Video Planet: A Teaching Case On The Detection Of Fraudulent Financial Reporting

Abstract

This paper presents a teaching case intended for use in an undergraduate auditing or fraud class. In the case, readers encounter an audit client, Video Planet, Inc., which exhibits many of the symptoms of companies that have been found to engage in fraudulent financial reporting. The case is intended to develop students’ skills at detecting and interpreting warning signs of fraudulent financial reporting. Section One presents the facts of the case. Section Two presents decisionguiding questions. Section Three provides teaching notes. Section Four provides a summary of the paper. 1. CASE FACTS ideo Planet, Inc. (VPI) is an international chain of stores specializing in renting copies of movies and video games to retail customers. VPI 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), VPI 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 VPI 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 VPI. 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 VPI’s smaller competitors have been forced into bankruptcy. One of VPI’s large competitors has responded to industry market pressures by discontinuing its late fee policy and starting its own online video subscription service. VPI has done the same, necessitating additional borrowing to cover the up-front costs of its online initiative. VPI’s online video subscription service has been operational for one year, with revenues climbing at a somewhat slower pace than anticipated. VPI’s CEO, Robert G. (“Bob”) Finley, has gone to some lengths to successfully convince stock analysts that its online initiative will soon bolster VPI’s bottom line significantly. In addition, VPI has announced that it is currently in talks with officials of the People’s Republic of China to enter that market by opening 100 stores in that country. Opening these new stores will probably require the incurrence of additional debt or equity financing. V