Posted: May 25th, 2022

Ethical Issues in Accounting Information Systems

Ethical Issues in AIS

Ethical Issues in Accounting Information Systems

This essay examines ethical issues in accounting information systems as presented in the case of DHB Industries. Now known as Point Blank Solutions, the company, which supplied body armor to the U.S. military and law enforcement agencies, was charged by the SEC on March 1, 2011 for engaging in “massive accounting fraud” (SEC, 2011). The agency filed separate charges against three of the company’s former outside directors and audit committee members for their complicity in the fraud.

According to the SEC, DHB Industries engaged in “pervasive accounting and disclosure fraud through its senior officers” (2011), along with misappropriating company assets to the personal benefit of the company’s former CEO. Their accounting and disclosure fraud resulted in the company’s filing “materially false and misleading periodic reports to investors” (2011). The SEC charged that the company’s senior management manipulated the company’s reported gross profit, net income, and other key figures in its earnings releases and public filings between 2003 and 2005. Their fraudulent activities included overstating inventory values, failure to include appropriate charges for obsolete inventory, and falsifying journal entries (SEC, 2011).

The three outside directors facilitated the misconduct by former DHB CEO David Brooks who diverted at least $10 million out of the company through fraudulent transactions with a related entity under his control. The SEC charged that the directors’ willful blindness to accounting red flags facilitated DHB’s improper payment of millions of dollars of Brooks’ personal expenses that included “luxury cars, jewelry, art, real estate, extravagant vacations and prostitution services” (SEC, 2011).

Despite being confronted with red flags indicating fraud, the three former directors approved or signed DHB’s false and misleading filings. Brooks allegedly sold his personal DHB stock for proceeds of about $186 million in late 2004 when DHB’s stock price was at its highest while in possession of material non-public information, which transaction violated insider trading laws (Cohn, 2011).

DHB senior management and directors’ fraudulent conduct included their manipulation of the company’s gross profit, net income and earnings. DHB’s former CFO was alleged to have lied to DHB’s auditors and provided fake inventory schedules and other documents to conceal their fraud. The SEC charged that the former CFO and COO routinely overstated the value of DHB’s inventory as well as directed the booking of numerous fraudulent journal entries in order to reduce the company’s cost of goods sold. Moreover, the CFO routinely overstated the value of DHB’s inventory by fraudulently increasing inventory quantities, labor costs, overhead costs, and the amount of raw materials used in DHB’s products. The two officers also transferred millions of dollars of expenses from cost of goods sold R. And D. costs in order to materially increase the company’s gross profit (SEC, 2011).

The effect of DHB ethical issues, which compromised their accounting information system, was to overstate DHB’s gross profit margins, as well as their earnings in some cases. Investors were given a false picture of DHB’s operating results. The resulting misstatement of the company’s financial position and profitability caused the stock price to climb, allowing the senior managers to profit by selling their own holdings at inflated prices. According the SEC, the company’s former COO and CFO together profited by more than $8.2 million from the cashless exercise of warrants and their sale of over 400,000 DHB shares before the public knew about the misrepresentations in DHB’s filings and financial statements.

The impact to DHB of the company’s overvaluation due to the executive’s massive accounting fraud was to force the company into filing bankruptcy. The company was also forced to restate its financials and settle with the SEC. DHB’s stock price declined by more than 45% in 2006 following information becoming public about the company’s accounting fraud along with the resignation of the CEO and CFO.

The role of the accountant has changed following the passage of the Sarbanes-Oxley (SOX) Act of 2002. Due to SOX provisions, certain consulting services, internal audit outsourcing along with certain other activities routinely provided to clients in the past became illegal when performed by the audit firm. The new restrictions on the practice of auditing were intended to strengthen auditor independence (Gantt, Generas & Lamberton, 2007).

Works Cited

Cohn, M. (2011, November 10). Body armor execs settle accounting fraud charges. Accounting Today for the Web CPA. Retrieved January 13, 2012 from: http://www.accountingtoday.com/news/Body-Armor-Execs-DHB-Point-Blank-Settle-Accounting-Fraud-Charges-60767-1.html

Gantt, K., Generas, G., & Lamberton, B. (2007, September). Sarbanes-Oxley, accounting scandals, and state accountancy boards. The CPA Journal online. Retrieved January 13, 2012 from: http://www.nysscpa.org/cpajournal/2007/907/essentials/p18.htm

Norris, F. (2011, March 3). For boards, S.E.C. keeps the bar low. New York Times website. Retrieved January 13, 2012 from: http://www.nytimes.com/2011/03/04/business/04norris.html?pagewanted=all

Securities and Exchange Commission. (2011, February 28). SEC charges military body armor supplier and former outside directors with accounting fraud. Retrieved January 13, 2012 from: http://sec.gov/news/press/2011/2011-52.htm

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