Report and PPP

ISSUES IN ACCOUNTING EDUCATION American Accounting Association Vol. 37, No. 4 DOI: 10.2308/ISSUES-19-047 November 2022 pp. 107–120

Bad Days at New Day Products

Robert R. Picard Idaho State University

Marcus Burger The University of North Carolina at Pembroke

Marla Kraut University of Idaho

ABSTRACT: This instructional case describes an embezzlement committed by the former executive director of a

Southeast Idaho nonprofit organization, New Day Products. The case, based on an organization that helps people

with disabilities, provides a rich context for students to learn about the important roles and responsibilities of nonprofit

organizations’ boards of directors. Highlighting the challenges faced by nonprofit boards of directors, the case asks

students to consider how New Day Products’ board of directors’ governance decisions, including choosing financial

statement reviews rather than audits, increased the executive director’s opportunities to commit fraud.

Keywords: fraud; embezzlement; nonprofits; internal controls; separation of duties; board of directors; board

oversight; governance; case studies.

I. THE CASE

J amie Davis, the office administrative assistant to the executive director (ED) at New Day Products, stared at the letter

from the IRS in shock and disbelief. The letter asserted that New Day Products owed over a million dollars in back

payroll taxes with associated interest and penalties. While Jamie suspected something amiss with how the ED managed

the organization, she scarcely imagined that things were this bad. Jamie recalled past questionable expenditures and reflected on

the ED’s seemingly extravagant spending habits as well as those among the ED’s family and friends. She realized that the

management style at New Day Products, a small nonprofit organization focused on helping people with disabilities, had

become increasingly secretive during the ED’s tenure. Employees seemed discouraged, even afraid, to question authority;

simple acts such as opening the mail were reserved for the ED. Jamie decided to open the IRS letter only because it appeared

urgent and because the ED was on vacation. Her decision would become the triggering event leading to the long unraveling of a

devastating fraud and embezzlement scheme orchestrated by Nancy John, the ED of New Day Products. Jamie wondered how

this could happen at an organization with a mission of helping people.

We thank Jolene Barnett-Stephens, New Day Products Board Member, and Terry Fredrickson, present New Day Products executive director, for their help developing the case. We wish everyone at New Day Products the best. We also thank Ken Smith, Professor Emeritus at Idaho State University, for his early help conducting interviews for the case. We appreciate the valuable feedback provided by workshop and conference participants at Idaho State University, the Northwestern Accounting Research Group Conference, and the 2019 AAA Western Regional Meeting. We express our gratitude to the TLC Section Paper Committee at the 2019 AAA Western Regional Meeting for selecting the case for the Best Paper Award. Finally, we thank our two anonymous reviewers for their insightful feedback and the Associate Editor and Editor, Elizabeth D. Almer and Valaria P. Vendrzyk, for their patience and guidance during the review process as we coped with COVID.

Robert R. Picard, Idaho State University, Accounting Department, Pocatello, ID, USA; Marcus Burger, The University of North Carolina at Pembroke, Thomas School of Business, Pembroke, NC, USA; Marla Kraut, University of Idaho, College of Business and Economics, Accounting Department, Moscow, ID, USA.

Editor’s note: Accepted by Valaria P. Vendrzyk.

Submitted: June 2019 Accepted: May 2022

Published Online: June 2022

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Differences between For-Profit and Nonprofit Organizations

Although for-profit and nonprofit organizations are similar in that they both comprise people working together to

accomplish their organizations’ missions and goals, they differ in fundamental ways. First, a primary goal of all for-profit

organizations is to generate profits for their owners. In contrast, the primary goals of nonprofit organizations generally focus on

providing benefits to society. Differences in the primary goals of for-profit and nonprofit organizations give rise to different

funding models. For-profit organizations are generally funded by investors who expect to obtain a return on their investment.

Nonprofit organizations are frequently funded by donations and government grants. Although donors and other funding sources

do not usually expect to receive monetary returns from their investments of time and resources, they do expect the nonprofit

organization to make measurable progress toward its mission. A nonprofit can generate income, but it must be recycled back

into the organization to achieve the organization’s objectives.

Second, for-profit organizations’ workforces primarily consist of competitively paid managers and staff, whereas a

nonprofit’s workforce often includes a large portion of volunteer efforts. As a result, employee pay is frequently higher at for-

profit organizations compared to nonprofit organizations, sometimes hindering nonprofit organizations from attracting equally

skilled employees. However, nonprofits can sometimes counter pay disparities by attracting employees who are strongly

motivated by the organization’s mission. Such differences in employee motivation between for-profit and nonprofit firms can

create markedly different cultures: for-profit cultures are often typified by aggressive profit-oriented activities whereas nonprofit

cultures are typified by their sense of community and the resulting intrinsic rewards. As a result, the public as well as the

nonprofit organization’s employees often assume that a nonprofit organization’s management and staff are serving the best

interests of the organization (Mann 2006).

Third, for-profit organizations pay income taxes on their taxable earnings. In contrast, organizations that are designated as

nonprofit organizations by Section 501(c) of the Federal Tax Code are exempt from paying some federal and, in most cases,

state income taxes. However, both types of organizations must withhold and remit any federal and state employee income,

Medicare, and Social Security taxes from employees’ paychecks. Both for-profit and nonprofit organizations must also remit to

tax authorities their matching contributions for employees’ Medicare and Social Security payments and any federal and state

unemployment taxes.

Fourth, for-profit organizations are owned by shareholders who have ownership claims to the organizations’ assets and,

through voting rights, control the composition of the organizations’ governing boards. Nonprofit organizations have no owners;

a nonprofit organization’s earnings must be reinvested in the firm. Nonprofit organizations are generally considered accountable

to the public that they serve and to the state agencies and tax authorities by which they are regulated. Much like for-profit

organizations, nonprofit organizations rely on boards of directors for financial and strategic oversight. Boards also help to

develop and maintain operational policies in support of the organization’s mission. However, the responsibilities of nonprofit

and for-profit boards of directors differ in key ways discussed in the next section.

Board Responsibilities and Differences between For-Profit and Nonprofit Boards

Except for an increased emphasis on mission, boards of directors at nonprofit organizations are much like their

counterparts at for-profit organizations. Boards of directors are generally responsible for the strategic and fiscal oversight of

their organizations. In exchange for their time and talents, for-profit board members can be well-compensated, commonly with

stock-based compensation that aligns their interests with those of shareholders. In contrast, nonprofit board members are not

compensated and may be expected to directly provide or generate financial support for the organization (Epstein and McFarlan

2011).

Like the board members of for-profit organizations, board members of nonprofit organizations have a legal fiduciary duty

to provide independent oversight of the organization’s assets and operations. While state laws vary, in general nonprofit board

members are legally responsible to provide adequate strategic, operational, and financial oversight over the organization, its

mission, and its senior executives (AICPA 2017). To achieve effective board governance, a nonprofit board should meet

regularly to review and approve the organization’s mission, strategy, budget, compensation practices, and other key financial

and operating policies. A board should comprise members having diverse ethnic, gender, and racial backgrounds to provide

broad perspectives and help ensure a fair and equitable review of organization policies. Boards should also have members with

diverse experience and expertise to provide the organizational and financial skills necessary to advance the organization’s

mission and provide adequate oversight. Although boards should consist of at least 5 members, they can often exceed 25

members for large organizations (Independent Sector 2015).

As with for-profit boards, management oversight is among a nonprofit board’s most important responsibilities. Boards are

generally responsible for hiring, evaluating, and firing, when necessary, their organizations’ EDs. A board of directors hires,

oversees, and evaluates ED performance and any changes in ED compensation. A nonprofit board should also review and

evaluate policies for approving expenditures to verify that they are consistent with the organization’s mission. For example, the

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board should require that management prepare appropriate written policies for authorizing expenditures. Such policies should

clearly establish who is authorized to approve payments, what documentation is required, and what kinds of expenditures are

permitted.

Although not required, nonprofit boards may wish to form an audit committee to provide stronger assurance of the

organization’s financial health. Audit committees are generally formed from a small subset of the board, such as three to five

members. Audit committees are not involved in the day-to-day accounting functions of the organization but they oversee the

assurance process that includes hiring and evaluating the organization’s independent auditors. Audit committees can also

follow through on auditor recommendations to ensure that they are implemented. Although a nonprofit board may choose not to

form an audit committee, it should continue to protect its independent oversight of the organization’s auditors by having the full

board perform such audit committee functions (National Council of Nonprofits 2020).

Differences between Board Responsibilities and Management Responsibilities

Management and boards of directors play distinctively different roles in their organizations. Whereas management is

responsible for planning and executing strategy and enforcing the organization’s operating procedures, boards of directors

provide broader and more general oversight by reviewing and approving strategy and setting broad policy guidelines. Boards of

directors are responsible for recruiting chief executives and devising their compensation contracts. They are also responsible for

assessing business risk and monitoring their organizations’ financial health and internal controls. In addition to monitoring

financial health, boards of directors should monitor an organization’s culture to assess whether it is conducive to meeting the

organization’s mission and goals (Grant Thornton 2016).

Organization Background

Founded in 1975, New Day Products is an Idaho nonprofit organization that provides comprehensive employment and

social services to people with disabilities in cooperation with private and public community organizations and businesses. Its

services include employment planning programs, employer and employee matching services, and in-house employment

opportunities. Its employment planning programs assist participants with vocational decisions through standardized testing,

situational assessments, and community-based job tryouts. Each individually tailored program culminates in a service report

that details the participant’s vocational strengths and developmental needs and helps the participant choose a vocation. New

Day Products’ matching services match the participant’s abilities to job requirements and provide additional assistance through

on-site job coaching. Its in-house employment opportunities include jobs such as wood container manufacturing, pallet repair,

bulk mailing operations, engraving, laundry, and janitorial services.

New Day Products’ social services include a developmental disabilities program and an adult living center. The

developmental disabilities program teaches life skills that not only encompass social skills but more fundamental skills such as

cooking. The program is tailored to each participant’s needs, goals, preferences, and interests, and the training is often provided

in context, whether at home or the workplace. Residents at New Day Products’ adult living center participate in the

developmental disabilities program, but the adult living center also fosters greater community interaction and involvement. In

addition to participating in arts, crafts, and games at the center, residents participate in field trips to local events.

When the fraud was revealed in 2009, New Day Products served seven counties in Southeast Idaho. Table 1 presents the

change in net assets that New Day Products reported to the IRS from 2005 through 2009 via IRS Form 990. The table shows

that New Day Products’ reported change in net assets was relatively stable just before the fraud was revealed. In 2008, its

revenues totaled $1,651,100, and its expenses totaled $1,631,321. Its four major funding sources were (1) the Idaho Division of

Vocational Rehabilitation. which helped fund its vocational training, (2) Medicaid, which provided partial funding for residents

of the adult living center, (3) federal and state cleaning contracts for janitorial services at local facilities including the FBI data

processing center, and (4) revenues from selling goods and services like its wood pallets and trophy engravings. Excess of

revenues over expenses from selling goods and services provided approximately 35 percent of its total funding. Table 2

summarizes the organization’s statement of financial position over the same periods. In 2008, the year before discovering the

fraud, New Day Products’ total assets were $533,775, and its total liabilities were $236,545.

A Brief Organization History

At its founding, New Day Products boasted a well-rounded board of directors consisting of 15 members with expertise in

accounting, legal, financial, vocational, and social work. As some board members had relatives who were beneficiaries of the

organization, the board was highly committed to the organization’s success. Leading the organization, Dick Kaup was an

experienced and dedicated executive director. Dick believed in a highly transparent management style. He kept the board fully

informed regarding all operational and financial matters.

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With detailed reports provided by Dick, the board monitored actual results against an annual budget and discussed

significant variances. The board oversaw internal controls assuring that no one person controlled an entire financial process

from beginning to end, with separation of duties enabled by the board-approved organizational structure. The board treasurer

reviewed Dick’s company credit card statement every month to ensure that all charges were reasonable and served legitimate

business purposes. Regular board training, including training about financial oversight, internal controls, legal and ethics issues,

and annual board self-evaluation enhanced board effectiveness. Staff members were similarly well-trained and adequately

supervised.

Idaho statutes do not require audits for nonprofit organizations, and New Day Products was also not required to have a

federal single audit. Dick believed that periodic independent audits provided a necessary deep dive into the processes and

documentation that supported the organization’s financial reporting. Compared to financial statement audits that required more

extensive procedures, financial statement reviews would have been less costly because they rely primarily on analytical

procedures and inquiries of management without looking at evidence to support the underlying transactions that comprise

account balances. But Dick preferred the ‘‘deeper dive’’ and viewed audits as another significant layer of fiscal oversight. By all

accounts, the organization operated smoothly and efficiently under Dick’s leadership.

When Dick retired, Steve Clark became the new ED. One board member described the next five years under Steve’s

directorship as ‘‘a period of complacency. We had been lulled into a sense of security knowing that Dick had done a wonderful

job and the organization was on solid footing.’’ While the board continued its monthly meetings and its biannual financial

statement audits, its membership began to shrink. One member left due to health problems, another retired and moved out of the

area, and two others left because their own businesses were taking up more of their time. With fewer resources, a lack of

expertise, and reduced focus, the board relaxed or abandoned altogether many of the board practices from the Dick Kaup era.

Notably, the board discontinued its regular board training sessions and self-evaluations. Amid these changes, rumors circulated

that Steve was not as committed or adept as his predecessor. The financial health of the organization had shown signs of

deteriorating. Staff turnover, historically quite low, began to increase.

TABLE 1

Comparative Statements of Change in Net Assets

For Fiscal Years Ended June 30,

2005 2006 2007 2008 2009a

Revenues:

Contributions, gifts, grants $3,184 $7,074 $6,677 — —

Program service revenue:

Custodial contracts 223,146 415,666 216,239 $214,673 $905,336

Production sales 297,532 352,985 399,471 399,627 931,528

Contracts with government agencies 936,495 899,949 1,094,704 1,036,277 —

Total program revenue 1,457,173 1,668,600 1,710,414 1,650,577 1,836,864

Other revenue 455 11,615 453 523 (197,735)

Total revenue 1,460,812 1,687,289 1,717,544 1,651,100 1,639,129

Expenses:

Program services 1,227,930 1,395,086 1,429,571 1,332,311 —

Salaries, general, and administrative 224,261 255,436 267,278 299,010 1,798,713

Total expenses 1,452,191 1,650,522 1,696,849 1,631,321 1,798,713

Excess (deficit) for the year 8,621 36,767 20,695 19,779 (159,584)

Prior period adjustment: (1,332,178)

Beginning net assets 211,368 219,989 256,756 277,451 297,230

Ending net assets $219,989 $256,756 $277,451 $297,230 $(1,194,532)

a New Day Products reclassified its program revenue and expenses in 2009. The comparative statements of change in net assets reproduce public information from New Day Products’ Form 990s submitted to the IRS. Schedule O of the filing that corresponds to the 2009 statement of change in net assets included the following note as supplemental information related to the prior period adjustment: ‘‘During the year it was realized that the director had paid for personal items and had not paid the required FICA for the past four years.’’

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Nancy John, New Day Products’ business manager, regularly attended board meetings. She oversaw many of the

organization’s administrative functions, including its accounting, payroll, and budget processes. She also prepared and

maintained the documents necessary to retain state government contracts and grant funding, both significant sources of

organization revenues. Nancy was openly critical of Steve’s leadership and some board members shared a similar sentiment.

Two additional board members left the organization to pursue other service opportunities, including the board treasurer, leaving

the board with no financial expertise and nine remaining members. Filling board vacancies proved difficult. A remaining board

member recalled that ‘‘as folks left the board, we would make an initial attempt at replacing their area of expertise, but things

would go on and we wouldn’t find a replacement.’’ In 2006, having lost confidence in Steve’s ability to lead the organization,

the board released Steve and appointed Nancy John as ED.

The Nancy John Years

Nancy John could have been two different people. To the board, she was a hardworking, engaged manager who was

‘‘always in control’’ of a situation. But to the staff, she was an intimidating micromanager who ran things ‘‘close to the vest,’’

never asked for input, and was quick to criticize, even punish, if things went unexpectedly. Immediately after assuming the ED

position, Nancy eliminated the business manager position as a ‘‘cost cutting move,’’ combining her prior position as business

manager with her new ED position. The change flattened the organization so that all managers reported directly to Nancy. The

new and prior organization charts, which were both presented to and approved by the board, are presented in Figure 1.

Another of Nancy’s first moves upon becoming ED was to transfer responsibilities for accounts payable from Jamie Davis

to Gail Hart. Jamie Davis had managed payables for several years and remained the office administrative assistant after the

change. But for Gail, the change was more meaningful. Formerly a minimum wage employee with a GED but no significant

business knowledge or experience, Gail, unbeknownst to the board or other staff, became the second-highest-paid staff member

in the organization. Nancy made Gail responsible not only for accounts payable but accounts receivable, and she took it upon

herself to personally train Gail in her new responsibilities. Gail’s job was to accumulate bills and present them to Nancy for

coding and approval. Gail then prepared the checks, which required two signatures including Nancy’s. To simplify the check-

signing and accounts payable process, Nancy instructed Gail to order signature stamps that would allow Nancy to stamp checks

with both required signatures, bypassing any benefit of having the control resulting from requiring two signatures on a check.

TABLE 2

Comparative Statements of Financial Position

At June 30,

2005 2006 2007 2008 2009

Cash $21,049 $74,019 $61,182 $56,986 $16,486

Accounts receivable 187,071 202,003 212,245 228,720 94,870

Inventories 119,100 125,250 130,600 136,230 50,662

Land, buildings, and equipment 49,088 42,085 115,201 111,839 100,709

Other assets — — — — 3,193

Total assets 376,308 443,357 519,228 533,775 265,920

Accounts payable 18,764 12,653 10,738 8,810 34,556

Mortgages 40,550 113,280 161,308 155,310 250,114

Unsecured notes payable — — — — 56,031

Accrued vacation 37,621 39,277 46,337 53,158 —

Payroll and sales taxes payable 18,607 21,391 23,394 19,267 1,119,751

Line of credit 40,777 — — — —

Total liabilities 156,319 186,601 241,777 236,545 1,460,452

Accumulated income 219,989 256,756 277,451 297,230 (1,194,532)

Total net assets 219,989 256,756 277,451 297,230 (1,194,532)

Total liabilities and net assets $376,308 $443,357 $519,228 $533,775 $265,920

The comparative statements of financial position reproduce public information from New Day Products’ Form 990s submitted to the IRS.

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In addition to her tendency to micromanage business processes, Nancy was known by her associates for another trait. One

manager recalled that ‘‘Nancy came in with a sense of entitlement. She basically kicked out the former ED by going to the

board with a number of allegations and then initiated a series of perks for herself including the construction of a private

restroom, gas cards to fuel her vehicle, and an expense account to cover the cost of almost daily ‘business’ meals.’’

Nancy frequently treated friends to lunch and wine or dinner and drinks, charging them to the company credit card. She

hired her husband to construct a private bathroom near her office for which the organization paid in excess of $40,000 in

material and labor. When questioned about her spending habits, Nancy would attempt to placate the questioning staff member

with gifts such as expensive bottles of wine for jobs well done. If the questioning continued, she replaced the staff member.

Nancy followed a similar approach for any staff member who was critical of her performance or questioned her methods or

policies. One staff member commented, ‘‘she didn’t hesitate to fire someone if she felt that they were not loyal. She created an

atmosphere where everyone was afraid of losing their job. Everyone was constantly looking over their shoulder.’’

To conceal her spending habits from the board, Nancy altered how New Day formatted its financial reports. Prior to Nancy

becoming ED, the board received annual budgets and detailed financial statements. Nancy no longer provided detailed annual

budgets and began abbreviating much of the previously provided information, including summarizing broad expense categories

into a single line item. As the board no longer included financial experts, no one objected to the lack of budgets and diminished

detail. Furthermore, the board no longer included a board treasurer. He departed two years earlier and had previously regularly

reviewed the ED’s credit card statement. During Nancy’s tenure as ED, the board met far less regularly, only once or twice a

year for Nancy’s updates. Board training and self-evaluation continued to be overlooked. After her second year as ED, Nancy

explained to the board that the broader deterioration of the organization’s financial picture was due to decreased funding from

federal and state sources. The board gave her the go-ahead to do what she needed to trim costs.

With her new self-assigned cost reduction mandate, Nancy eliminated the organization’s biannual audits (audits conducted

every two years) in favor of biannual financial statement reviews just months prior to when the organization’s first audit would

FIGURE 1 New Day Products Organization Charts

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have been performed with Nancy as ED. Because neither state statutes nor any of the organization’s funding sources required a

full audit, or even a financial statement review, Nancy reasoned with the board that a financial statement review would suffice

and was still more than what was absolutely required; a review was nearly as good as an audit, she explained, but would be less

expensive and less administratively burdensome. However, since the board was providing little to no financial oversight, the

switch from a biannual audit to a biannual financial statement review further diminished the organization’s overall financial

oversight. In the span of a few years, the organization went from strong internal financial oversight coupled with biannual

financial statement audits to little or no internal financial oversight coupled with biannual financial statement reviews.

Additionally, Nancy eliminated most employees’ employment benefits, while preserving her own and her family’s health

insurance. She also initiated certain personnel reductions, some of which were offset by questionable promotions and pay

increases. For example, Nancy replaced the current community services coordinator by promoting her daughter to the position.

Because Nancy’s daughter was promoted from within the department, the change eliminated her previous position. Much of

those cost savings, however, were offset as Nancy’s daughter received a new salary that was nearly 80 percent higher than that

of the previous coordinator. Similarly, other personnel reductions were partially offset when Nancy awarded herself an 11

percent pay raise.

Nancy never consulted the board with these changes, and the abbreviated financial reports combined with a lack of board

member financial expertise resulted in them not inquiring further. Notably, at the time Nancy John’s fraud was discovered, only

five board members remained, one of whom was seriously ill, leaving the board at one-third the size it had been throughout

much of Dick’s leadership and lacking many of the skillsets necessary to effectively oversee the organization. Fortunately,

Nancy’s changes caught the attention of her administrative assistant, Jamie Davis. Jamie had an ‘‘inkling that something wasn’t

quite right,’’ and she began documenting what she believed represented financial irregularities.

The Discovery

One of Nancy John’s rules was that she was the only one allowed to open the mail. If she was gone for a day or two, the

mail was placed on her desk, and she would open and route it when she returned. However, in December of 2009, Nancy had

decided to take the week of December 21 off, since the office would be closed anyway on Thursday and Friday for the

Christmas holiday. On Tuesday of Christmas week, a certified letter requiring a signature arrived from the IRS. Jamie Davis

signed for the letter and, believing it was urgent, opened it so that she could call Nancy to report on its contents. What she saw

shocked her. The letter stated that New Day Products owed the IRS in excess of $1 million in delinquent payroll taxes along

with interest and penalties that were attributable to the prior four years.1 Jamie had no idea what to do, but she felt strongly that

calling Nancy was not an option. Looking for guidance, she called Mike Williams, a manager she knew and trusted. Mike, who

knew Joy Robbins, the current board chair, immediately called her and told her ‘‘You’ve got to get down here right now. It

looks like we have a major problem!’’ When Joy arrived, Jamie showed her the letter and shared her misgivings about Nancy’s potential financial improprieties.

After reading the letter, Joy instructed Mike and Jamie to keep everything completely confidential until she could get the board

together to form an action plan. Two of the four remaining board members were traveling that week. Consequently, a meeting

would have to wait until the following week. Still, Jamie called the board members that she could reach and left messages for

the others. She notified them that there would be an emergency board meeting the following Monday. She also told them that

they were to keep the meeting notification confidential, especially from Nancy John. Next, she called New Day Products’

attorney, advising him of the situation and inviting him to the board meeting.

Nancy John returned to her office on Monday unaware of the circumstances. That evening, the board discussed the IRS

letter and reviewed Jamie’s notes. The attorney advised the board to engage a tax attorney and to place Nancy on paid leave.

She was not to be allowed into the building until further notice. Joy made the call to Nancy that evening.

The Investigation

The next day, Jamie and other key staff members began documenting questionable transactions. On Wednesday, they

contacted the local police department to report the fraud. A report was filed, and the investigation commenced immediately

after the Christmas holiday.

Rumors began circulating among the remaining staff and some of the organization’s clients that Nancy John was being

investigated for fraud and mismanagement. Concerns arose that the organization was in danger of dissolving. The local

newspaper caught wind of the investigation and called Joy for a comment. Joy admitted that an investigation had begun but that

no one had been charged. Moreover, she explained that she was very concerned about New Day’s developmentally disabled

1 The amounts were approximately $900,000 in overdue payroll taxes, $200,000 in penalties, and $20,000 in interest over the period 2005–2009.

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clients and the trauma and stress that a news story might trigger. She asked the paper to hold off reporting on the story until

more was known and until the organization had a plan to cope with the likely consequences. Perhaps surprisingly, the editors

agreed to hold off reporting the story for the time being.

Meanwhile, rumors continued to spread. Convinced that a crime had been committed that put the organization at risk of

financial collapse, staff members and clients became agitated and angry. Some repeatedly called the newspaper and police to

ask why they were not reporting the crime or investigating it more aggressively. Newspaper and police department

representatives contacted Joy to request that she ask her staff and organization clients to stop calling. Realizing the potential

harm that might befall New Day’s clients and staff if their fears continued unaddressed, Joy contacted the board and New Day

Products’ attorney to initiate a series of meetings with the staff, the organization’s clients, and their families. The board used the

meetings not only to inform the organization’s stakeholders, but also to help manage the resulting anger and stress. They

brought in extra counselors and social workers, but things were to remain rocky for a long time.

Selected board members, New Day staff, and a police investigator began sifting through the organization’s financial

records. They discovered Nancy had used organization funds for personal expenditures including credit card payments, home

utility payments, and retail club membership fees. After the board felt that they had gathered sufficient evidence, Nancy John’s

employment was terminated on January 20, 2010. The financial evidence suggested that Nancy had committed substantial asset

misappropriations. To better determine the types and amounts of the misappropriations, the police department strongly

suggested adding a forensic accountant to the investigation in February. New Day agreed and promptly did so. Pressured by the

timeframe imposed by the prosecuting attorney’s office, concerned about New Day’s weakened financial position and the

potential cost of a full forensic audit, and recognizing the low probability of collecting any significant restitution from Nancy,

the board asked the forensic accountant to break off its investigation and discovery efforts as soon as it identified total asset

misappropriations in excess of $100,000. Table 3 chronicles the significant events that followed the discovery of the fraud.

The Forensic Accountant’s Report

Over one year later, the forensic accounting firm submitted its report detailing the amounts misappropriated, including how

the amounts were stolen and who benefited. The report classified Nancy’s misappropriations into three schemes: an authorized

maker scheme, a falsified salary scheme, and a falsified payroll withholding scheme.

TABLE 3

Timeline of Significant Events that Followed Discovery of the Fraud

12/22/2009 � Jamie Davis opens an IRS letter notifying New Day Products of past due payroll taxes and penalties in

excess of $1 million. � Jamie notifies Joy, the board chair, who takes control of the organization.

12/28/2009 � The board places Nancy on paid leave.

12/29/2009 � The staff begin reviewing internal records and documenting questionable transactions.

12/30/2009 � The staff initiate a police investigation.

01/20/2010 � Nancy’s employment is terminated.

02/01/2010 � A forensic accountant begins investigating the misappropriation.

03/26/2010 � Jamie receives an anonymous phone threat to reveal unflattering personal information if she doesn’t cease

‘‘[expletive] with my friend Nancy.’’ 07/14/2010 � A police investigator meets with Jamie to discuss her history with the organization and its bookkeeping

practices and controls. They also discuss Gail Hart’s responsibilities as accounts receivable and payable

clerk.

10/04/2010 � New Day Products hires a new ED, Terry Fredrickson.

05/03/2011 � The forensic audit report is completed. It indicates that Nancy misappropriated at least $172,004. Terry

provides a copy of the report to the police.

08/01/2011 � The police charge Nancy with grand theft by embezzlement.

12/12/2011 � Nancy pleads not guilty.

03/12/2012 � Nancy pleads guilty during a plea bargain. � Nancy is sentenced to a fixed prison term of five years with a subsequent indeterminate term of three years. � The sentence is suspended in exchange for Nancy spending ten days in Bannock County Jail, paying

$20,000 in restitution to New Day Products, and receiving a supervised probation with the Idaho

Department of Correction for a period of ten years.

09/20/2013 � The court issues its final restitution order at $50,403.03, reflecting amounts that Nancy John either admitted

to or that were undoubtedly for personal use.

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In an authorized maker scheme, an employee having signature authority uses that authority to disburse funds for her own

or another’s benefit by signing her own name. The forensic accounting report indicates that Nancy John carried out an

authorized maker scheme from 2006 to 2010. The scheme amounted to $105,591 from 2006 to 2010, where $16,340 arose

from checks Nancy had authorized against the organization’s bank accounts and $89,251 corresponded to charges against the

company’s credit card. In one example, Nancy authorized invoices for new windows and a deck on her home, coding them for

expense and reimbursement purposes as leasehold improvements. The invoices included not only amounts due to The Home

Depot but also to Nancy’s husband. In another example, Nancy was reimbursed for personal purchases of wine, filet mignon,

and salmon coded as office supplies. Some of the checks and credit card charges for personal purposes were made to Cable

One, Dillards, Weightwatchers, Gamekeeper, Scentsy, ID Liquor Store, and Skinny You. In a third example, Nancy charged

the company credit card for airline tickets to San Diego and for a Caribbean cruise for herself, her husband, and another couple.

Following up with the other couple, the forensic accountant discovered that they had reimbursed Nancy for both trips. The

couple provided cancelled checks as proof of their reimbursement. However, Nancy kept the reimbursed funds.

The falsified salary scheme involved unauthorized raises. On June 28, 2006, the board authorized raises for New Day

Products employees who had been with the company for at least 12 months at 1.5 percent for a cost-of-living increase. This was

to continue each year unless otherwise changed by the board. Nancy John, however, authorized herself yearly raises of 9.8

percent, 32.6 percent, and 33.1 percent, in addition to the 1.5 percent increase authorized by the board. The total for ‘‘falsified

salary’’ amounted to $58,657.

In the falsified payroll withholding scheme, Nancy falsely reported her payroll withholdings to the IRS and the Idaho State

Tax Commission, so that she received as pay what should have been withheld and forwarded to the taxing authorities. The amount

directly attributable to Nancy’s pay totaled $7,757. Additionally, payroll taxes that were shown as withheld from New Day

employees’ paychecks were not recorded as payroll tax liabilities on the company’s financial statements and not remitted to the

IRS. Payroll expense was recorded at the net amount on the New Day financial reports. Payroll tax returns were filed, but the

withheld payroll taxes were not remitted with the returns due to deteriorating operating cash flows and Nancy’s continuing

misappropriations and management perks. By this point, New Day did not have adequate cash to cover its payroll tax and

withholding obligations. The failure to remit the taxes resulted in not only overdue taxes but also substantial interest and penalties.

In summary, the forensic audit report identified at least $172,004 (authorized maker scheme of $105,591, falsified salary of

$58,658, and falsified payroll withholding reporting of $7,757) in misappropriations that benefited Nancy directly that were

difficult to justify as legitimate business expenditures between January 1, 2006 and February 28, 2010. The report concluded

that Nancy John was able to perform the various types of fraudulent schemes due to ‘‘the lack of sufficient separation of duties

within New Day Products’’ and ‘‘minimal written policies governing the recording of the Organizations accounting

transactions’’ and because ‘‘some policies were not enforced or were by-passed by management.’’

The Court’s Ruling

On September 20, 2013, the court issued its final restitution order. The order stated:

At the outset the Court notes that the evidence in this case certainly supports the conclusion that John was a poor

financial manager and that New Day has suffered significant financial losses and problems as a result of Defendant’s

mismanagement during her term as the Executive Director. However, it can also be said, and was said by those witnesses

for the State that evaluated the records in this case, that New Day had inadequate controls and oversight in place to

correct mismanagement or to discover and respond to criminal conduct. Certainly the evidence supports the conclusion

that New Day has now instituted better oversight procedures to prevent such mismanagement and/or criminal conduct in

the future. This being said, the Court’s challenge is to, consistent with the standards listed above, determine which losses

or claims by New Day were ‘caused,’ both actually and proximately, by the criminal conduct of Defendant to which she

pled guilty. While the court does not doubt that New Day has suffered substantial financial losses resulting from the

overall management and criminal conduct of Defendant, the only restitution that can be ordered is that which is

attributable to criminal conduct, not to mismanagement. (Bannock County District Court 2011)

In summary, New Day Products was denied full restitution for Nancy’s actions because some actions were

indistinguishable from, or could be construed as, ineffective but purposeful management decisions.

The order continued, indicating that the board’s lack of oversight, including lack of internal controls, might have provided

an opportunity for the ‘‘unauthorized expenses,’’ and the board did not question the salary increases even though they were

included in periodic reports. The Court again reiterated that New Day Products did not ‘‘prove’’ that many of the alleged

misappropriations were not business expenses. Rather, New Day Products opined that the amounts would not be expenses

incurred in the conduct of its ordinary business. In conclusion, the order set restitution at only $50,403.03, reflecting amounts

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that Nancy John either admitted to or that were undoubtedly for personal use. The costs of the private restroom, her daughter’s

promotion, and many of the meal costs were among the many items not included in the restitution settlement amount.

Upon further assessment, the court agreed that, because Nancy was unable to make any larger payment, she would make

monthly restitution payments to New Day Products of $100/month. As part of Nancy’s guilty plea, she received a criminal

sentence of five years in prison, later commuted to ten days in jail with ten years of probation. While the final sentence and

restitution might appear minimal, they did leave Nancy with a criminal record, likely impairing her professional future.

The Aftermath

Misappropriations, reckless spending, mismanagement, and litigation costs left the organization with less than $2,500 in

cash, a traumatized staff and clients, and a liability to the IRS in excess of $1 million for unpaid FICA payments plus interest

and penalties.2 In the year leading up to Nancy John’s termination, the organization lost federal and state contracts, and funding

from the United Way and the local Civitan’s group. Each was integral to New Day Products’ ability to serve its clients.

In 2010, the board hired a consultant to handle bookkeeping duties and establish a system of financial controls. It also hired

a new ED, Terry Fredrickson, who came with a strong background in management and counseling. His skills were vital to

managing the company’s recovery, including over the next several months assisting the forensic accountant and others with the

investigation. With his counseling skills, Terry was able to help employees, clients, customers, and members of the community

cope with the trauma that they had experienced in the aftermath of Nancy’s leadership. Terry actively recruited additional board

members with appropriate areas of expertise, and he assessed and redesigned New Day Products’ organizational structure and

operating policies, with the board’s approval.

With the help of New Day Products’ tax attorney, Terry negotiated a settlement with the IRS for the payroll tax liability.

The settlement burdened New Day Products with considerable debt but satisfied the entire tax liability by 2016. Under Terry’s

leadership and with strong community support, the organization has again begun to prosper and fulfill its mission.

II. CASE REQUIREMENTS

1. Summarize the general attributes and responsibilities of a board of directors. In what ways does the board of a nonprofit

organization significantly differ from that of a for-profit organization?

2. Consider the state of the organization’s board of directors immediately prior to the fraud’s discovery. Evaluate the

board’s oversight given what you now know about a board’s oversight responsibilities. Identify three specific activities

that the board no longer performed or could have done differently that might have prevented the fraud from occurring.

In your discussion, be sure to describe what each activity would have accomplished to help prevent the fraud.

3. Using the fraud triangle as a guide, speculate on the incentives/pressures, opportunities, and attitude/rationalizations

that are present in the case relative to Nancy John, the newly promoted executive director (ED) at New Day Products,

that may have contributed to fraud and/or embezzlement.

4. Consider the differences between financial statement reviews and financial statement audits by examining their

respective standards, specifically those of the American Institute of CPAs (AICPA), AR-C 90A paras. .04 and .39 and

AU-C 200 paras. .04 and .06.

a. Contrast the objectives of financial statement reviews and financial statement audits, and contrast the levels of

assurance provided by each.

b. Given that neither an audit nor a review was required by the state or the organization’s funding sources, why might

an organization like New Day Products still have wanted to undertake one?

c. Is it reasonable to expect that the fraud would have been discovered by a financial statement audit? Why or why not?

d. Why might Nancy have preferred a financial statement review over a financial statement audit if she were trying to

decrease the probability of the fraud being detected?

5. Assume that periodic audits rather than reviews continued for the duration of Nancy’s term as ED and that you were on

the audit team and participating in the team meeting discussion considering fraud risk.

a. Identify several (8–10) internal control weaknesses that are ‘‘red flags’’ related to perceived opportunity that would

have indicated the potential for fraud in the case.

b. What changes to the year-end audit program would the audit team make as a response to the ‘‘red flags’’ that they

identified during the assessment of fraud risks and the evaluation of internal controls?

c. Why might a financial statement review not have picked up on any of these ‘‘red flags’’?

2 In Form 990 for June 30, 2009, a prior period adjustment of $1,332,180 was reported. In the Schedule O, the prior period adjustment was described as follows: ‘‘During the year it was realized that the director had paid for personal items and had not paid the required FICA for the past four years.’’

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6. Do you agree with the judge’s ruling regarding Nancy John’s culpability for the fraud? Why or why not?

REFERENCES

American Institute of Certified Public Accountants (AICPA). 2017. Not-for-profit governance & management resources. Available at:

https://www.aicpa.org/interestareas/notforprofit/resources/governancemanagement.html

Bannock County District Court. 2011. State of Idaho vs. Nancy K John, CR-2011-12639. Pocatello, ID.

Epstein, M. J., and F. W. McFarlan. 2011. Nonprofit vs. for-profit boards: Critical differences. Strategic Finance 92 (9): 28–35.

Grant Thornton. 2016. Not-for-Profit Board Guidebook. Available at: https://www.grantthornton.com/content/dam/grantthornton/website/

assets/content-page-files/nfp/pdfs/2016/NFP-Board-guide/nfp-board-guide.pdf

Independent Sector. 2015. Principles for Good Governance and Ethical Practice. Washington, DC: Independent Sector. Available at:

https://www.independentsector.org/wp-content/uploads/2016/11/Principles2015-Web-1.pdf

Mann, G. A. 2006. A motive to serve: Public service motivation in human resource management and the role of PSM in the nonprofit

sector. Public Personnel Management 35 (1): 33–47. https://doi.org/10.1177/009102600603500103

National Council of Nonprofits. 2020. Nonprofit audit guide. Available at: https://www.councilofnonprofits.org/nonprofit-audit-guide

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