The Molex Inc Case Study

Introduction
The Molex Corporation is an electronic connector manufacturing firm,
which is based in Illinois. This company is facing a financial reporting
problem in which the financial statements were overstated. Joe King ,the
CEO of the company, was appointed in July of 2001, and was responsible
for managing and inventory control, among other very important duties.
Diane Bullock was hired in 2003, to replace the previous CFO. Both Bullock
and King were being accused of what? by the external auditors, Deloitte &
Touche, for not disclosing an 8 million pre-tax inventory valuation error.
Financial reporting Problem
The financial reporting problem at Molex was that, the profit on inventory
sales that the company made between its subsidiaries but which had not
yet been sold to external customers had not been excluded from the
company's consolidated earnings and also in the company's inventory
(Palepu & Healy, 2008). Basically, Molex reported additional inventory and
earnings from the internal inventory sales. As a result, the companys
earnings, net income, and inventory were overstated by $8 Million before
taxes and $5.8 million after taxes, with $3 million before taxes and $2.2
million after-taxes was from year ended June 30, 2004. As it was stated on
page 12-27 of the Business Analysis and Valuation applications, The main
problem came from the CEO and CFO decision to not disclose this error on
the financial statements that were released on July 21, 2004 (Palepu &
Healy, 2008). The auditors were not thrilled about the poor (of) decision of
King and Bullock to withholding this information from them. As a result, the
auditors no longer have trust on the CEO and CFO and requested that they
should be fired and replaced.
Problem Correction
The error shouldve been reversed when it occurred. The mistake was an
overstatement of 8 million before taxes and 5.8 after tax with 3 million
before tax and 2.2 million after tax happened in the previous year, which
ended on June 30, 2004. The error wouldve been correct on the current

period first quarter results. To correct the overstatement of 8 million in

inventory, a credit or decrease for $8 mill shouldve been done on the
inventory account, and the retained earnings shouldve been debited for the
same amount:
Retained Earnings$8,000,000
Inventory.
$8,000,000
When an error of overstatement like this one happens, the financial
statements have to be restated in order(ed) to bring net income to the
correct amount. The Cost of goods sold shouldve been increased by $8
million and the same
$8 mill needed to be deducted from net income on the income statement.
They should have followed (Following) with disclosure notes to describe
why this error occurred and how it impacted the statement and accounts
that it touched. For instance, the notes would describe the presence of the
correction on the current period of beginning inventory, and retainED
earnings.
Role of Top Management, The Audit committee and The External Auditor in
Financial Reporting
The audit committees role in financial reporting is to ensure that accurate
and transparent disclosure is being presented to the public, investors, and
shareholders. The role of top management in financial reporting is to make
sure that the financial statements and disclosures are in accordance to
GAAP, and that everything disclosed is truthful, while not hurting the
business. The role of an external auditor is to ensure that the financial
statements are presented fairly and without material misstatements in
accordance to GAAP; basically, auditors guarantee the SEC that the
company did in fact follow(ed) the rules and is in compliance with GAAP, or
if the company is trying to, or has already, committed fraud. Given that the
error of Molex was believed to be immaterial, the CEO and CFO decided
not to take the issue to the auditors, since the error wouldnt have affected
the financial performance of the company. Management assumed that
since no(t) harm was caused to financial performance or earnings the

auditor didnt need to be informed. But the manager had not analyzed the
magnitude of the error at the time of its occurrence. The issue was taken to
the auditors when managers saw a huge overstatement of $8 mills on net
income and inventory.
Auditors Concern about the Problem
The external auditors were very concerned about the error because they
were not informed until after the fourth quarter results were released and
prior to releasing the first quarter results on September 30, 2004. They
were very concerned that they, as external auditors, didnt see the error,
and that the corporate finance group of Molex were the ones who caught it.
This made the external auditors look bad because it can seem as if they
didnt carefully test(ed) the financial results, which were presented to them
by Molex on July 27, 2004, in order to detect if an error had occurred in the
financial statements. Good point. Besides looking inept, the auditors were
concerned about the corporate issues affecting accounting and specially
the audit profession. During that time, a couple a big fortune 500
companies, such as Enron, had fallen due to scandals and fraud(s)
revolving(involving) misstated financial statements and reports, which
resulted in huge losses to investors and added to the recession. As a
consequently(consequence), the Sarbanes Oxley Act of 2003 was created
to regulate auditing, especially the independency of audit firms and the
company they served. As stated on page 12-26 of Business Analysis and
Valuation applications, a lot of Deloitte & Touches clients were involved in
fraudulent accounting and misstatements of financial statements,
therefore, Deloitte and Touche was concerned with their reputation being in
jeopardy once again because of the Molex error (Palepu & Healy, 2008).
Should the CFO and CEO Be Replaced
The requests of the auditors to replace both the CEO and CFO are silly and
bad for business. There are a number of important reasons that would let
me to say no to that request. Mainly, I would say no because it would look
really bad for the company to fire their CEO and CFO while an error is
being fixed. Additionally, an error is not intentional and it is obvious that the
CEO and CFO truly believed that the error was not material, that is why
external auditors exist. The external auditors passed the financial results

for the previous year (fourth quarter), and the auditors failed to discover the
error. Therefore, I would force the auditor to forget about the idea of firing
my employee, and I would have asked them to resign(ed) on the basis of
their fault to detect the error. This would violate the SECs listing
requirements of filing the quarter results on time, and force the auditors to
approved the error fixes and leave my employees along(alone). I would
definitely have bonuses and some benefits cut off from the CFO and CEO.
Additionally, I would make them take audit and ethics mandatory courses.
They would have to go on a long trial period before they can get a raise
and bonuses again.