Introduction
My report is built around SEC Accounting and Auditing Enforcement Release AAER-3330 Koss Corporation. Before I dive into AAER-3330 let me begin by giving some information into Koss Corporation.
John C Koss founded the J.C. Koss Hospital Television Rental Company in 1953. After a short time Koss was looking for new ideas, and partnered with Martin Lange to eventually develop a stereo headphone. Based in Milwaukee, Wisconsin, USA, in 1991 Koss Audio & Video Electronics started producing and selling consumer electronics products as a separate company in Hazelwood, Missouri, USA. The Koss family owns more than 75% of the firm.
Having only a high-school education, John C Koss worked with Lange, an engineer, to develop the headphone that launched the company almost by accident, as they came upon the headphone idea as a result of an attempt to market a portable phonograph.
Working out of 2 nearby locations in the early 1970s - one housing Koss TV-Rental, which also did electronics and musical instrument repairs - and their main facility 2 blocks to the east - Koss pioneered the high-end "electro-static" "ES series" headphone market. These headphones set the standard for wide-range frequency response; Koss also provide the bulk of headphones in supporting educational and library AV department equipment. Being very durable, they required service for wear & tear on cords and ear pads - and K&M Electronics (Klenworth & Midwest based in Minneapolis), working out of the TV Rental location, supported the repair efforts, mainly of headphones that came in by the case from those customer locations. Koss headphones were easy and cost-effective to repair. At this site, in a separate garage setup, the Musical instrument and electronics repair was done. The TV-Rental and repair site was managed by John's brother Pete Koss. Eventually Koss dominated the headphone market, competing mainly with Telex. Koss however was considered a higher quality unit at the time, offering a wide line of models. Growth in the late 1970s caused them to move to their present location on the north side of Milwaukee.
In addition to selling headphones under their own brand, Koss headphones are also rebranded as Radio Shack headphones under license and sold in Radio Shack stores. They will usually have the same drivers as the Koss phones, and these can usually be spotted by the fact that the minijack connector has the Koss logo on it. Radio Shack sells them as Titanium Diaphragm headphones. Some of their more popular products are the Koss Plug and Koss Spark Plug which are noise isolation earphones. Their ability to be adapted to take the high-end Etymotic ear tip (known as the Koss Hybrid), and the popular Koss Porta Pro has contributed to their success. Their budget-priced headphones (the KSC series in particular) are widely regarded as some of the best low-end headphones on the market. Since 1989, all headphones manufactured in North America by KOSS come with a limited lifetime warranty, which covers normal use by the initial user or purchaser.
Diversification into related electronics areas in the 1980s ended in disaster for Koss, who filed for bankruptcy protection after a net loss in 1984 of $6 million. Koss emerged from Chapter 11 bankruptcy proceedings in 1985.

Michael J. Koss has been the President and Chief Operating Officer of Koss Corporation since 1987 and its Chief Executive Officer since 1991. During the past 25 years, Mr. Koss served at Koss Corp., in a variety of senior management positions including Marketing, Operations and Corporate Development. He also served as the Chief Financial Officer of Koss Corp. from 1987 to January 2010. He has been Vice Chairman of Koss Corporation since 1998 and has been its Director ... since 1985. He has been Director of Strattec Security Corp. since 1995. He served as a Non Executive Director of Intelligent Energy Holdings PLC. Mr. Koss served as a Director of Milwaukee Insurance Group, Inc., since 1991 and Genius Products Inc. from September 1, 2004 to October 20, 2005.
On October 24, 2011 The Securities and Exchange Commission filed a complaint against and proposed settlement with Koss Corporation and Michael J. Koss the corporations CEO and former CFO based on Koss Corporation’s preparation of materially inaccurate financial statements, book and records, and lack of adequate internal controls from fiscal years 2005 through 2009. During this period, Sujata Sachdeva, Koss’s former Principal Accounting Officer, Secretary, and Vice-President of Finance, and Julie Mulvaney, Koss’s former Senior Accountant, engaged in a wide-ranging accounting fraud to cover up Sachdeva’s embezzlement of over $30 million from Koss.
Factors leading to the misrepresentation
In August of 2009 American Express made contact directly with Michael Koss in order to inquire about a check issued from Koss Corporation to American Express in the amount of $296,494 as payment for Sujata Sachdeva’s American Express Card. This telephone call began a series of events that culminated in Koss filing a Form 8-K on December 24, 2009 in which the Koss Audit Committee concluded that the Koss’s previously issued financial statements on Forms 10-K for the fiscal years ended June 30, 2006, 2007, 2008 and 2009 and on Form 10-Q for the three months ended September 30, 2009 should no longer be relied upon because of te discovery of unauthorized financial transactions. On June 30, 2010 Koss Corporation filed a SEC Form 10-K/A which detailed the events that lead to a massive $34 million dollar embezzlement and several years of materially misstated financial statements that had been audited by Grant Thornton LLP and submitted to to the SEC on forms 10-Q and 10-K. The details behind the embezzlement read like a sordid crime novel and included events such as: * The alleged fraud was initially estimated at $4.5 million, but within a couple of days the estimate grew to $20 million over four years * Sachdeva, with the assistance of Mulvaney, embezzled funds from Koss using numerous fraudulent wire transfers, cashier's checks and petty cash withdrawals, most of which Sachdeva spent on lavish shopping sprees. The yearly amounts stolen were significant relative to Koss's sales and shareholders' equity. For example, during fiscal year 2009,Sachdeva stole approximately $8.5 million, while Koss reported total sales of approximately $41.7 million and retained earnings of approximately $17.1 million at year-end SEC Involvement * Sachdeva and Mulvaney made more than $16 million in fraudulent wire transfers-all to pay Sachdeva's personal charge card bills. Sachdeva, who had the authority to approve and process wire transfers, authorized Mulvaney to make the fraudulent transfers online. For example, in October 2009, 17 fraudulent wire transfers totaling $1,509,595 were sent to satisfy charges made by Sachdeva on her personal charge card. Two of those transfers alone totaled $1,018,595. * Sachdeva earned an average of $190,000 in total annual compensation in fiscal 2008 and 2009. Yet allegedly she spent millions at Milwaukee area boutiques, and the federal criminal complaint against her says there were "several large piles" of clothing with tags attached sitting in her office at Koss. Several individual price tags were in excess of $2,000. * According to the SEC’s complaint, Sachdeva used the embezzled funds to finance an extravagant lifestyle, including prolific purchases of designer clothes, furs, purses, shoes, and jewelry as well as china, statues, and household furnishings. She also used the stolen funds to buy automobiles, pay for airline tickets and hotels during personal travel, and finance home improvements and renovations.
The main issues behind this massive embezzlement are these known factors 1. Koss's internal controls over cash were inadequate. While Koss's internal controls policy required Michael Koss to approve invoices of $5,000 or more for payment, its controls did not prevent Sachdeva and Mulvaney from processing large wire transfers and cashier's checks outside of the accounts payable system to pay for Sachdeva's personal purchases without seeking or obtaining MJK's approval. In addition, there was no independent review of the petty cash account. Although MJK was required !o review accounts payable checks before the checks were mailed, MJK and Sachdeva were each authorized to independently withdraw or transfer funds from Koss's bank accounts. 2. MJK knew that Koss's computerized accounting system was almost 30 years old and he twice deferred proposals for a new system. Koss's and MJK's failure to implement and maintain effective controls over Koss's information systems in part allowed Sachdeva and Mulvaney to carry out the embezzlement and accounting fraud 3. Because access to the old accounting system could not be locked at the end of the month, Sachdeva and Mulvaney were able to bypass an internal control requiring MJK to authorize changes to the monthly books after they were closed. Sachdeva and Mulvaney thus accessed the accounting system and made improper post-closing entries 4. MJK did not properly verify that Koss's accounting systems were secure or adequately monitored. Koss's computer system did not have an audit trail of usage, so there was no record of who made entries into the accounting system. Koss did not regularly change the passwords to access the computers, and accounting department terminals were not locked when unattended. Koss did not have IT security policies and controls to log and monitor network and application security violations or to report incidents to management. Without proper access 5. Due to the limited number of people working in Koss’s accounting department, many critical duties were combined and given to a few employees.
Accounting Issues
Sachdeva and Mulvaney used various methods to disguise the embezzlements in Koss’s books and records. First false journal entries reclassified cash to sales, thereby masking Sachdeva’s thefts of cash as reductions in sales. Second, false journal entries were made to eliminate sales and reduce cash balances. Third, false journal entries decreased both accrued liabilities and Koss’s bank account balance and the cost of goods sold and decreased accounts receivable, inventory, and finished goods which kept the inventory balance in check with the false journal entries reducing sales and increasing the cost of goods sold. Sachdeva and Mulvaney entered these false journal entries without any supporting documentation for the transactions as was requires by Koss’s internal controls for legitimate transactions.

Auditors

Outcomes