have a group of our porters carry the sadhu. Pasang had resisted the idea, saying that the porters would have to exert all their energy to get themselves over the pass. He believed they could not carry a man down 1,000 feet to the hut, reclimb the slope, and get across safely before the snow melted. Pasang had pressed Stephen not to delay any longer. The Sherpas had carried the sadhu down to a rock in the sun at about 15,000 feet and pointed out the hut another 500 feet below. The Japanese had given him food and drink. When they had last seen him, he was listlessly throwing rocks at the Japanese party's dog, which had frightened him. We do not know if the sadhu lived or died. For many of the following days and evenings, Stephen and I discussed and debated our behavior toward the sadhu. Stephen is a committed Quaker with deep moral vision. He said, "I feel that what happened with the sadhu is a good example of the breakdown between the individual ethic and the corporate ethic. No one person was willing to assume ultimate responsibility for the sadhu. Each was willing to do his bit just so long as it was not too inconvenient. When it got to be a bother, everyone just passed the buck to someone else and took off. Jesus was relevant to a more individualistic stage of society, but how do we interpret his teaching today in a world filled with large, impersonal organizations and groups?" I defended the larger group, saying, "Look, we all cared. We all gave aid and comfort. Everyone did his bit. The New Zealander carried him down below the snow line. I took his pulse and suggested we treat him for hypothermia. You and the Swiss gave him clothing and got him warmed up. The Japanese gave him food and water. The Sherpas carried him down to the sun and pointed out the easy trail toward the hut. He was well enough to throw rocks at a dog. What more could we do?" "You have just described the typical affluent Westerner's response to a problem. Throwing money—in this case, food and sweaters—at it, but not solving the fundamentals!" Stephen retorted. "What would satisfy you?" I said. "Here we are, a group of New Zealanders, Swiss, Americans, and Japanese who have never met before and who are at the apex of one of the most powerful experiences of our lives. Some years the pass is so bad no one gets over it. What right does an almost naked pilgrim who chooses the wrong trail have to disrupt our lives? Even the Sherpas had no interest in risking the trip to help him beyond a certain point." Stephen calmly rebutted, "I wonder what the Sherpas would have done if the sadhu had been a well-dressed Nepali, or what the Japanese would have done if the sadhu had been a well-dressed Asian, or what you would have done, Buzz, if the sadhu had been a well-dressed Western woman?" "Where, in your opinion," I asked, "is the limit of our responsibility in a situation like this? We had our own well-being to worry about. Our Sherpa guides were unwilling to jeopardize us or the porters for the sadhu. No one else on the mountain was willing to commit himself beyond certain self-imposed limits." Stephen said, "As individual Christians or people with a Western ethical tradition, we can fulfill our obligations in such a situation only if one, the sadhu dies in our care; two, the sadhu demonstrates to us that he can undertake the two-day walk down to the village; or three, we carry the sadhu for two days down to the village and persuade someone there to care for him." "Leaving the sadhu in the sun with food and clothing—where he demonstrated hand-eye coordination by throwing a rock at a dog—comes close to fulfilling items one and two," I answered. "And it wouldn't have made sense to take him to the village where the people appeared to be far less caring than the Sherpas, so the third condition is impractical. Are you really saying that, no matter what the implications, we should, at the drop of a hat, have changed our entire plan?" The Individual versus the Group Ethic Despite my arguments, I felt and continue to feel guilt about the sadhu. I had literally walked through a classic moral dilemma without fully thinking through the consequences. My excuses for my actions include a high adrenaline flow, a superordinate goal, and a once-in-a-lifetime opportunity—common factors in corporate situations, especially stressful ones. Real moral dilemmas are ambiguous, and many of us hike right through them, unaware that they exist. When, usually after the fact, someone makes an issue of one, we tend to resent his or her bringing it up. Often, when the full import of what we have done (or not done) hits us, we dig into a defensive position from which it is very difficult to emerge. In rare circumstances, we may contemplate what we have done from inside a prison. Had we mountaineers been free of stress caused by the effort and the high altitude, we might have treated the sadhu differently. Yet isn't stress the real test of personal and corporate values? The instant decisions that executives make under pressure reveal the most about personal and corporate character. Among the many questions that occur to me when I ponder my experience with the sadhu are: What are the practical limits of moral imagination and vision? Is there a collective or institutional ethic that differs from the ethics of the individual? At what level of effort or commitment can one discharge one's ethical responsibilities? Not every ethical dilemma has a right solution. Reasonable people often disagree; otherwise there would be no dilemma. In a business context, however, it is essential that managers agree on a process for dealing with dilemmas. Our experience with the sadhu offers an interesting parallel to business situations. An immediate response was mandatory. Failure to act was a decision in itself. Up on the mountain, we could not resign and submit our résumés to a headhunter. In contrast to philosophy, business involves action and implementation—getting things done. Managers must come up with answers based on what they see and what they allow to influence their decision-making processes. On the mountain, none of us but Stephen realized the true dimensions of the situation we were facing. One of our problems was that as a group, we had no process for developing a consensus. We had no sense of purpose or plan. The difficulties of dealing with the sadhu were so complex that no one person could handle them. Because the group did not have a set of preconditions that could guide its action to an acceptable resolution, we reacted instinctively as individuals. The cross-cultural nature of the group added a further layer of complexity. We had no leader with whom we could all identify and in whose purpose we believed. Only Stephen was willing to take charge, but he could not gain adequate support from the group to care for the sadhu. Some organizations do have values that transcend the personal values of their managers. Such values, which go beyond profitability, are usually revealed when the organization is under stress. People throughout the organization generally accept its values, which, because they are not presented as a rigid list of commandments, may be somewhat ambiguous. The stories people tell, rather than printed materials, transmit the organization's conceptions of what is proper behavior. For 20 years, I have been exposed at senior levels to a variety of corporations and organizations. It is amazing how quickly an outsider can sense the tone and style of an organization and, with that, the degree of tolerated openness and freedom to challenge management. Organizations that do not have a heritage of mutually accepted, shared values tend to become unhinged during stress, with each individual bailing out for himself or herself. In the great takeover battles we have witnessed during past years, companies that had strong cultures drew the wagons around them and fought it out, while other companies saw executives—supported by golden parachutes—bail out of the struggles. Because corporations and their members are interdependent, for the corporation to be strong, the members need to share a preconceived notion of correct behavior, a "business ethic," and think of it as a positive force, not a constraint. As an investment banker, I am continually warned by well-meaning lawyers, clients, and associates to be wary of conflicts of interest. Yet if I were to run away from every difficult situation, I wouldn't be an effective investment banker. I have to feel my way through conflicts. An effective manager can't run from risk either; he or she has to confront risk. To feel "safe" in doing that, managers need the guidelines of an agreed-upon process and set of values within the organization. After my three months in Nepal, I spent three months as an executive-in-residence at both the Stanford Business School and the University of California at Berkeley's Center for Ethics and Social Policy of the Graduate Theological Union. Those six months away from my job gave me time to assimilate 20 years of business experience. My thoughts turned often to the meaning of the leadership role in any large organization. Students at the seminary thought of themselves as antibusiness. But when I questioned them, they agreed that they distrusted all large organizations, including the church. They perceived all large organizations as impersonal and opposed to individual values and needs. Yet we all know of organizations in which people's values and beliefs are respected and their expressions encouraged. What makes the difference? Can we identify the difference and, as a result, manage more effectively? The word ethics turns off many and confuses more. Yet the notions of shared values and an agreed-upon process for dealing with adversity and change—what many people mean when they talk about corporate culture—seem to be at the heart of the ethical issue. People who are in touch with their own core beliefs and the beliefs of others and who are sustained by them can be more comfortable living on the cutting edge. At times, taking a tough line or a decisive stand in a muddle of ambiguity is the only ethical thing to do. If a manager is indecisive about a problem and spends time trying to figure out the "good" thing to do, the enterprise may be lost. Business ethics, then, has to do with the authenticity and integrity of the enterprise. To be ethical is to follow the business as well as the cultural goals of the corporation, its owners, its employees, and its customers. Those who cannot serve the corporate vision are not authentic businesspeople and, therefore, are not ethical in the business sense. At this stage of my own business experience, I have a strong interest in organizational behavior. Sociologists are keenly studying what they call corporate stories, legends, and heroes as a way organizations have of transmitting value systems. Corporations such as Arco have even hired consultants to perform an audit of their corporate culture. In a company, a leader is a person who understands, interprets, and manages the corporate value system. Effective managers, therefore, are action-oriented people who resolve conflict, are tolerant of ambiguity, stress, and change, and have a strong sense of purpose for themselves and their organizations. If all this is true, I wonder about the role of the professional manager who moves from company to company. How can he or she quickly absorb the values and culture of different organizations? Or is there, indeed, an art of management that is totally transportable? Assuming that such fungible managers do exist, is it proper for them to manipulate the values of others? What would have happened had Stephen and I carried the sadhu for two days back to the village and become involved with the villagers in his care? In four trips to Nepal, my most interesting experience occurred in 1975, when I lived in a Sherpa home in the Khumbu for five days while recovering from altitude sickness. The high point of Stephen's trip was an invitation to participate in a family funeral ceremony in Manang. Neither experience had to do with climbing the high passes of the Himalayas. Why were we so reluctant to try the lower path, the ambiguous trail? Perhaps because we did not have a leader who could reveal the greater purpose of the trip to us. Why didn't Stephen, with his moral vision, opt to take the sadhu under his personal care? The answer is partly because Stephen was hard-stressed physically himself and partly because, without some support system that encompassed our involuntary and episodic community on the mountain, it was beyond his individual capacity to do so. I see the current interest in corporate culture and corporate value systems as a positive response to pessimism such as Stephen's about the decline of the role of the individual in large organizations. Individuals who operate from a thoughtful set of personal values provide the foundation for a corporate culture. A corporate tradition that encourages freedom of inquiry, supports personal values, and reinforces a focused sense of direction can fulfill the need to combine individuality with the prosperity and success of the group. Without such corporate support, the individual is lost. That is the lesson of the sadhu. In a complex corporate situation, the individual requires and deserves the support of the group. When people cannot find such support in their organizations, they don't know how to act. If such support is forthcoming, a person has a stake in the success of the group and can add much to the process of establishing and maintaining a corporate culture. Management's challenge is to be sensitive to individual needs, to shape them, and to direct and focus them for the benefit of the group as a whole. For each of us, the sadhu lives. Should we stop what we are doing and comfort him; or should we keep trudging up toward the high pass? Should I pause to help the derelict I pass on the street each night as I walk by the Yale Club en route to Grand Central Station? Am I his brother? What is the nature of our responsibility if we consider ourselves to be ethical persons? Perhaps it is to change the values of the group so that it can, with all its resources, take the other road. The Sadhu was handed off from one group to another due to what? A. The lack of an organizational ethical culture B. The lack of Koh and Boo's ethical climate C. The lack of a common corporate culture D. All of these choices are correct.

D. All of these choices are correct.

17. Which of the following was not a finding of the ACFE Report to the Nation on Occupational Fraud? A. Fraud is more likely to be detected by tips than any other way B. Frauds lasted a medium of 16 months before detection C. Asset misappropriation schemes was the most common type of occupational fraud D. External auditors discover about 15 percent of the frauds

D. External auditors discover about 15 percent of the frauds

2. [The following information applies to the questions displayed below.] Bowen H. McCoy Reprinted with permission from "The Parable of the Sadhu," by Bowen H. McCoy, Harvard Business Review. Copyright © Harvard Business Publishing. Last year, as the first participant in the new six-month sabbatical program that Morgan Stanley has adopted, I enjoyed a rare opportunity to collect my thoughts as well as do some traveling. I spent the first three months in Nepal, walking 600 miles through 200 villages in the Himalayas and climbing some 120,000 vertical feet. My sole Western companion on the trip was an anthropologist who shed light on the cultural patterns of the villages that we passed through. During the Nepal hike, something occurred that has had a powerful impact on my thinking about corporate ethics. Although some might argue that the experience has no relevance to business, it was a situation in which a basic ethical dilemma suddenly intruded into the lives of a group of individuals. How the group responded holds a lesson for all organizations, no matter how defined. The Sadhu The Nepal experience was more rugged than I had anticipated. Most commercial treks last two or three weeks and cover a quarter of the distance we traveled. My friend Stephen, the anthropologist, and I were halfway through the 60-day Himalayan part of the trip when we reached the high point, an 18,000-foot pass over a crest that we'd have to traverse to reach the village of Muklinath, an ancient holy place for pilgrims. Six years earlier, I had suffered pulmonary edema, an acute form of altitude sickness, at 16,500 feet in the vicinity of Everest base camp—so we were understandably concerned about what would happen at 18,000 feet. Moreover, the Himalayas were having their wettest spring in 20 years; hip-deep powder and ice had already driven us off one ridge. If we failed to cross the pass, I feared that the last half of our once-in-a-lifetime trip would be ruined. The night before we would try the pass, we camped in a hut at 14,500 feet. In the photos taken at that camp, my face appears wan. The last village we'd passed through was a sturdy two-day walk below us, and I was tired. During the late afternoon, four backpackers from New Zealand joined us, and we spent most of the night awake, anticipating the climb. Below, we could see the fires of two other parties, which turned out to be two Swiss couples and a Japanese hiking club. To get over the steep part of the climb before the sun melted the steps cut in the ice, we departed at 3.30 a.m. The New Zealanders left first, followed by Stephen and myself, our porters and Sherpas, and then the Swiss. The Japanese lingered in their camp. The sky was clear, and we were confident that no spring storm would erupt that day to close the pass. At 15,500 feet, it looked to me as if Stephen was shuffling and staggering a bit, which are symptoms of altitude sickness. (The initial stage of altitude sickness brings a headache and nausea. As the condition worsens, a climber may encounter difficult breathing, disorientation, aphasia, and paralysis.) I felt strong—my adrenaline was flowing—but I was very concerned about my ultimate ability to get across. A couple of our porters were also suffering from the height, and Pasang, our Sherpa sirdar (leader), was worried. Just after daybreak, while we rested at 15,500 feet, one of the New Zealanders, who had gone ahead, came staggering down toward us with a body slung across his shoulders. He dumped the almost naked, barefoot body of an Indian holy man—a sadhu—-at my feet. He had found the pilgrim lying on the ice, shivering and suffering from hypothermia. I cradled the sadhu's head and laid him out on the rocks. The New Zealander was angry. He wanted to get across the pass before the bright sun melted the snow. He said, "Look, I've done what I can. You have porters and Sherpa guides. You care for him. We're going on!" He turned and went back up the mountain to join his friends. I took a carotid pulse and found that the sadhu was still alive. We figured he had probably visited the holy shrines at Muklinath and was on his way home. It was fruitless to question why he had chosen this desperately high route instead of the safe, heavily traveled caravan route through the Kali Gandaki gorge. Or why he was shoeless and almost naked, or how long he had been lying in the pass. The answers weren't going to solve our problem. Stephen and the four Swiss began stripping off their outer clothing and opening their packs. The sadhu was soon clothed from head to foot. He was not able to walk, but he was very much alive. I looked down the mountain and spotted the Japanese climbers, marching up with a horse. Without a great deal of thought, I told Stephen and Pasang that I was concerned about withstanding the heights to come and wanted to get over the pass. I took off after several of our porters who had gone ahead. On the steep part of the ascent where, if the ice steps had given way, I would have slid down about 3,000 feet, I felt vertigo. I stopped for a breather, allowing the Swiss to catch up with me. I inquired about the sadhu and Stephen. They said that the sadhu was fine and that Stephen was just behind them. I set off again for the summit. Stephen arrived at the summit an hour after I did. Still exhilarated by victory, I ran down the slope to congratulate him. He was suffering from altitude sickness—walking 15 steps, then stopping, walking 15 steps, then stopping. Pasang accompanied him all the way up. When I reached them, Stephen glared at me and said, "How do you feel about contributing to the death of a fellow man?" I did not completely comprehend what he meant. "Is the sadhu dead?" I inquired. "No," replied Stephen, "but he surely will be!" After I had gone, followed not long after by the Swiss, Stephen had remained with the sadhu. When the Japanese had arrived, Stephen had asked to use their horse to transport the sadhu down to the hut. They had refused. He had then asked Pasang to have a group of our porters carry the sadhu. Pasang had resisted the idea, saying that the porters would have to exert all their energy to get themselves over the pass. He believed they could not carry a man down 1,000 feet to the hut, reclimb the slope, and get across safely before the snow melted. Pasang had pressed Stephen not to delay any longer. The Sherpas had carried the sadhu down to a rock in the sun at about 15,000 feet and pointed out the hut another 500 feet below. The Japanese had given him food and drink. When they had last seen him, he was listlessly throwing rocks at the Japanese party's dog, which had frightened him. We do not know if the sadhu lived or died. For many of the following days and evenings, Stephen and I discussed and debated our behavior toward the sadhu. Stephen is a committed Quaker with deep moral vision. He said, "I feel that what happened with the sadhu is a good example of the breakdown between the individual ethic and the corporate ethic. No one person was willing to assume ultimate responsibility for the sadhu. Each was willing to do his bit just so long as it was not too inconvenient. When it got to be a bother, everyone just passed the buck to someone else and took off. Jesus was relevant to a more individualistic stage of society, but how do we interpret his teaching today in a world filled with large, impersonal organizations and groups?" I defended the larger group, saying, "Look, we all cared. We all gave aid and comfort. Everyone did his bit. The New Zealander carried him down below the snow line. I took his pulse and suggested we treat him for hypothermia. You and the Swiss gave him clothing and got him warmed up. The Japanese gave him food and water. The Sherpas carried him down to the sun and pointed out the easy trail toward the hut. He was well enough to throw rocks at a dog. What more could we do?" "You have just described the typical affluent Westerner's response to a problem. Throwing money—in this case, food and sweaters—at it, but not solving the fundamentals!" Stephen retorted. "What would satisfy you?" I said. "Here we are, a group of New Zealanders, Swiss, Americans, and Japanese who have never met before and who are at the apex of one of the most powerful experiences of our lives. Some years the pass is so bad no one gets over it. What right does an almost naked pilgrim who chooses the wrong trail have to disrupt our lives? Even the Sherpas had no interest in risking the trip to help him beyond a certain point." Stephen calmly rebutted, "I wonder what the Sherpas would have done if the sadhu had been a well-dressed Nepali, or what the Japanese would have done if the sadhu had been a well-dressed Asian, or what you would have done, Buzz, if the sadhu had been a well-dressed Western woman?" "Where, in your opinion," I asked, "is the limit of our responsibility in a situation like this? We had our own well-being to worry about. Our Sherpa guides were unwilling to jeopardize us or the porters for the sadhu. No one else on the mountain was willing to commit himself beyond certain self-imposed limits." Stephen said, "As individual Christians or people with a Western ethical tradition, we can fulfill our obligations in such a situation only if one, the sadhu dies in our care; two, the sadhu demonstrates to us that he can undertake the two-day walk down to the village; or three, we carry the sadhu for two days down to the village and persuade someone there to care for him." "Leaving the sadhu in the sun with food and clothing—where he demonstrated hand-eye coordination by throwing a rock at a dog—comes close to fulfilling items one and two," I answered. "And it wouldn't have made sense to take him to the village where the people appeared to be far less caring than the Sherpas, so the third condition is impractical. Are you really saying that, no matter what the implications, we should, at the drop of a hat, have changed our entire plan?" The Individual versus the Group Ethic Despite my arguments, I felt and continue to feel guilt about the sadhu. I had literally walked through a classic moral dilemma without fully thinking through the consequences. My excuses for my actions include a high adrenaline flow, a superordinate goal, and a once-in-a-lifetime opportunity—common factors in corporate situations, especially stressful ones. Real moral dilemmas are ambiguous, and many of us hike right through them, unaware that they exist. When, usually after the fact, someone makes an issue of one, we tend to resent his or her bringing it up. Often, when the full import of what we have done (or not done) hits us, we dig into a defensive position from which it is very difficult to emerge. In rare circumstances, we may contemplate what we have done from inside a prison. Had we mountaineers been free of stress caused by the effort and the high altitude, we might have treated the sadhu differently. Yet isn't stress the real test of personal and corporate values? The instant decisions that executives make under pressure reveal the most about personal and corporate character. Among the many questions that occur to me when I ponder my experience with the sadhu are: What are the practical limits of moral imagination and vision? Is there a collective or institutional ethic that differs from the ethics of the individual? At what level of effort or commitment can one discharge one's ethical responsibilities? Not every ethical dilemma has a right solution. Reasonable people often disagree; otherwise there would be no dilemma. In a business context, however, it is essential that managers agree on a process for dealing with dilemmas. Our experience with the sadhu offers an interesting parallel to business situations. An immediate response was mandatory. Failure to act was a decision in itself. Up on the mountain, we could not resign and submit our résumés to a headhunter. In contrast to philosophy, business involves action and implementation—getting things done. Managers must come up with answers based on what they see and what they allow to influence their decision-making processes. On the mountain, none of us but Stephen realized the true dimensions of the situation we were facing. One of our problems was that as a group, we had no process for developing a consensus. We had no sense of purpose or plan. The difficulties of dealing with the sadhu were so complex that no one person could handle them. Because the group did not have a set of preconditions that could guide its action to an acceptable resolution, we reacted instinctively as individuals. The cross-cultural nature of the group added a further layer of complexity. We had no leader with whom we could all identify and in whose purpose we believed. Only Stephen was willing to take charge, but he could not gain adequate support from the group to care for the sadhu. Some organizations do have values that transcend the personal values of their managers. Such values, which go beyond profitability, are usually revealed when the organization is under stress. People throughout the organization generally accept its values, which, because they are not presented as a rigid list of commandments, may be somewhat ambiguous. The stories people tell, rather than printed materials, transmit the organization's conceptions of what is proper behavior. For 20 years, I have been exposed at senior levels to a variety of corporations and organizations. It is amazing how quickly an outsider can sense the tone and style of an organization and, with that, the degree of tolerated openness and freedom to challenge management. Organizations that do not have a heritage of mutually accepted, shared values tend to become unhinged during stress, with each individual bailing out for himself or herself. In the great takeover battles we have witnessed during past years, companies that had strong cultures drew the wagons around them and fought it out, while other companies saw executives—supported by golden parachutes—bail out of the struggles. Because corporations and their members are interdependent, for the corporation to be strong, the members need to share a preconceived notion of correct behavior, a "business ethic," and think of it as a positive force, not a constraint. As an investment banker, I am continually warned by well-meaning lawyers, clients, and associates to be wary of conflicts of interest. Yet if I were to run away from every difficult situation, I wouldn't be an effective investment banker. I have to feel my way through conflicts. An effective manager can't run from risk either; he or she has to confront risk. To feel "safe" in doing that, managers need the guidelines of an agreed-upon process and set of values within the organization. After my three months in Nepal, I spent three months as an executive-in-residence at both the Stanford Business School and the University of California at Berkeley's Center for Ethics and Social Policy of the Graduate Theological Union. Those six months away from my job gave me time to assimilate 20 years of business experience. My thoughts turned often to the meaning of the leadership role in any large organization. Students at the seminary thought of themselves as antibusiness. But when I questioned them, they agreed that they distrusted all large organizations, including the church. They perceived all large organizations as impersonal and opposed to individual values and needs. Yet we all know of organizations in which people's values and beliefs are respected and their expressions encouraged. What makes the difference? Can we identify the difference and, as a result, manage more effectively? The word ethics turns off many and confuses more. Yet the notions of shared values and an agreed-upon process for dealing with adversity and change—what many people mean when they talk about corporate culture—seem to be at the heart of the ethical issue. People who are in touch with their own core beliefs and the beliefs of others and who are sustained by them can be more comfortable living on the cutting edge. At times, taking a tough line or a decisive stand in a muddle of ambiguity is the only ethical thing to do. If a manager is indecisive about a problem and spends time trying to figure out the "good" thing to do, the enterprise may be lost. Business ethics, then, has to do with the authenticity and integrity of the enterprise. To be ethical is to follow the business as well as the cultural goals of the corporation, its owners, its employees, and its customers. Those who cannot serve the corporate vision are not authentic businesspeople and, therefore, are not ethical in the business sense. At this stage of my own business experience, I have a strong interest in organizational behavior. Sociologists are keenly studying what they call corporate stories, legends, and heroes as a way organizations have of transmitting value systems. Corporations such as Arco have even hired consultants to perform an audit of their corporate culture. In a company, a leader is a person who understands, interprets, and manages the corporate value system. Effective managers, therefore, are action-oriented people who resolve conflict, are tolerant of ambiguity, stress, and change, and have a strong sense of purpose for themselves and their organizations. If all this is true, I wonder about the role of the professional manager who moves from company to company. How can he or she quickly absorb the values and culture of different organizations? Or is there, indeed, an art of management that is totally transportable? Assuming that such fungible managers do exist, is it proper for them to manipulate the values of others? What would have happened had Stephen and I carried the sadhu for two days back to the village and become involved with the villagers in his care? In four trips to Nepal, my most interesting experience occurred in 1975, when I lived in a Sherpa home in the Khumbu for five days while recovering from altitude sickness. The high point of Stephen's trip was an invitation to participate in a family funeral ceremony in Manang. Neither experience had to do with climbing the high passes of the Himalayas. Why were we so reluctant to try the lower path, the ambiguous trail? Perhaps because we did not have a leader who could reveal the greater purpose of the trip to us. Why didn't Stephen, with his moral vision, opt to take the sadhu under his personal care? The answer is partly because Stephen was hard-stressed physically himself and partly because, without some support system that encompassed our involuntary and episodic community on the mountain, it was beyond his individual capacity to do so. I see the current interest in corporate culture and corporate value systems as a positive response to pessimism such as Stephen's about the decline of the role of the individual in large organizations. Individuals who operate from a thoughtful set of personal values provide the foundation for a corporate culture. A corporate tradition that encourages freedom of inquiry, supports personal values, and reinforces a focused sense of direction can fulfill the need to combine individuality with the prosperity and success of the group. Without such corporate support, the individual is lost. That is the lesson of the sadhu. In a complex corporate situation, the individual requires and deserves the support of the group. When people cannot find such support in their organizations, they don't know how to act. If such support is forthcoming, a person has a stake in the success of the group and can add much to the process of establishing and maintaining a corporate culture. Management's challenge is to be sensitive to individual needs, to shape them, and to direct and focus them for the benefit of the group as a whole. For each of us, the sadhu lives. Should we stop what we are doing and comfort him; or should we keep trudging up toward the high pass? Should I pause to help the derelict I pass on the street each night as I walk by the Yale Club en route to Grand Central Station? Am I his brother? What is the nature of our responsibility if we consider ourselves to be ethical persons? Perhaps it is to change the values of the group so that it can, with all its resources, take the other road. One might say that each group was operating at which ethical level? A. Rest's notion of Law and Order Stage 4 B. Kohlberg's Moral Sensitivity C. Thorne's Moral Development Leading to Ethical Motivation D. Kohlberg's Stage Two

D. Kohlberg's Stage Two

18. Which of the following is NOT an element of the corporate governance system? A. Board of directors B. Internal controls C. Executive compensation policies D. Monitoring by top management

D. Monitoring by top management

16. Required Information Refer to Question 13. At the time, revenue recognition required a firm to include ___________. A. Persuasive evidence of an arrangement B. Receipt of a purchase order from the buyer's budget and the Purchasing Office C. The seller's price, which is fixed or determinable D. Delivery, which is assured by the FOB seller destination terms E. Persuasive evidence of an arrangement and a fixed or determinable seller's price.

E. Persuasive evidence of an arrangement and a fixed or determinable seller's price.