Lemon Case Study

The Case of Kay Lemon

Detect/Prevent Fraud in Financial Statements

Professor K. Day

Angela Born

March 1, 2015

Case of Kay Lemon

Lemon concealed her larceny by using the technique of false debits. These debits were made to the inventory account overvaluing the assets on the books. She used a billing scheme to cover her theft by inflating the amount of payment made to the vendor on the books. Per the books, the vendor was paid a larger amount than the actual invoiced amount and she was able to hide her theft. Her scheme was simple. However, as she continually debited the inventory account, the assets on the books increased year to year. The article stated the lighting store never took a physical inventory. Due to the lack of physical inventory, Lemon assumed she could hide her theft by inflating the inventory balance on the books.

Each year, an external CPA prepared the tax returns each year for the small business. It is interesting that the CPA did not call attention to the increasing cost of goods sold compared to sales each year. A major read flag is a sudden increase in cost of goods sold and comparable sales to the year prior. Lemon was able to hide her fraud for eight years without being discovered despite numerous red flags. These red flags should have been readily seen by the CPA preparing the tax returns. The CPA never performed an audit of the company’s financials, but it would be assumed that the CPA would inform the company that their operating budget was thinning each year.

The red flags that should have been caught by the CPA were inventory increasing versus sales increases, decreasing inventory turnover, inventory rising faster than total assets, and cost of goods sold not reconciling to tax returns (Wells). It is assumed that Lemon gave the CPA books and records with the inflated inventory and did not attempt to mask or create a second set of books. “The obvious way to increase inventory asset value is to create various...