DIGITAL POINT INC : FRAUD CASE STUDY

Digital Point, Inc. (DPI) is an international chain of stores specializing in renting copies of movies and video games to retail customers. DPI also sells new and used copies of these products, and offers “memberships” entitling members to unlimited use of DVDs or video games for one year (one DVD or game at a time). With over 7,000 stores worldwide (approximately 5,000 in the U.S. and 2,000 in 23 other countries), DPI is among the top two or three companies in the industry. Founded twenty years ago, it has been an audit client of your CPA firm for the past three years.
For several years, the traditional movie and video game rental industry has been saturated, and recently has been declining by an average of 4% per year as measured by industry gross margins and by 6% per year as measured by industry profits. Lately, companies in the movie rental industry have been facing stiff competition on a number of fronts. First, competing companies such as Netflix offer internet-based subscription services, taking business away from traditional stores like DPI and forcing them to discontinue charging late fees to customers, a significant source of revenues. Second, companies such as Wal-Mart, Circuit City and Best Buy have been selling new copies of both newly-released and classic DVDs at rock-bottom prices, sometimes even at a loss, also taking business away from traditional stores like DPI. Finally, many customers have turned to video-on-demand cable and satellite providers (often in conjunction with digital video recorders, or DVRs) to satisfy their desire for quality in-home movie experiences. Overall, U.S. consumer spending on in-home movie viewing has been increasing at a rate of 11% per year, though this rate is expected to slow to about 8% over the next five years.

Many of DPI’s smaller competitors have been forced into