Molex Case Study (finance/mgt)

FIN 485

Wed: Molex Case Write Up

Q1: Does the error represent a material misstatement?

According to GAAP, information is material "If its omission or misstatement could influence the economic decision of users taken on the basis of the financial statements." Based on this definition and the following ratios, we believe Molex did in fact misstate the Balance Sheet and Income Statements for the period ending in June of 2004. In September, prior to making these errors public information, Molex released its yearly financials indicating it earned $175,950,000 in Net Income [Exhibit 2]. This numeric includes the overstatement to income of $5,800,000, after tax value, representing roughly 3.3% of the Net Income. The case describes how inventory is overvalued by $8 million, which would decrease Inventory in June of 2004 from $265,344 million to $257,244 million. This is a substantial 3.15% over representation of the companies inventory. By recognizing profits on inventory sales between subsidiaries, Molex is effectively sending bad data to investors who depend on accurate information. Comparing the gross margins from one period to the previous period produces the gross margin index. When the GMI is greater than 1 the company's gross margins have deteriorated and management is motivated to show better numbers. Like the SGI, the GMI sounds a potential note of caution for material misstatement. Molex’s GMI was calculated by comparing 2003 and 2004 financial highlights in Exhibit 2, which roughly equaled .9 indicating potential earnings manipulation.

Q2: Reasons/factors for the reluctance to disclose information

There are many factors that led to Molex not relaying the information to Deloitte & Touche. First, we will address general business environment factors that led to this reluctance. Two years prior to this error, publicly traded companies such as Enron and Tyco International (Molex top competitor) manipulated earnings which led to the collapse of their stock price, costing investors billions of dollars. This misrepresentation shook the public’s confidence in security markets and inevitably led to regulation in terms of financial reporting. The Sarbanes-Oxley Act of 2002 held top executives, such as Mr. King and Ms. Bullock, personally responsible for intentional or accidental misrepresentation of balance sheets, income statements, etc. These changes in the business environment should have influenced Molex’s management to report the errors immediately on July 21, 2004. These errors however affected results for several years, so perhaps management thought it was necessary to “dress up” the errors to make them look as immaterial as possible. Exhibit 1 in the case shows NASDAQ’s stock price fluctuations throughout