ACT 580 CSU Global Module 2 Fraud Risk Brainstorming at Tesla Case Study

This article summarizes a research study carried out by ACFE in order to understand what technologies are being used to prevent and detect fraud. Surveys were sent to 80,011 ACFE members and 884 responded. The major findings highlighted by the report include:

Main data analysis techniques used to prevent fraud were exception reporting and anomaly detection which is used by 55% of respondents and 13% stated that they expect to adopt these technologies in the next two years. This shows a 9% decrease of active users compared to a similar report prepared on 2019. The second most widely used data analysis technique was automated reg flags which was used by 54% of respondents and 17% stated that they would adopt this technology in the short term. The percentage remained the same compared to the previous 2019 report. Artificial intelligence and machine learning techniques were only used by 17% of respondents but 26% of them stated that they would adopt them in the short term.

The most commonly used software applications for implementing exception reporting and anomaly detection were Excel, in-house apps. ACL. IDEA, and SAS. The most common applications for implementing automated red flags were Excel, SAP, ACL, and SAS.

ACFE & SAS. (2022). Anti-Fraud Technology Benchmarking Report. In Fraud-magazine.com (pp. 1–30). ACFE.

https://www.fraud-magazine.com/whitepapers.aspx

Option #1: Fraud Risk Brainstorming at TeslaRead the following case study:Hess, M. F., & Andiola, L. M. (2018). Fraud risk brainstorming at Tesla MotorsLinks to an external site.. Issues in Accounting Education, 33(2), 19–34.Case Requirements:In a paper, address the following questions.Fraud risks related to Tesla’s culture, leadership, and governance structure.How would you describe the ‘‘tone at the top’’ set by Tesla’s leader, Elon Musk? How do Mr. Musk’s leadership style and his ‘‘tone at the top’’ contribute to possible fraud risk at Tesla Motors?How would you describe the company’s culture? How might this culture create pressures and rationalizations for fraud?Review Tesla’s Code of Business Conduct and Ethics (see ‘‘Tesla’s Code of Business Conduct and Ethics’’Links to an external site.). How might any potential weaknesses in this code contribute to fraud risk at this company?Describe some possible concerns regarding Tesla’s board of directors. How might these concerns create opportunities and rationalizations for fraud?Fraud risks related to Tesla’s incentive structures and stock performance.To what extent are executives and employees incentivized with shares and stock options? [See Tesla’s 2015 Annual Report,Links to an external site. Item 7 Management’s Discussion and Analysis (MD&A) and Item 8 Financial Statements and Supplementary Data section, Note 10.]How do these pay structures create pressures/incentives for fraud?Review Tesla’s stock performance over the last two years (refer to Exhibit 3 in the article). What fraud pressures are created by this stock performance?Fraud risks indicated by the results of preliminary analytical procedures.What fraud risks may be indicated by the year-to-year comparisons of Tesla’s financial statements? (Refer to Exhibits 1 and 2 in the article.) Be specific.How does the company perform relative to its peers? (Refer to Exhibit 4 in the article.) Do these ratios and trends seem reasonable? Be specific.Assignment Paper Requirements:Write a paper (memo) of a minimum of six double-spaced pages, not counting the title and reference pages, which you must include.Copy and paste each one of the questions above into your paper in bold type to ensure you have answered each of the requirements.Use terms, evidence, and concepts from class readings, including professional business language.Cite at least three credible academic or professional sources for this assignment.

ISSUES IN ACCOUNTING EDUCATION
Vol. 33, No. 2
May 2018
pp. 19–34
American Accounting Association
DOI: 10.2308/iace-51973
Fraud Risk Brainstorming at Tesla Motors
Megan F. Hess
Washington & Lee University
Lindsay M. Andiola
Virginia Commonwealth University
ABSTRACT: This instructional case offers students the opportunity to explore the fraud risk assessment process
and participate in a simulated fraud brainstorming session as required by AS 2401 (formerly SAS 99) for financial
statement audits. Drawing on publicly available information about Tesla, Inc. (formerly Tesla Motors), the
revolutionary company behind the popular Model S all-electric vehicle, the case materials guide students through
multiple learning objectives. These objectives include learning how to: (1) recognize the factors that contribute to
financial statement fraud risk; (2) identify and evaluate the likelihood and severity of fraud risks; (3) analyze the ways
that fraud risks can lead to material misstatements in the financial statements; (4) understand the purpose of and
how to conduct a fraud brainstorming session; and (5) develop audit procedures that respond to assessed fraud
risks. In a post-case learning assessment, students reported significant improvement in their knowledge,
comprehension, and application of these learning objectives. Students also indicated that they enjoyed learning
about these concepts in the context of this popular company. This case has both an individual and a group
component, and it is designed for use in an auditing or forensic accounting course at either the undergraduate or the
graduate level.
Keywords: fraud risk factors; fraud triangle; brainstorming session; fraud risk matrix; AS 2401; SAS 99.
INTRODUCTION
O
ne of the most important skills needed by accountants today is the ability to analyze and detect fraud risks (Carpenter
2007; Center for Audit Quality [CAQ] 2010; PricewaterhouseCoopers [PwC] 2015). The Association of Certified
Fraud Examiners (ACFE 2016) estimates that the typical organization loses 5 percent of its revenues every year to
fraud. Beyond these losses, financial statement frauds also have far-reaching negative consequences on investors, employees,
suppliers, and other stakeholders of the corporation. Because of the importance of fraud detection to the integrity of our
markets, auditing standards (i.e., Public Company Accounting Oversight Board [PCAOB] 2016a, 2016b, AS 2401; American
Institute of Certified Public Accountants [AICPA] 2006, AU Section 316; International Federation of Accountants [IFAC]
2008, ISA 240) require that accountants fulfill their responsibility to obtain reasonable assurance that the financial statements
they audit are free of material misstatement due to error or fraud. In particular, Auditing Standard (AS) 2401 (formerly
Statement on Auditing Standards No. 99), Consideration of Fraud in a Financial Statement Audit, requires that fraud risk
brainstorming sessions be incorporated into every audit engagement. These sessions are designed to increase the probability
that auditors will detect intentional misstatements and to help set the right tone for professional skepticism and heightened
sensitivity to fraud risk throughout the engagement (Ramos 2003).
YOUR TASK
This case requires you to imagine that you have been asked to participate in a fraud risk brainstorming session as part of
the planning procedures for the 2016 financial statement audit of Tesla Motors. This case has two parts. In Part I, you will read
We thank Allen D. Blay (associate editor) and two anonymous reviewers for their valuable input and guidance. We also thank Mary Durkin, Jared Eustler,
Gary Sullivan, and Kim Westermann, as well as participants at the 2016 AAA Forensic Section Midyear Meeting for their feedback and assistance.
Finally, we thank Anthony Williams for his research assistance.
Supplemental materials can be accessed by clicking the links in Appendix B.
Editor’s note: Accepted by Valaria P. Vendrzyk.
Submitted: March 2016
Accepted: November 2017
Published Online: November 2017
19
Hess and Andiola
20
background information on Tesla Motors, learn how the concept of the ‘‘fraud triangle’’ is used to identify fraud risk factors,
and work to complete the Part I case requirement questions designed to help you identify some of the financial statement fraud
risks associated with this company.
In Part II, you will learn how to conduct a fraud risk brainstorming session and how to adapt your planned procedures to
respond to identified fraud risks. After reading Part II, you will work as part of an audit team to conduct a fraud risk
brainstorming session. During this session, your team will be responsible for completing a fraud risk matrix and writing up a
memo for the audit file that documents the results of your fraud risk assessment and identifies how your team believes the
nature, timing, and extent of the audit procedures should be altered to respond to these identified risks.
It is important to note that as of September 2017, Tesla Motors has not been accused of financial statement fraud.
Nevertheless, you and your team should resist the natural inclination to presume that management is honest, and exercise
professional skepticism in evaluating fraud risks at this company. Auditing standards remind us that we should conduct the
engagement with a mindset that recognizes the possibility that a material misstatement due to fraud could be present, regardless
of any past experience with the entity and regardless of the auditor’s belief about management’s honesty and integrity (PCAOB
2016a).
PART I
Tesla Motors Case Background
Founding and History of Tesla Motors
Tesla Motors (NASDAQ: TSLA) was founded in 2003 by a group of engineers in Silicon Valley with the vision of
accelerating the world’s transition to sustainable transport. To that end, Tesla Motors has created ‘‘cars without compromise’’—
that is, all-electric vehicles that offer all of the torque, power, and style of high-end automobiles with none of the emissions.
The company’s mission is ‘‘to accelerate the advent of sustainable transport by bringing compelling mass market electric cars to
market as soon as possible’’ (Tesla Motors 2015). Tesla’s first release was the Roadster in 2008, which offered 0 to 60 mph
acceleration in 3.7 seconds and a range of 245 miles per charge of its lithium-ion battery. In 2012, Tesla launched the Model S,
a four-door sedan that was named Motor Trend’s 2013 Car of the Year. At the beginning of 2016, with more than 107,000
vehicles on the road worldwide, Tesla’s product line expanded to include the Model X, a crossover vehicle that entered volume
production at the end of 2015, and the Model 3, a lower-priced vehicle with an expected release in 2017. However, Tesla does
not limit its vision to only automobiles. The company is described as ‘‘a technology and design company with a focus on
energy innovation’’ (Tesla Motors 2016b).
Tesla has revolutionized the automobile industry in many ways. In addition to proving that all-electric vehicles can
perform as well, if not better than, gas-powered vehicles, Tesla has challenged the conventional approach of how vehicles
are sold. Rather than selling through dealership franchises, Tesla sells and services its vehicles through its own network,
including acceptance of online orders. To help establish the value of the Tesla brand and encourage early adopters to buy
their vehicles, Tesla offers ‘‘resale value guarantees’’ to customers. Under this program, customers have the option of selling
their vehicle back to Tesla Motors during the period of 36 to 39 months after delivery for a pre-determined resale value
(Tesla Motors 2016b).
Due to widespread publicity and generally positive reviews of the vehicles, Tesla has enjoyed greater demand for its
vehicles than it can fulfill. As such, the company has been collecting deposits from customers at the time they place an order for
a vehicle and, in some locations, at certain additional milestones up to the point of delivery. In addition, a closer look at Tesla’s
income statement reveals that Tesla sells much more than just cars. Tesla also earns revenue from related services, including
access to its Supercharging network and software updates on the vehicles. Tesla also earns revenue from the sale of regulatory
credits from energy tax credits and from the sale of components to other manufacturers. Finally, Tesla earns revenue from
‘‘Tesla Energy,’’ a division of the company offering battery-powered energy solutions for home, businesses, and utilities (Tesla
Motors 2016b). Tesla’s income statement and balance sheet for the past three years are presented in Exhibit 1 and 2,
respectively.
Tesla launched an initial public offering in June 2010 that raised $226 million in equity. At the time, the company
employed less than 1,000 employees and had less than $150 million in revenue. The company has since experienced rapid
growth. During the period 2011–2015, revenues have grown more than 1,000 percent from $204 million in 2011 to $4.1 billion
in 2015. After several years of trading between $22 and $33 per share, Tesla’s surprise announcement of quarterly profits in
2013 drove the stock into the triple-digits (Taylor 2013). In March 2016, the company enjoyed a market capitalization of
almost $30 billion and traded at about $200 per share. Tesla Motors stock performance for the period 01/01/2014 to 03/31/2016
is provided in Exhibit 3.
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EXHIBIT 1
Tesla Motors Income Statement
Tesla’s Leadership
Tesla Motors is led by CEO and co-founder Elon Musk. Mr. Musk made his fortune as a co-founder of PayPal, which was
acquired by eBay in 2002 for $1.4 billion. He is also the CEO of Space Exploration Technologies Corp., better known as
SpaceX, a company that aims to develop the world’s first private spacecraft for commercial space travel, and he is chairman of
the board of SolarCity Corporation, a company that aims to expand the availability of clean, affordable energy. A self-made
man and serial entrepreneur, Mr. Musk’s innovations and charisma have earned him the reputation as a ‘‘real-life Iron Man’’ in
reference to the Marvel Comics super hero (Smith 2014).
Mr. Musk is known for his bold vision and his even bolder proclamations. In a live interview in 2009, he called a New York
Times journalist that wrote a critical review of Tesla an ‘‘idiot’’ (https://www.youtube.com/watch?v¼rwDU–NPqZ0; see also,
http://www.businessinsider.com/elon-musk-calls-times-writer-a-huge-douchebag-and-an-idiot-video-2009-4). In an early 2015
earnings call with analysts, Mr. Musk also declared that he thought Tesla’s market capitalization could rival Apple Inc.’s $700
billion in the next ten years, which would be more than the market capitalizations of Ford Motor Company, General Motors
Company (GM), Honda Motor Company, Ltd., Toyota Motor Corporation, BMW, and Mercedes-Benz combined. Mr. Musk
made this declaration in the face of production delays, weakening market conditions, and falling gas prices, which has
traditionally made the sale of electric cars more difficult.
Tesla’s future prospects appear to depend on Mr. Musk’s ability to achieve feats that other carmakers would never dream
of. As an incentive for him to make his bold vision a reality, Tesla’s Board of Directors granted 5,274,901 stock options to Mr.
Musk that will ‘‘vest’’ or become available to him to exercise based on his ability to lead the company toward meeting specific
production and performance goals, including the successful completion of the Model X and Model 3 prototypes and reaching
100,000 units in total vehicle production (Tesla Motors 2016b).
In addition to overseeing Mr. Musk’s plans and providing the company with guidance, Tesla’s Board of Directors is tasked
with protecting the interests of Tesla’s stockholders, including the responsibility for risk oversight. Following best practices for
corporate governance, Tesla’s guidelines suggest that the majority of Tesla’s directors should be ‘‘outsiders,’’ meaning noncompany employees, and it has a standing Audit Committee to which both internal and external auditors report directly (Tesla
Motors 2016a). Some have raised concerns, however, about whether Tesla’s board is as independent as it appears. CtW
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EXHIBIT 2
Tesla Motors Balance Sheet
Investment Group, which works with union-based pension funds and holds 200,000 shares of Tesla, recently called on the
company to separate the chairman of the board and CEO roles, both of which Elon Musk now holds, and to prohibit immediate
family members from serving on the board (Sage 2016). Mr. Musk’s brother, Kimbal Musk, currently serves on the boards of
both Tesla and SpaceX. Board member Brad Buss is also a former employee of SolarCity, Mr. Musk’s related company.
Tesla’s Employee Culture
Tesla’s culture has been described as ‘‘high risk, high reward,’’ and the company prides itself on operating like an internet
startup (Fehrenbacher 2015). Employees regularly work long hours and the atmosphere has been described as ‘‘grueling.’’
Nevertheless, many employees have enjoyed big payouts because of their association with Tesla. In mid-2015, Jerome Guillen,
then Tesla’s Vice President of Sales and Services, exercised options and sold shares netting him $4 million. Guillen has
subsequently taken a leave of absence from Tesla. In addition, Tesla’s longtime CFO, Deepak Ahuja, has recently retired from
Tesla after making millions by exercising his stock options in 2015. While the environment may be one of high pressure for
employees, many may enjoy working in the innovative and mission-driven environment Tesla promotes. As an example of
Tesla’s commitment to transparency and the advancement of energy alternatives, Tesla made the radical announcement that it
would not initiate patent lawsuits against anyone who, in good faith, wanted to use its technology (Tesla Motors 2015).
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EXHIBIT 3
Tesla Motors (TSLA) Stock Performance
(01/01/2014–03/31/2016)
Source: Stock chart from Yahoo! Finance.
Challenges for Tesla and Its Future
Despite the company’s rapid growth and popularity, Tesla has also experienced a number of setbacks. The company has
struggled to reach desired production levels, which has resulted in lengthy delays for customers. Competitors, such as BMW,
Nissan Motor Company Ltd., and GM, have been developing all-electric alternatives and boast much higher production and
distribution capabilities than Tesla. Exhibit 4 presents a peer comparison of Tesla’s financials with current competitors. In
addition, analysts have raised questions about Tesla’s reliance on emissions credits to shore up losses and the company’s
exposure to lawsuits and lobbying by dealership unions to block states from allowing direct automotive sales to consumers
(Taylor 2013).
Moreover, while Tesla’s Model S achieved an overall five-star safety rating by the National Highway Traffic Safety
Administration, questions about the safety of Tesla’s new technology have continued to plague the company. In November
2013, a class action lawsuit was filed against Tesla and Mr. Musk, alleging that he had made false and/or misleading
representations with respect to the safety of the Model S. The case was dismissed in September 2014 by the trial court, but the
plaintiff’s appeal is still pending as of early 2016 (Tesla Motors 2016b).
Tesla has big plans for the future of its business. With the popularity of Tesla’s vehicles continuing to climb, the company
has begun to expand its operations. Among these expansions, the company has invested in an assembly facility in The
Netherlands and a specialized production plant in Lathrop, California. Tesla has also entered into strategic partnerships with
companies like Panasonic Corporation to focus on reducing the costs of lithium-ion battery packs. In addition, Tesla recently
announced the beginning of construction on its multi-billion-dollar investment in a ‘‘Gigafactory’’ in Nevada that will facilitate
production of more affordable electric vehicles and battery-powered energy alternatives (Tesla Motors 2015).
According to the company’s 2015 annual report, Tesla plans to continue expanding stores and its service infrastructure
worldwide. The company will invest $1.5 billion in capital expenditures in equipment to support cell production at the
Gigafactory, to begin installation of Model 3 vehicle production machinery, to open about 80 retail locations and service
centers, and to energize about 300 new Supercharger locations (Tesla Motors 2016b). These bold expansion plans could put
Tesla at the center of an energy revolution, or they could cause the company to implode under the weight of significant debt
levels and even greater expectations.
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EXHIBIT 4
Peer Comparison
Using the Fraud Triangle to Identify Fraud Risk Factors
Auditing standards define fraud as an intentional act that results in a material misstatement in the financial reports (PCAOB
2016a). Research shows that fraud is more likely when three conditions are present: incentives or pressures, opportunities, and
attitudes or rationalizations. These three conditions are known collectively as the ‘‘fraud triangle’’ (Cressey 1953). Auditors use
the fraud triangle as a tool to help identify areas of risk during the fraud risk brainstorming process. These risks are referred to
as fraud risk factors. The next section describes each of the three conditions in more detail and provides examples from recent
research of how each condition is linked with fraud.
The first leg of the fraud triangle is incentives or pressures. This condition is present whenever management and/or
employees have incentives or are under pressures to commit fraud (Arens, Beasley, and Alvin 2010). Research shows that when
management compensation is tied to earnings and/or stock performance (e.g., bonuses, stock options), the likelihood of fraud is
higher (Healy and Wahlen 1999; Fields, Lys, and Vincent 2001). Other incentives than greed can also contribute to fraud risk.
A recent study finds that CFOs may become involved in deceptive accounting practices not for personal financial gain, but
rather to appease their CEOs and protect their jobs (Feng, Ge, Luo, and Shevlin 2011). Performance pressures also cause
managers and employees to engage in fraud. A recent survey finds that 64 percent of employees engage in unethical behavior
because they feel pressure to ‘‘do whatever it takes’’ to meet business targets (KPMG 2013). Changes in the external
environment, such as declines in customer demand, increased competition, or new regulations can threaten the financial
stability of a firm and generate pressure to ‘‘cook the books’’ and create the appearance of success while the firm attempts to
adapt to the environmental changes. Paradoxically, both high-performing firms (e.g., MacLean 2008; Mishina, Dykes, Block,
and Pollock 2010) and low-performing firms (e.g., Harris and Bromiley 2007; Zhang, Bartol, Smith, Pfarrer, and Khanin 2008)
have higher risks of financial statement fraud because both situations put pressure on executives to meet or exceed last period’s
earnings. Managers at poorly performing firms may also feel pressure to manipulate earnings or inflate asset balances in order
to meet debt covenant requirements and avoid defaulting on loans.
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The second leg of the fraud triangle is opportunities. This condition is present whenever circumstances allow management
or employees to commit and conceal fraudulent behavior (Arens et al. 2010). Many different factors create opportunities for
fraud. The use of significant accounting estimates creates opportunities for earnings management and fraud, especially in the
area of reserves, allowances, and depreciation (PCAOB 2016c). Difficulty in verifying estimates and valuations also creates
opportunities for manipulation, particularly in areas such as intangible assets and Level 3 fair market valuations (PCAOB
2016d). In addition, fraud risks are higher when internal controls are weak or ineffective, when company policies are
ambiguous or enforced unevenly, or when oversight of financial reporting is inadequate; all of these circumstances make it
easier to commit and conceal fraudulent activity. Finally, transactions and financial relationships with related parties can create
opportunities to commit and conceal fraud (PCAOB 2016b).
The last leg of the fraud triangle is attitudes or rationalizations. This condition is present whenever management or
employees exhibit an attitude, character, or set of ethical values that would enable committing a dishonest act (i.e., ‘‘bad
apples’’) or whenever the environment imposes sufficient pressure on management or employees to cause good people to
rationalize engaging in bad behavior (i.e., ‘‘bad barrels’’) (Treviño and Youngblood 1990; Arens et al. 2010). Auditors should
be alert to the risk of bad apples for situations in which management has a history of being dishonest and violating laws and
regulations, or a reputation for making overly aggressive or unrealistic forecasts. In these circumstances, auditors should be
skeptical of management’s integrity and the veracity of their statements. Auditors also need to identify circumstances in which
good people may be tempted to make bad choices. Under the right pressure(s), managers and employees can rationalize
fraudulent activity as acceptable or even necessary, and thus disengage from the feelings of guilt and regret that normally
prevent people from behaving dishonestly. For example, management might rationalize financial statement fraud if the act
prevents the loss of jobs or the closure of the business. Employees can also rationalize stealing from a company as ‘‘getting
what they are due’’ if they feel underpaid or underappreciated. Finally, managers might rationalize committing fraud if they
suspect that competitors are doing the same.
Detecting rationalization risks can be difficult, but auditors should be alert for potential indicators such as the use of
euphemistic language, social norms in the company and/or industry that treat dishonesty as a part of doing business, and the
tone at the top set by the company’s CEO. A CEO who explicitly values ethics and honesty and emphasizes not only results,
but also the just means used to reach those results can foster ethical choices, whereas a CEO who is perceived as unethical or
even ethically neutral can foster an environment in which fraud is more easily rationalized (Treviño, Hartman, and Brown
2000).
By examining fraud risk factors using the three legs of the fraud triangle, auditors may develop more accurate fraud risk
assessments and become better prepared to alter the nature, timing, and extent of their audit procedures to respond to these
identified risks.
Part I Case Requirements: Identifying Fraud Risk Factors
You should work individually to complete responses to each of the assigned case requirement questions using the
information on Tesla Motors provided above and, where noted, in the case supplements, available for download in Appendix B.
Your responses should be completed before proceeding to Part II.
1. Fraud risks related to Tesla’s culture, leadership, and governance structure.
a. How would you describe the ‘‘tone at the top’’ set by Tesla’s leader, Elon Musk? How do Mr. Musk’s leadership
style and his ‘‘tone at the top’’ contribute to possible fraud risk at Tesla Motors?
b. How would you describe the company’s culture? How might this culture create pressures and rationalizations for
fraud?
c. Review Tesla’s Code of Business Conduct and Ethics (see Appendix B for the link to ‘‘Tesla’s Code of Business
Conduct and Ethics’’). How might any potential weaknesses in this code contribute to fraud risk at this company?
d. Describe some possible concerns regarding Tesla’s board of directors. How might these concerns create
opportunities and rationalizations for fraud?
2. Fraud risks related to Tesla’s incentive structures and stock performance.
a. To what extent are executives and employees incentivized with shares and stock options (see Appendix B for the
link to ‘‘Tesla’s 2015 Annual Report,’’ Item 7 Management’s Discussion and Analysis (MD&A) and Item 8
Financial Statements and Supplementary Data section, Note 10)? How do these pay structures create pressures/
incentives for fraud?
b. Review Tesla’s stock performance over the last two years (refer to Exhibit 3). What fraud pressures are created by
this stock performance?
3. Fraud risks related to revenue recognition at Tesla.
a. What does Tesla sell and how does the company account for revenue, accounts receivable, and COGS (see ‘‘Tesla’s
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26
2015 Annual Report,’’ Item 1 Business, Item 7 MD&A, and Item 8 Financial Statements and Supplementary Data,
Note 2)?
b. How might these revenue-recognition practices create opportunities, incentives, and/or rationalizations for fraud?
4. Fraud risks related to Tesla’s business and operating conditions.
a. Review the business risks disclosed by the company (see Tesla’s 2015 Annual Report, Item 1A Risk Factors and
Item 8 Financial Statements and Supplementary Data, Note 2 and Note 13). How might some of these business risks
from the external environment also create fraud risks within Tesla?
b. What fraud risks are posed by Tesla’s expansion plans and the company’s ability to operate as a going concern (see
‘‘Tesla’s 2015 Annual Report,’’ refer to Item 1A)?
c. What related-party transactions support Tesla’s financial performance (see ‘‘Tesla’s 2015 Annual Report,’’ Item 1
Manufacturing)? How might these transactions create opportunities for fraud?
5. Fraud risks indicated by the results of preliminary analytical procedures.
a. What fraud risks may be indicated by the year-to-year comparisons of Tesla’s financial statements (refer to Exhibits
1 and 2)?
b. How does the company perform relative to its peers (refer to Exhibit 4)? Do these ratios and trends seem
reasonable?
PART II
Fraud Brainstorming Session Best Practices
Brainstorming refers to an idea-generation process in which multiple participants share and explore their thoughts on a
particular topic. The brainstorming approach is advantageous in that the process can help participants identify and synergize
multiple ideas and perspectives in a relatively short amount of time. However, the process is not always effective;
brainstorming sessions may fail to deliver quality results for a number of reasons. Participants may consciously or
unconsciously engage in ‘‘social loafing’’ and hesitate to share their ideas because they think their efforts are either less
important or less identifiable (Latané, Williams, and Harkins 1979). Research shows that inexperienced auditors may be
especially prone to social loafing when working in a group setting, which may cause them to produce significantly fewer and
less well-developed mental simulations of possible fraud schemes (Chen, Trotman, and Zhou 2015). Fraud brainstorming
sessions may also suffer process losses from ‘‘production blocking,’’ a phenomenon whereby participants lose an idea while
waiting their turn and listening to others (Diehl and Stroebe 1987). Brainstorming sessions can also deteriorate due to
‘‘groupthink,’’ a phenomenon whereby a group coalesces on a single perspective rather than considering multiple ideas or
points of view (Beasley and Jenkins 2003).
To minimize these obstacles to effective fraud risk brainstorming, groups should use content facilitation techniques, such
as prompts, to stimulate idea generation (Lynch, Murthy, and Engle 2009). The case requirements you completed in Part I of
this case are examples of the types of prompts used by auditors in actual fraud risk brainstorming sessions. To minimize the
risks of groupthink and production blocking, auditors commonly work individually to develop a list of fraud risks prior to
joining the brainstorming session, and spend an average of five hours on preparing for each session (Dennis and Johnstone
2016). Brainstorming sessions can also be enhanced by following best practices (see Brazel, Carpenter, and Jenkins [2010] for
a recent field study of fraud risk brainstorming activities in audit firms). These best practices include a brainstorming session
that:
a. is led by a partner or forensic specialist;
b. includes an IT audit specialist;
c. is held early in the audit process (pre-planning or audit-planning stage);
d. includes extensive discussion about how management might perpetrate fraud;
e. includes extensive discussion about audit responses to fraud risk;
f. includes significant contributions from managers on the audit team; and
g. includes significant contributions from the audit partner.
Responding to Assessed Fraud Risks
In addition to using the concept of the fraud triangle as a tool to identify fraud risks, auditors may work in their fraud risk
brainstorming sessions to create a fraud risk matrix to help them better identify and respond to assessed fraud risks. A fraud risk
matrix is a tool that helps auditors connect identified fraud risk factors with possible fraud schemes and the account balances
that may be affected. The fraud risk matrix allows auditors to make a preliminary assessment of the likelihood and significance
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EXHIBIT 5
Sample Fraud Risk Matrix
of such a scheme occurring within their client’s company. This then allows them to adapt the nature, timing, and extent of their
planned audit procedures to respond to the more likely and/or more significant identified fraud risks. Exhibit 5 provides an
example of a fraud risk matrix.
Auditing standards note that determining the nature, timing, and extent of planned audit procedures is a matter of
professional judgment. When the likelihood and/or significance of material misstatement due to fraud or error is high, the
auditor should respond by planning audit procedures that will increase both the quality—that is, the reliability and relevance—
and the quantity of the evidence collected (AICPA 2006). For example, when the likelihood of a particular fraud scheme is low
and the significance is low (e.g., employees being paid for unworked overtime when little to no overtime was reported in the
year), the audit team may decide that inquiries of associated personnel are sufficient to determine whether evidence of a
material misstatement exists for the account balances affected by such a scheme. When the likelihood of a particular fraud
scheme is high, but the significance is low (e.g., employees submitting false travel expense reimbursement claims for amounts
not requiring a receipt), the audit team may respond with additional procedures beyond inquiries of personnel to include both
tests of controls and analytical procedures, and determine whether additional substantive procedures are needed as this evidence
is evaluated. However, when the potential significance of a fraud scheme is high even when the likelihood may be low (e.g.,
members of management colluding to overstate revenue), auditors should plan for more substantive testing. Substantive testing
can include observing and/or re-performing significant transactions, recalculating balances, obtaining third-party confirmations,
and making physical inspections of assets and records. In response to increased risks of fraud, the timing of testing may also be
adjusted to perform more testing near the end of a period rather than at an interim date.
Once the fraud risk brainstorming session is complete, a member of the team is designated to document the results of the
session, which include: the identified fraud risks, the potential fraud schemes and the balances that would be affected, the
group’s assessment of the likelihood and significance of such schemes occurring, and the plan for adapting the nature, timing,
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and/or extent of audit procedures to respond to this fraud risk assessment. This documentation may take the form of a
memorandum that is added to the audit file.
Part II Case Requirements: Conducting a Fraud Brainstorming Session
In Part II of this case, you will work in a group to simulate an audit team that is conducting a fraud risk brainstorming
session for Tesla Motors. Your instructor will provide you with further instructions regarding the composition of your audit
team and the timing of this brainstorming session. The following case requirements will help guide your activities in this
simulated brainstorming session.
1. Conducting the fraud brainstorming session.
a. Share and discuss your individual responses to each of the case requirement questions from Part I.
b. Work together to develop a fraud risk matrix (see Exhibit 5 for an example) that identifies the three fraud risk factors
that your team believes present the greatest concern to the audit based on your team’s assessment of their likelihood
and significance. Focus on those fraud risk areas that pose the greatest potential threat for a material misstatement in
the financials.
c. Determine how the nature, timing, and extent of the audit procedures should be altered to respond to these identified
risks.
2. Documenting the results of the fraud brainstorming session.
Document your conclusions from this brainstorming session in a memorandum for the audit file. A template for your
reference is included in Appendix A. Your documentation should include:
a. The date, the attendees, and the purpose of the session, as well as how long the session lasted.
b. The three most concerning fraud risks at Tesla, the potential fraud schemes and account balances that would be
affected, and the group’s assessment of the likelihood and significance of such schemes occurring in a fraud risk matrix
(from 1b above).
c. The team’s consensus (or lack thereof, if applicable) regarding the overall risk of fraud at Tesla Motors.
d. The team’s plan for adapting the nature, timing, and/or extent of audit procedures to respond to this fraud risk
assessment.
REFERENCES
American Institute of Certified Public Accountants (AICPA). 2006. Consideration of Fraud in a Financial Statement Audit. AU. Section
316. New York, NY: AICPA.
Arens, I. R. J., M. S. Beasley III, and A. Alvin. 2010. Auditing and Assurance Services: An Integrated Approach-13/E. Englewood Cliffs,
NJ: Pearson Prentice Hall.
Association of Certified Fraud Examiners (ACFE). 2016. Report to the Nations on Occupational Fraud and Abuse. Available at: http://
www.acfe.com/rttn2016/docs/2016-report-to-the-nations.pdf
Beasley, M. S., and J. G. Jenkins. 2003. A primer for brainstorming fraud risks. Journal of Accountancy 196 (6): 32.
Brazel, J. F., T. D. Carpenter, and J. G. Jenkins. 2010. Auditors’ use of brainstorming in the consideration of fraud: Reports from the field.
The Accounting Review 85 (4): 1273–1301. https://doi.org/10.2308/accr.2010.85.4.1273
Carpenter, T. D. 2007. Audit team brainstorming, fraud risk identification, and fraud risk assessment: Implications of SAS No. 99. The
Accounting Review 82 (5): 1119–1140. https://doi.org/10.2308/accr.2007.82.5.1119
Center for Audit Quality (CAQ). 2010. Report on Deterring and Detecting Financial Reporting Fraud: A Plan for Action. Available at:
http://www.thecaq.org/deterring-and-detecting-financial-reporting-fraud
Chen, C. X., K. T. Trotman, and F. Zhou. 2015. Nominal versus interacting electronic fraud brainstorming in hierarchical audit teams. The
Accounting Review 90 (1): 175–198. https://doi.org/10.2308/accr-50855
Cressey, D. R. 1953. Other People’s Money; A Study of the Social Psychology of Embezzlement. Ann Arbor, MI: Free Press: University of
Michigan.
Dennis, S. A., and K. M. Johnstone. 2016. A field survey of contemporary brainstorming practices. Accounting Horizons 30 (4): 449–472.
https://doi.org/10.2308/acch-51503
Diehl, M., and W. Stroebe. 1987. Productivity loss in brainstorming groups: Toward the solution of a riddle. Journal of Personality and
Social Psychology 53 (3): 497–509. https://doi.org/10.1037/0022-3514.53.3.497
Fehrenbacher, K. 2015. Tesla’s startup culture has big risks and rewards. Fortune.com. Available at: http://fortune.com/2015/08/21/teslasstartup-culture-musk/
Feng, M., W. Ge, S. Luo, and T. Shevlin. 2011. Why do CFOs become involved in material accounting manipulations? Journal of
Accounting and Economics 51 (1-2): 21–36. https://doi.org/10.1016/j.jacceco.2010.09.005
Issues in Accounting Education
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Fields, T. D., T. Z. Lys, and L. Vincent. 2001. Empirical research on accounting choice. Journal of Accounting and Economics 31 (1-3):
255–307. https://doi.org/10.1016/S0165-4101(01)00028-3
Harris, J., and P. Bromiley. 2007. Incentives to cheat: The influence of executive compensation and firm performance on financial
misrepresentation. Organization Science 18 (3): 350–367. https://doi.org/10.1287/orsc.1060.0241
Healy, P. M., and J. M. Wahlen. 1999. A review of the earnings management literature and its implications for standard setting.
Accounting Horizons 13 (4): 365–383. https://doi.org/10.2308/acch.1999.13.4.365
International Federation of Accountants (IFAC). 2008. The Auditor’s Responsibilities Relating to Fraud in an Audit of Financial
Statements. IAS 240. Available at: http://www.ifac.org/system/files/downloads/a012-2010-iaasb-handbook-isa-240.pdf
KPMG. 2013. Integrity Survey 2013. Available at: http://www.kpmg-institutes.com/institutes/advisory-institute/articles/2013/07/integritysurvey-2013.html
Latané, B., K. Williams, and S. Harkins. 1979. Many hands make light the work: The causes and consequences of social loafing. Journal
of Personality and Social Psychology 37 (6): 822–832. https://doi.org/10.1037/0022-3514.37.6.822
Lynch, A. L., U. S. Murthy, and T. J. Engle. 2009. Fraud brainstorming using computer-mediated communication: The effects of
brainstorming technique and facilitation. The Accounting Review 84 (4): 1209–1232. https://doi.org/10.2308/accr.2009.84.4.1209
MacLean, T. L. 2008. Framing and organizational misconduct: A symbolic interactionist study. Journal of Business Ethics 78 (1–2): 3–
16. https://doi.org/10.1007/s10551-006-9324-x
Mishina, Y., B. J. Dykes, E. S. Block, and T. G. Pollock. 2010. Why ‘‘good’’ firms do bad things: The effects of high aspirations, high
expectations, and prominence on the incidence of corporate illegality. Academy of Management Journal 53 (4): 701–722. https://
doi.org/10.5465/AMJ.2010.52814578
PricewaterhouseCoopers (PwC). 2015. Data Driven: What Students Need to Succeed in a Rapidly Changing Business World. Available
at: https://www.pwc.com/us/en/faculty-resource/assets/pwc-data-driven-paper-feb2015.pdf
Public Company Accounting Oversight Board (PCAOB). 2016a. Consideration of Fraud in a Financial Statement Audit. AS 2401.
Washington, DC: PCAOB.
Public Company Accounting Oversight Board (PCAOB). 2016b. Related Parties. AS 2410. Washington, DC: PCAOB.
Public Company Accounting Oversight Board (PCAOB). 2016c. Auditing Accounting Estimates. AS 2501. Washington, DC: PCAOB.
Public Company Accounting Oversight Board (PCAOB). 2016d. Auditing Fair Value Measurements and Disclosures. AS 2502.
Washington, DC: PCAOB.
Ramos, M. 2003. Auditors’ responsibility for fraud detection. Journal of Accountancy 195 (1): 28–36.
Sage, A. 2016. Tesla investor group wants more independent board, cites Musk ties. Reuters (June 28). Available at: http://www.reuters.
com/article/us-solarcity-m-a-tesla-idUSKCN0ZE2ZL
Smith, A. 2014. Who is Elon Musk? Tech Billionaire, SpaceX Cowboy, Tesla Pioneer—and Real Life Iron Man. The Telegraph (January
4). Available at: http://www.telegraph.co.uk/technology/news/10544247/Meet-tech-billionaire-and-real-life-Iron-Man-Elon-Musk.
html
Taylor, A., III. 2013. 9 Questions for Tesla’s Elon Musk. Fortune (June 12). Available at: http://fortune.com/2013/06/12/9-questions-forteslas-elon-musk/
Telsa Motors. 2015. About Tesla. Palo Alto, CA: Tesla Motors; Available at: https://www.teslamotors.com/about
Telsa Motors. 2016a. Corporate Governance Guidelines. Palo Alto, CA: Tesla Motors. Available at: http://ir.tesla.com/corporategovernance-document.cfm?DocumentID¼14836
Telsa Motors. 2016b. Tesla Motors Inc 2015 Annual Report. Palo Alto, CA: Tesla Motors. Available at: http://files.shareholder.com/
downloads/ABEA-4CW8X0/1651466307x0xS1564590-16-13195/1318605/filing.pdf
Treviño, L. K., and S. A. Youngblood. 1990. Bad apples in bad barrels: A causal analysis of ethical decision-making behavior. The
Journal of Applied Psychology 75 (4): 378–385. https://doi.org/10.1037/0021-9010.75.4.378
Treviño, L. K., L. P. Hartman, and M. Brown. 2000. Moral person and moral manager: How executives develop a reputation for ethical
leadership. California Management Review 42 (4): 128–142. https://doi.org/10.2307/41166057
Zhang, X., K. M. Bartol, K. G. Smith, M. D. Pfarrer, and D. M. Khanin. 2008. CEOs on the edge: Earnings manipulation and stock-based
incentive misalignment. Academy of Management Journal 51 (2): 241–258. https://doi.org/10.5465/AMJ.2008.31767230
APPENDIX A
Memo Template to Document the Results of a Fraud Brainstorming Session
Date: [DATE OF SESSION]
Participants: [NAME OF ALL SESSION PARTICIPANTS]
Length of Session: [TIME IN HOURS_MINUTES]
Purpose of the Session: [FILL IN]
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30
Part A—Assessment of Fraud Risks
[INSERT FRAUD MATRIX HERE]
Part B—Overall Fraud Risk Assessment
As a group, how would you rate the overall potential of a risk of material misstatement due to fraud at this client (e.g., low
risk, moderate risk, or high risk)? Provide justification for your assessment and note any dissension about this assessment
among the team members, if applicable.
Part C—Planning the Nature, Timing, and Extent of Procedures
Based on the identified fraud risk factors and the level of assessed fraud at this client, how would your group modify the
nature, timing, and/or extent of the planned audit procedures? Discuss at least three audit procedures that should be performed
on this audit in response to the fraud risk factors identified above. Your group should try to be as specific as possible (i.e., the
account(s) that you would focus on, the procedure(s) you may perform, and when you would perform the procedure).
1. [FILL IN]
2. [FILL IN]
3. [FILL IN]
APPENDIX B
iace-51973_ Tesla’s Code of Business Conduct and Ethics: http://dx.doi.org/10.2308/iace-51973.s01
iace-51973_ Tesla’s 2015 Annual Report: http://dx.doi.org/10.2308/iace-51973.s02
Issues in Accounting Education
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Fraud Risk Brainstorming at Tesla Motors
31
CASE LEARNING OBJECTIVES AND IMPLEMENTATION GUIDANCE
This instructional case involves identifying fraud risk factors at a public company and conducting a fraud risk
brainstorming session, consistent with the guidance under AS 2401, Consideration of Fraud in a Financial Statement Audit.
We see the instructional value of this case as two-fold. Not only does the case incorporate important auditing and forensic
concepts like assessing fraud risk and applying the fraud triangle, but also the case gives students first-hand experience with
conducting a fraud risk brainstorming session in a team environment and documenting this process. While there are a number
of cases published in the last 15 years that focus on the issue of identifying fraud risk factors and responding to fraud risks (e.g.,
Agoglia, Brown, and Hanno 2003; Ballou and Mueller 2005; Owhoso and Weickgenannt 2010; Gifford and Howe 2011; Rufus
and Hahn 2011; Dickins and Reisch 2012; Dee, Durtschi, and Mindak 2014), we are not aware of any instructional cases that
combine fraud risk assessment with guidance on how to conduct and document a fraud risk brainstorming session. Students
also indicated that they found this case to be realistic and enjoyed learning about these concepts in the context of this popular
company.
Learning Objectives
There are five learning objectives for this case:
1. To recognize the factors that contribute to financial statement fraud risk (Part I).
2. To identify and evaluate the likelihood and severity of fraud risks for a particular organization (Part I).
3. To analyze the ways that fraud risks can lead to material misstatements in the financial statements (Parts I and II).
4. To understand the purpose of and how to conduct a fraud brainstorming session as a team (Part II).
5. To develop audit procedures that respond to assessed fraud risks (Part II).
Implementation Guidance
This case is designed for use in either undergraduate- or graduate-level courses that feature an emphasis on fraud risk
assessments or assurance (e.g., auditing, fraud, forensic accounting). This case offers students the opportunity to explore the
fraud risk assessment process and to participate in a simulated fraud brainstorming session. To be most effective and more
closely simulate an actual fraud brainstorming session, we recommend that Part I of the case be completed by students
individually as a take-home assignment. Instructors will need to provide students with the case document in order for them to
complete Part I. Students should turn in Part I as an individual assignment (Deliverable 1), and then use their responses from
Part I as inputs for the brainstorming session in Part II. Students report spending approximately 3.5 hours to complete all of the
case requirement questions in Part I. To minimize the time required, instructors may choose to divide the case requirements
among the students (e.g., half of the students complete case Requirements 1 and 2 (six questions) and the other half complete
case Requirements 3 through 5 (seven questions). Before moving to Part II, we encourage instructors to dedicate some class
time (10–15 minutes) to review student responses to Part I and explain the tasks and deliverables associated with Part II. More
guidance on discussing the key concepts of this case is provided in the Teaching Notes.
For Part II of the case, instructors will need to group students into small audit teams (‘‘investigation teams’’ if using in a
forensic accounting class) to hold a fraud risk brainstorming session. The instructor will also need to provide students with
guidance on when they should hold their brainstorming session and how long they should spend brainstorming. We
recommend that students dedicate no more than one hour to the brainstorming session and reserve one to two hours for
documenting their results (Deliverable 2). We suggest that Part II be completed as a take-home group assignment, but
instructors also could complete Part II of the case as an in-class activity.
Following the completion and documentation of the team brainstorming sessions, we recommend that instructors lead a
class discussion of the key learning objectives from the case (about 30 minutes). Guidance on these topics and solutions are
available in the Teaching Notes. This discussion should highlight some of the challenges of (1) assessing fraud risk factors, (2)
conducting effective brainstorming sessions, and (3) linking risk factors to appropriate audit responses. Through this
discussion, instructors can elicit observations from the students on the effectiveness of their brainstorming session, as well as
specific examples of the fraud risk factors documented in their fraud risk matrices and the suggested audit procedures to reduce
these risks.
Customizing the Case
The usage of this case can vary somewhat depending on the specific student audience. The instructor can tailor the
difficulty of the case and the focus of the case depending on the knowledge and skill level of the students, as well as the focus
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32
of the class (i.e., auditing versus fraud). To increase the difficulty of the case, instructors can implement one or more of the
following ideas:
 Assign additional readings from the academic literature related to financial statement fraud risks (e.g., MacLean 2008;
Mishina, Dykes, Block, and Pollock 2010) or fraud brainstorming (e.g., Brazel, Carpenter, and Jenkins 2010; Dennis
and Johnstone 2016). As part of the class discussion of the key learning objectives, the instructor can facilitate a
dialogue on the findings taken from the academic research literature.
 Assign additional analytical procedures for Part I, such as the calculation of Beneish’s (1997) ‘‘M-Score’’ for Tesla.
Instructors may find Wells’ (2001) article ‘‘Irrational Ratios’’ helpful in guiding students’ efforts to calculate and
interpret Beneish’s M-Score.
 Increase the number of fraud risks documented in the fraud risk matrix and the number of audit procedures described in
the memorandum of the fraud brainstorming session.
To simplify the case, instructors can implement one or more of the following ideas:
 Allow students to work in groups of two to complete Part I.
 Remove the case requirement in Part II that requires students to identify the nature, timing, and extent of audit
procedures.
 Conduct Part II as a class activity with the entire class participating in the session as one team.
Evidence of Efficacy
To assess the effectiveness of the case, we tested it in five undergraduate audit classes (185 students) and two graduate
fraud classes (39 students) at three public and two private universities (four independent instructors and one author). Pre- and
post-test surveys were Institutional Review Board (IRB) approved, were formatted similarly to those in Worrell (2010) and
Dow, Watson, and Shea (2013), and were administered using comparable procedures to avoid any potential demand effects.
The pre-test survey was administered a few days prior to assigning the case. Students were informed that the survey was to
assess their knowledge and comfort level with specific course-related topics, that it was entirely voluntary, and that all
responses would remain anonymous. The post-test survey was administered on the submission date of the completed
Deliverable 2.
The questions used in the survey, the pre-test and post-test means, and significance levels are presented in Table 1, Panel
A. In addition, Table 1, Panel B presents the results of several additional questions asked after completion of the case. To assess
the case’s impact on students’ knowledge, we asked students six questions before and after case completion that dealt with their
understanding of the key learning objectives of the case.1 Table 1, Panel A shows that the case significantly increased students’
knowledge of fraud risk factors and fraud brainstorming sessions (p , 0.001, two-tailed in both). In addition, the case made
students more comfortable with applying the fraud triangle, creating a fraud risk matrix, adapting audit procedures, and
conducting a fraud brainstorming session (p , 0.001, two-tailed for all).
In addition, Table 1, Panel B indicates that students perceived the case to be a realistic scenario (77.0 percent agree or
strongly agree), that was interesting (75.8 percent agree or strongly agree), and provided a positive learning experience (78.2
percent agree or strongly agree). In addition, students felt that the case required them to think critically (80.6 percent agree or
strongly agree) and apply their professional skepticism (78.2 percent agree or strongly agree). We also asked students to
provide verbal feedback about the case. An overwhelming number of responses indicated that students liked that the case used a
real, recognizable, and current company, with real data and information. For example, one student commented that ‘‘the issues
Tesla faces are realistic issues that auditors have to be able to analyze and assess for any company.’’ In addition, several
students pointed out that they liked conducting the actual brainstorming session to be able to pool their ideas and better
understand how the session would work in practice. Thus, the case appears to provide a realistic learning environment to help
students prepare for procedures they will be asked to do in audit practice.
TEACHING NOTES
Teaching Notes are available only to non-student-member subscribers to Issues in Accounting Education through the
American Accounting Association’s electronic publications system at http://aaapubs.org/. Non-student-member subscribers
should use their usernames and passwords for entry into the system where the Teaching Notes can be reviewed and printed.
Please do not make the Teaching Notes available to students or post them on websites.
1
We investigated whether the responses differed by level (i.e., undergraduate, graduate), but results were quantitatively similar. Therefore, the combined
results are presented in Table 1.
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Fraud Risk Brainstorming at Tesla Motors
33
TABLE 1
Student Learning Perceptions
Panel A: Questions Asked Before and After Case Completion
Survey Item
1. Rate your level of knowledge of identifying fraud risk factors of an organization.
2. Rate how comfortable you feel applying the fraud triangle to identify fraud risk factors.
3. Rate your level of knowledge of the purpose of fraud brainstorming sessions.
4. Rate how comfortable you feel creating a fraud risk matrix.
5. Rate how comfortable you feel adapting audit procedures to respond to assessed fraud risks.
6. Rate how comfortable you feel conducting a fraud brainstorming session.
Pre-Case
Mean
(SD)
Post-Case
Mean
(SD)
3.34
(1.26)
3.66
(1.35)
3.34
(1.38)
2.64
(1.20)
3.23
(1.24)
3.08
(1.32)
4.70
(1.11)
4.98
(1.09)
5.10
(1.16)
4.52
(1.17)
4.41
(1.13)
4.91
(1.09)
t-statistic
10.7***
10.0***
12.8***
14.8***
9.3***
14.0***
Panel B: Questions Asked After Case Completion
Survey Item
This case represents a realistic scenario.
The case encouraged me to think critically
about the factors that contribute to fraud
risk.
The case encouraged me to apply
professional skepticism.
I found the case interesting.
The case was a positive learning experience.
Strongly
Disagree
1
Disagree
2
Somewhat
Disagree
3
Neutral
4
Somewhat
Agree
5
Agree
6
Strongly
Agree
7
Mean
(SD)
0.0%
(0)
0.0%
0.0%
(0)
0.6%
1.2%
(2)
0.6%
4.8%
(8)
4.3%
17.0%
(28)
13.9%
39.4%
(65)
49.1%
37.6%
(62)
31.5%
6.07
(0.92)
6.04
(0)
0.0%
(1)
0.0%
(1)
0.0%
(7)
4.8%
(23)
17.0%
(81)
46.7%
(52)
31.5%
(0.91)
6.05
(0)
0.0%
(0)
0.0%
(0)
(0)
0.0%
(0)
0.6%
(1)
(0)
4.8%
(8)
2.4%
(4)
(8)
3.6%
(6)
6.7%
(11)
(28)
15.8%
(26)
12.1%
(20)
(77)
46.7%
(77)
45.5%
(75)
(52)
29.1%
(48)
32.7%
(54)
(0.83)
5.92
(1.02)
5.98
(1.02)
***Signifies p , 0.001.
Panel A presents results of a pre-case and post-case comparison of a set of six questions. Responses were provided on a series of seven-point scales with 1
labeled ‘‘low knowledge’’ and ‘‘highly uncomfortable’’ and 7 labeled ‘‘high knowledge’’ and ‘‘highly comfortable’’ (for questions 1 and 3, and 2, 4–6,
respectively). The pre-case data includes 185 (146 undergraduate and 39 graduate) students and the post-case data includes 165 (132 undergraduate and 33
graduate) students.
Panel B presents results of five additional post-case questions. Responses were provided on a series of seven-point scales with 1 labeled ‘‘strongly
disagree’’ and 7 labeled ‘‘strongly agree.’’
If you are a non-student-member of AAA with a subscription to Issues in Accounting Education and have any trouble
accessing this material, then please contact the AAA headquarters office at info@aaahq.org or (941) 921-7747.
REFERENCES
Agoglia, C. P., K. F. Brown, and D. M. Hanno. 2003. Dickinson Technologies, Inc.: Assessing control environment and fraud risk. Issues
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Ballou, B., and J. M. Mueller. 2005. Helecom communications: Considering fraud risk on an engagement before and after analyzing a key
business process. Issues in Accounting Education 20 (1): 99–118. https://doi.org/10.2308/iace.2005.20.1.99
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Beneish, M. D. 1997. Detecting GAAP violation: Implications for assessing earnings management among firms with extreme financial
performance. Journal of Accounting and Public Policy 16 (3): 271–309. https://doi.org/10.1016/S0278-4254(97)00023-9
Brazel, J. F., T. D. Carpenter, and J. G. Jenkins. 2010. Auditors’ use of brainstorming in the consideration of fraud: Reports from the field.
The Accounting Review 85 (4): 1273–1301. https://doi.org/10.2308/accr.2010.85.4.1273
Dee, C., C. Durtschi, and M. P. Mindak. 2014. Grand Teton Candy Company: Connecting the dots in a fraud investigation. Issues in
Accounting Education 29 (3): 443–458. https://doi.org/10.2308/iace-50763
Dennis, S. A., and K. M. Johnstone. 2016. A field survey of contemporary brainstorming practices. Accounting Horizons 30 (4): 449–472.
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Dickins, D., and J. T. Reisch. 2012. Enhancing auditors’ ability to identify opportunities to commit fraud: Instructional resource cases.
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Mishina, Y., B. J. Dykes, E. S. Block, and T. G. Pollock. 2010. Why ‘‘good’’ firms do bad things: The effects of high aspirations, high
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Worrell, J. L. 2010. Blazer communications: A procurement audit simulation. Issues in Accounting Education 25 (3): 527–546. https://
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Nominating and Corporate Governance Committee Charter
Adopted Dec 16, 2009
As modified on December 12, 2017
PURPOSE
The purpose of the Corporate Governance and Nominating Committee (the “Committee”) of the Board of Directors (the
“Board”) of Tesla, Inc. (the “Company”) shall be to review and make recommendations to the Board on matters
concerning corporate governance; Board composition; identification, evaluation and nomination of director candidates;
composition of Board committees and conflicts of interest.
In furtherance of these purposes, the Committee will undertake those specific duties and responsibilities listed below and
such other duties as the Board may from time to time prescribe.
MEMBERSHIP
The Committee members shall be appointed by, and shall serve at the discretion of, the Board. The Committee shall
consist of no fewer than three members of the Board. The Board may designate one member of the Committee as its chair.
The Committee may form and delegate authority to subcommittees when appropriate. Members of the Committee shall not
have a relationship with the Company or its affiliates that may interfere with the exercise of their independence, and shall
otherwise be deemed “Independent Directors” as defined by the listing standards of the Nasdaq Stock Market, Inc. (the
“Nasdaq Rules”).
RESPONSIBILITIES AND DUTIES
The responsibilities and duties of the Committee shall include:
Corporate Governance Generally
•
Reviewing annually the principles of corporate governance approved by the Board, including the Company’s Code of
Business Conduct and Ethics and Corporate Governance Guidelines, to ensure that they remain relevant and are being
complied with and monitored by management, recommending changes to the Board as necessary;
•
Overseeing the Company’s corporate governance practices, including reviewing proposed changes to the Company’s
Certificate of Incorporation and Bylaws and making recommendations to the Board;
•
Determining the manner in which stockholders may send communications to the Board (as a whole or individually), as
well as the process by which stockholder communications will be relayed to the Board and what the Board’s response, if
any, should be;
•
Reviewing periodically the succession planning for the Chief Executive Officer and other executive officers, reporting its
findings and recommendations to the Board, and working with the Board in evaluating potential successors to these
executive management positions;
•
Reviewing any stockholder proposals properly submitted for action at the annual meeting of stockholders and
recommending Board responses;
•
Overseeing compliance by the Board and its committees with applicable laws and regulations, including those
promulgated by the Securities and Exchange Commission and the Nasdaq Rules;
•
Reviewing the disclosure included in the Company’s proxy statement regarding the Company’s corporate governance
practices, including its Board nomination process;
•
Investigating, or authorizing on its behalf an investigation of, any matter relating to any purpose, responsibility, duty, or
power of the Committee set forth in this charter or applicable law, or delegated to the Committee by the Board, and
obtaining unrestricted access to the Company’s books, records and employees in furtherance of any such investigation;
and
•
Reviewing, and recommending changes if appropriate to the Board with respect to, its own charter, structure,
membership requirements and processes on an annual basis;
Board Composition, Evaluation and Nominating Activities
•
Evaluating the independence of members of the Board and Board nominees against the independence requirements of
the Securities and Exchange Commission, the Nasdaq rules and other applicable laws;
•
Overseeing the Board evaluation process including conducting periodic evaluations of the performance of the Board as
a whole and each Board committee and evaluating the performance of Board members eligible for re-election;
•
Reviewing and making recommendations to the Board regarding the composition and size of the Board, and
determining the relevant criteria (including any minimum qualifications) for Board membership including issues of
character, integrity, judgment, diversity, age, independence, skills, education, expertise, business acumen, business
experience, length of service, understanding of the Company’s business, other commitments and the like;
•
Establishing and periodically reviewing procedures for the submission of candidates for election to the Board (including
recommendations by stockholders of the Company);
•
Establishing procedures for identifying and evaluating nominees for Director;
•
Reviewing and recommending candidates for election to the Board at the annual meeting of stockholders or at any
special meeting of stockholders at which one or more directors are to be elected, in compliance with the Company’s
policies and procedures for consideration of Board candidates;
•
Prospectively identifying, considering and recommending candidates to fill new positions or vacancies on the Board; in
performing these duties, the Committee shall have the authority, at the Company’s expense, to retain and terminate any
search firm to be used to identify Board candidates and shall have authority to approve the search firm’s fees and other
retention terms;
•
Reviewing and making recommendations to the Board with respect to the Directors’ stock option grants under the 2010
Equity Incentive Plan (as amended) and any proposed amendments thereto, subject to obtaining stockholder approval
of any amendments as required by applicable law or the Nasdaq Rules;
•
Evaluating and making recommendations for continuing education activities of Board members;
Board Committees
•
Periodically reviewing the charter, size and composition of each Board committee and making recommendations to the
Board for the creation of additional Board committees or a change in mandate or dissolution of Board committees;
•
Recommending to the Board persons to be members of the various Board committees;
Conflicts of Interest
•
Reviewing and approving the Company’s Code of Business Conduct and Ethics for all personnel;
•
Considering questions of possible conflicts of interest of Board members and of corporate officers; and
•
Reviewing actual and potential conflicts of interest of Board members and corporate officers, other than related party
transactions reviewed by the Audit Committee, and approving or prohibiting any involvement of such persons in matters
that may involve a conflict of interest or taking of a corporate opportunity.
In performing its duties, the Committee shall have the authority, at the Company’s expense, to retain, hire, and obtain
advice, reports or opinions from internal or external legal counsel, search firms and expert advisors to assist with the
execution of the Committee’s duties and responsibilities as set forth in this charter or applicable law, or delegated to the
Committee by the Board.
MEETINGS
The Committee will meet as often as may be deemed necessary or appropriate, in its judgment, in order to fulfill its
responsibilities, but not less than two times a year. The Committee may meet either in person or telephonically, and at such
times and places as the Committee determines. The Committee may establish its own meeting schedule, which it will
provide to the Board. The Committee may invite to its meetings other Board members, Company management and such
other persons as the Committee deems appropriate in order to carry out its responsibilities. The chairperson of the
Committee shall preside at each meeting; if a chairperson is not designated or present, an acting chair may be designated
by the Committee members present.
MINUTES
The Committee will maintain written minutes of its meetings, which will be filed with the minutes of the meetings of the
Board.
REPORTS
The Chair of the Committee shall make regular reports to the full Board on the actions and recommendations of the
Committee.
COMPENSATION
Members of the Committee shall receive such fees, if any, for their service as Committee members as may be determined
by the Board in its sole discretion.
TESLA MOTORS INC
FORM
10-K
(Annual Report)
Filed 02/24/16 for the Period Ending 12/31/15
Address
Telephone
CIK
Symbol
SIC Code
Industry
Sector
Fiscal Year
3500 DEER CREEK RD
PALO ALTO, CA 94070
650-681-5000
0001318605
TSLA
3711 – Motor Vehicles and Passenger Car Bodies
Auto & Truck Manufacturers
Consumer Cyclical
12/31
http://www.edgar-online.com
© Copyright 2016, EDGAR Online, Inc. All Rights Reserved.
Distribution and use of this document restricted under EDGAR Online, Inc. Terms of Use.
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
x
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2015
OR
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from
to
Commission File Number: 001-34756
Tesla Motors, Inc.
(Exact name of registrant as specified in its charter)
Delaware
(State or other jurisdiction of
incorporation or organization)
91-2197729
(I.R.S. Employer
Identification No.)
3500 Deer Creek Road
Palo Alto, California
(Address of principal executive offices)
94304
(Zip Code)
(650) 681-5000
(Registrant’s telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
Title of each class
Common Stock, $0.001 par value
Name of each exchange on which registered
The NASDAQ Stock Market LLC
Securities registered pursuant to Section 12(g) of the Act:
None
Indicate by check mark whether the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes x
No ¨
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act. Yes ¨
No x
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 (“Exchange Act”) during the
preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x
No
¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted
pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x
No ¨
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of
registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated
filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act:
Large accelerated filer
x
Accelerated filer
¨
Non-accelerated filer
¨
(Do not check if a smaller reporting company)
Smaller reporting company
¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨
No x
The aggregate market value of voting stock held by non-affiliates of the registrant, as of June 30, 2015, the last day of registrant’s most recently completed second fiscal quarter, was
$26,340,519,416 (based on the closing price for shares of the registrant’s Common Stock as reported by the NASDAQ Global Select Market on June 30, 2015). Shares of Common Stock held by
each executive officer, director, and holder of 5% or more of the outstanding Common Stock have been excluded in that such persons may be deemed to be affiliates. This determination of
affiliate status is not necessarily a conclusive determination for other purposes.
As of January 31, 2016, there were 132,056,338 shares of the registrant’s Common Stock outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant’s Proxy Statement for the 2015 Annual Meeting of Stockholders are incorporated herein by reference in Part III of this Annual Report on Form 10-K to the extent
stated herein. Such proxy statement will be filed with the Securities and Exchange Commission within 120 days of the registrant’s fiscal year ended December 31, 2015.
TESLA MOTORS, INC.
ANNUAL REPORT ON FORM 10-K FOR THE YEAR ENDED DECEMBER 31, 2015
INDEX
Page
PART I.
Item 1.
Item 1A.
Item 1B.
Item 2.
Item 3.
Item 4.
Business
Risk Factors
Unresolved Staff Comments
Properties
Legal Proceedings
Mine Safety Disclosures
4
13
27
28
28
28
Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Selected Financial Data
Management’s Discussion and Analysis of Financial Condition and Results of Operations
Quantitative and Qualitative Disclosures About Market Risk
Financial Statements and Supplementary Data
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
Controls and Procedures
Other Information
29
31
32
43
45
74
74
74
Directors, Executive Officers and Corporate Governance
Executive Compensation
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
Certain Relationships and Related Transactions, and Director Independence
Principal Accountant Fees and Services
75
75
75
75
75
Exhibits and Financial Statement Schedules
75
PART II.
Item 5.
Item 6.
Item 7.
Item 7A.
Item 8.
Item 9.
Item 9A.
Item 9B.
PART III.
Item 10.
Item 11.
Item 12.
Item 13.
Item 14.
PART IV.
Item 15.
Signatures
82
2
Forward-Looking Statements
The discussions in this Annual Report on Form 10-K contain forward-looking statements reflecting our current expectations that involve risks and
uncertainties. These forward-looking statements include, but are not limited to, statements concerning our strategy, future operations, future financial position,
future revenues, projected costs, profitability, expected cost reductions, capital adequacy, expectations regarding demand and acceptance for our technologies,
growth opportunities and trends in the market in which we operate, prospects and plans and objectives of management. The words “anticipates”, “believes”,
“estimates”, “expects”, “intends”, “may”, “plans”, “projects”, “will”, “would” and similar expressions are intended to identify forward-looking statements,
although not all forward-looking statements contain these identifying words. We may not actually achieve the plans, intentions or expectations disclosed in our
forward-looking statements and you should not place undue reliance on our forward-looking statements. Actual results or events could differ materially from
the plans, intentions and expectations disclosed in the forward-looking statements that we make. These forward-looking statements involve risks and
uncertainties that could cause our actual results to differ materially from those in the forward-looking statements, including, without limitation, the risks set
forth in Part I, Item 1A, “Risk Factors” in this Annual Report on Form 10-K and in our other filings with the Securities and Exchange Commission. We do not
assume any obligation to update any forward-looking statements.
3
P ART I
I TEM 1.
BUSINESS
Overview
We design, develop, manufacture and sell high-performance fully electric vehicles and energy storage products. We have established our own network of
vehicle sales and service centers and Supercharger stations globally to accelerate the widespread adoption of electric vehicles. Our vehicles, electric vehicle
engineering expertise, and business model differentiates us from incumbent automobile manufacturers.
We currently produce and sell two fully electric vehicles, the Model S sedan and the Model X sport utility vehicle (SUV). Both vehicles offer exceptional
performance, functionality and attractive styling. We commenced deliveries of Model S in June 2012 and as of December 31, 2015 we have delivered over 107,000
new Model S vehicles worldwide. We have continued to improve Model S by introducing performance, all-wheel drive dual motor, and autopilot options, as well
as free over-the-air software updates.
We commenced customer deliveries of Model X in the third quarter of 2015. This unique vehicle offers exceptional safety, seating for seven people, allwheel drive, and our autopilot functionality. We are currently ramping production and deliveries of Model X in the United States and plan to offer it in Europe and
Asia in 2016.
After the Model X, our goal is to introduce the Model 3, a lower priced sedan designed for the mass market. We intend to unveil Model 3 in the first quarter
of 2016 and start production and deliveries in late 2017.
The commercial production of fully electric vehicles that meets consumers’ range and performance expectations requires substantial design, engineering,
and integration work on almost every system of our vehicles. Our design and vehicle engineering capabilities, combined with the technical advancements of our
powertrain system, have enabled us to design and develop electric vehicles that we believe overcome the design, styling, and performance issues that have
historically limited broad consumer adoption of electric vehicles. As a result, our customers enjoy several benefits, including:
·
Long Range and Recharging Flexibility. Our vehicles offer ranges that significantly exceed those of any other commercially available electric
vehicle. In addition, our vehicles incorporate our proprietary on-board charging system, permitting recharging from almost any available electrical
outlet. Our vehicles also offer fast charging capability from our Supercharger network. We believe the long-range and charging flexibility of our
vehicles will help reduce consumer anxiety over range, alleviate the need for expensive, large-scale charging infrastructure, and differentiate our
vehicles as compared to those of our competitors.
·
High-Performance Without Compromised Design or Functionality. Our vehicles deliver unparalleled driving experiences with instantaneous and
sustained acceleration through an extended range of speed. In addition, our vehicles provide best in class storage in the trunk and hood while offering
design and performance comparable to, or better than, other premium vehicles.
·
Energy Efficiency and Cost of Ownership. Our vehicles offer consumers an attractive cost of ownership when compared to similar internal
combustion engine or hybrid electric vehicles. Using only an electric powertrain enables us to create more energy efficient vehicles that are
mechanically simpler than currently available hybrid or internal combustion engine vehicles. The cost to fuel our vehicles is less compared to
internal combustion vehicles. We also expect our electric vehicles will have lower relative maintenance costs than hybrid, plug-in hybrid, or internal
combustion engine vehicles due to fewer moving parts and the absence of certain components, including oil, oil filters, spark plugs and engine
valves. Additionally, government incentives that are currently available can reduce the cost of ownership even further.
We sell our vehicles through our own sales and service network which we are continuing to grow globally. We believe the benefits we receive from
distribution ownership will enable us to improve the overall customer experience, the speed of product development and the capital efficiency of our business. We
are also continuing to build our network of Superchargers in the United States, Europe and Asia to provide fast charging that enables convenient long distance
travel.
In addition to developing our own vehicles, we sell energy storage products. We recently announced the next generation of our energy storage products, the
7 kWh and 10 kWh Powerwall for residential applications and the 100 kWh Powerpack for commercial and industrial applications. We began production and
deliveries of these products, which we market under the Tesla Energy brand, in the third quarter of 2015.
We manufacture our products primarily at our facilities in Fremont, California, Lathrop, California, Tilburg, Netherlands and at our Gigafactory near Reno,
Nevada. We are currently using battery packs manufactured at the Gigafactory for our energy storage products, and will do so for our vehicles in the future.
Our Vehicles and Products
We currently design, develop, manufacture and sell fully electric vehicles and energy storage products.
4
Model S
Model S is a fully electric, four-door, five-adult passenger sedan that offers compelling range and performance with zero tailpipe emissions. Model S offers
a range on a single charge of up to 288 miles as determined using the United States EPA’s combined two-cycle city/highway test. We offer performance and allwheel drive dual motor system options. The performance version of our All-Wheel Drive Dual Motor Model S accelerates from 0 to 60 miles per hour in 2.8
seconds with the Ludicrous speed upgrade.
Model S offers a unique combination of functionality, convenience, safety and styling without compromising performance and energy efficiency. With the
battery pack in the floor of the vehicle and the motor and gearbox in line with the rear axle, our single motor Model S provides best in class storage space. Model S
is also available with premium luxury features, including a 17 inch touch screen driver interface, our advanced autopilot system with both active safety and
convenience features, and over-the-air software updates. We believe the combination of performance, safety, styling, convenience and energy efficiency of Model
S positions it as a compelling alternative to other vehicles in the luxury and performance segments.
Model X
Model X is a sport utility vehicle that offers exceptional functionality with high performance features such as our fully electric, all-wheel drive dual motor
system and our autopilot system. Model X provides up to 257 miles of range on a single charge, and can accelerate from 0 to 60 as quickly as 3.2 seconds with the
Ludicrous speed upgrade. Model X seats seven adults and incorporates a unique falcon wing door system for superior access to the second and third seating rows.
Although the National Highway Traffic Safety Administration has not yet conducted crash testing on Model X, based on our internal testing, we expect Model X to
receive the highest safety rating in every category. We began customer deliveries of Model X in the third quarter of 2015 in the United States. After its initial
launch in the United States, Model X will be sold in all the markets where Model S is available including in Asia and Europe.
Model 3
We have also publicly announced our intent to develop a third generation electric vehicle, called Model 3, to be produced at the Tesla Factory. We intend to
offer this vehicle at a lower price point and expect to produce it at higher volumes than our Model S or Model X. We plan to unveil Model 3 in March of 2016 and
expect to start production and deliveries of this vehicle in late 2017.
Energy Storage Applications
Using the energy management technologies and manufacturing processes developed for our vehicle powertrain systems, we have developed energy storage
products for use in homes, commercial sites and utilities. The applications for these battery systems include backup power, peak demand reduction, demand
response and wholesale electric market services. We began selling our home systems in 2013 and our commercial and utility systems in 2014. We recently
announced the next generation of our energy storage products under the Tesla Energy brand.
The Tesla Energy product portfolio will include energy storage products with a wide range of applications, from use in single homes to use in larger utilityscale projects. Tesla Powerwall is a rechargeable lithium-ion battery designed to store energy at a residential and small commercial level for load shifting, backup
power and self-consumption of solar power generation. Powerwall is available in storage sizes of 10kWh, optimized for backup applications, or 7kWh, optimized
for daily use applications. In addition, we offer a 100 kWh Powerpack for peak shaving, load shifting and demand response for commercial customers and for
renewable firming and a variety of grid services for utilities. For utility scale systems, 100kWh battery blocks can be grouped together to offer installation of over
10MWh. We began production of our Tesla Energy products at the Gigafactory in the fourth quarter of 2015.
Technology
Our core competencies are powertrain engineering, vehicle engineering, innovative manufacturing and energy storage. Our core intellectual property resides
not only within our electric powertrain, but also within our ability to design a vehicle that utilizes the unique advantages of an electric powertrain and the latest
advancements in consumer technologies. Our powertrain consists of our battery pack, power electronics, motor, gearbox and control software. We designed our
powertrain originally for our first vehicle, the Tesla Roadster, and commercialized improvements into vehicles manufactured by Daimler and Toyota, and
ultimately into the Model S and Model X. Today, we offer several powertrain variants for the Model S and Model X that incorporate years of research and
development performed since the original design. In addition, we have designed our vehicles to incorporate the latest advances in consumer technologies, such as
mobile computing, sensing, displays, and connectivity. Further evolution of our technology continues for Model 3, which we plan to offer at significantly lower
price. In addition, advancements originally commercialized in our vehicles are being leveraged for our storage applications.
5
Battery Pack
We design our battery packs to achieve high energy density at a low cost while also maintaining safety, reliability and long life. Our proprietary technology
includes systems for high density energy storage, cooling, safety, charge balancing, structural durability, and electronics management. We have also pioneered
advanced manufacturing techniques to manufacture large volumes of battery packs with high quality and low costs.
We have significant expertise in the safety and management systems needed to use lithium-ion cells in the automotive environment, and have actively
worked with lithium-ion cell suppliers to further optimize cell designs to increase overall performance. These advancements have enabled us to improve cost and
performance of our batteries over time. For example, in 2015 alone, we upgraded the battery of our lowest range Model S from 60 kWh to 70 kWh, and our highest
range Model S to 90 kWh.
Our engineering and manufacturing efforts have been performed with a longer-term goal of building a foundation for further development. For instance, we
have designed our battery pack to permit flexibility with respect to battery cell chemistry and form factor. In so doing, we can leverage the substantial investments
and advancements being made globally by battery cell manufacturers to continue to improve cost. We maintain extensive testing and R&D capabilities at the
individual cell level, the full battery-pack level, and other critical battery pack systems. As a result, we have built an expansive body of knowledge on lithium-ion
cell vendors, chemistry types, and performance characteristics. We believe that the flexibility of our designs, combined with our research and real-world
performance data, will enable us to continue to evaluate new battery cells as they become commercially viable, and thereby optimize battery pack system
performance and cost for our current and future vehicles.
Power Electronics
The power electronics in our electric vehicle powertrain govern the flow of high voltage electrical current throughout the vehicle. The power electronics
have two primary functions, powering our electric motor to generate torque while driving and delivering energy into the battery pack while charging.
The first function is accomplished through the drive inverter, which converts direct current (DC) from the battery pack into alternating current (AC) to drive
our induction motors. The drive inverter also provides “regenerative braking” functionality, which captures energy from the wheels to charge the battery pack when
needed. Tesla has developed a family of drive inverter designs that are customized to its proprietary motor designs to most efficiently meet the demands of each of
our vehicles. The primary technological advantages to our designs include the ability to drive large amounts of current in a small physical package.
The second function, charging the battery pack, is accomplished by the charger, which converts alternating current (usually from a wall outlet or other
electricity source) into direct current that can be accepted by the battery. Tesla vehicles can recharge on a wide variety of electricity sources due to the design of
this charger, from a common household outlet to high power circuits meant for more industrial uses. In most markets, Tesla vehicles come with a Mobile
Connector that allows for multiple different charging services to be used. In many markets, Tesla offers a Tesla Wall Connector that can be set up to provide higher
power charging than the Mobile Connectors.
On the road, customers can also charge using our Supercharger network or at a variety of destinations that have deployed our charging equipment. In
addition, Model S vehicles can charge at a variety of public charging stations around the world, either natively or through a suite of adapters. This flexibility in
charging provides customers with additional mobility, while also allowing them to conveniently charge the vehicle overnight at home.
Dual Motor Powertrain
In October of 2014, we launched the initial version of our dual motor powertrain, which uses two electric motors to provide greater efficiency, performance,
and range in an all-wheel drive configuration. Conventional all-wheel drive vehicles distribute power to the wheels from a single engine driving a complex
mechanical transmission system. By contrast, Tesla’s dual motor powertrain digitally and independently controls torque to the front and rear wheels. The almost
instantaneous response of the motors, combined with low centers of gravity provides drivers with controlled performance and increased traction control.
Vehicle Control and Infotainment Software
The performance and safety systems of our vehicles and their battery packs require sophisticated control software. There are numerous processors in our
vehicles to control these functions, and we write custom firmware for many of these processors. The flow of electricity between the battery pack and the motor
must be tightly controlled in order to deliver the performance and behavior expected in the vehicle. For example, software algorithms enable the vehicle to mimic
the “creep” feeling which drivers expect from an internal combustion engine vehicle without having to apply pressure on the accelerator. Similar algorithms control
traction, vehicle stability and the sustained acceleration and regenerative braking of the vehicle. Software also is used extensively to monitor the charge state of
each of the cells of the battery pack and to manage all of its safety systems. Drivers use the information and control systems in our vehicles to optimize
performance, customize vehicle behavior, manage charging modes and times and control all infotainment functions. We develop almost all of this software,
including most of the user interfaces, internally.
6
Autopilot Systems
We have developed an expertise in vehicle autopilot systems, including auto-steering, traffic aware cruise control, lane changing, automated parking, driver
warning systems and automated braking functions. In October of 2014, we began equipping all Model S vehicles with hardware to allow for the incremental
introduction of autopilot technology. Our autopilot systems relieve our drivers of the most tedious and potentially dangerous aspects of road travel. Although the
driver is ultimately responsible for controlling the vehicle, our system provides safety and convenience functionality that allows our customers to rely on it much
like the system that airplane pilots use when conditions permit. Our autopilot system leverages an advanced set of hardware including a forward radar, a forwardlooking camera, 12 long-range ultrasonic sensors, and a high-precision digitally controlled electric assist braking system. This hardware suite, along with over-theair firmware updates and field data feedback loops from the onboard camera, radar, ultrasonics, and GPS, enables the system to continually learn and improve its
performance.
Vehicle Design and Engineering
In addition to the design, development and production of the powertrain, we have created significant in-house capabilities in the design and engineering of
electric vehicles and electric vehicle components and systems. We design and engineer bodies, chassis, interiors, heating and cooling and low voltage electrical
systems in house and to a lesser extent in conjunction with our suppliers. Our team has core competencies in computer aided design and crash test simulations
which we expect to reduce the product development time of new models.
Additionally, our team has expertise in lightweight materials, a very important characteristic for electric vehicles given the impact of mass on range. Model
S and Model X are built with a lightweight aluminum body and chassis which incorporates a variety of materials and production methods that help optimize the
weight of the vehicle.
Vehicle Sales and Marketing
Company-Owned Stores and Galleries
We market and sell cars directly to consumers through an international network of company-owned stores and galleries. Our Tesla stores and galleries are
highly visible, premium outlets in major metropolitan markets, some of which combine retail sales and service. We have also found that opening a service center in
a new geographic area can increase demand. As a result, we have complemented our store strategy with sales facilities and personnel in service centers to more
rapidly expand our retail footprint. We refer to these as “Service Plus” locations. Including all of our stores, galleries, Service Plus and service facilities, we
operated 208 locations around the world as of December 31, 2015.
We own our sales and service network because the traditional franchised distribution and service model is not viable for a business like ours. In our
company-owned network, our customers deal directly with our own Tesla-employed sales and service staff, creating a differentiated buying experience from the
buying experience consumers have with franchised automobile dealers and service centers. We believe we will also be able to better control costs of inventory,
manage warranty service and pricing, maintain and strengthen the Tesla brand, and obtain rapid customer feedback.
Tesla Supercharger Network
We are building a network of up to 120 kW fast charging equipment, each called a Tesla Supercharger, throughout North America, Europe and Asia for fast
charging of Tesla vehicles. Our Supercharger network is a strategic corporate initiative designed to remove a barrier to the broader adoption of electric vehicles
caused by the perception of limited vehicle range and to provide fast charging to enable long-distance travel. The Tesla Supercharger is an industrial grade, high
speed charger designed to replenish 170 miles of range in the battery pack in as little as 30 minutes. Supercharger stations typically have between four to ten
Superchargers and are strategically placed primarily along well-travelled highways to allow Model S and Model X owners to enjoy long distance travel with
convenient, minimal stops. As of December 31, 2015, we had 584 Supercharger stations open in North America, Europe, and Asia. We are planning to continue to
expand the Supercharger network in the United States, Europe and Asia.
Destination Charging
We are working with a wide variety of hospitality locations, including hotels and popular destinations, to offer an additional charging option for our
customers. These destination charging partners deploy our wall connectors and provide charging to Model S owners that patronize their businesses. As of
December 31, 2015, over 1,800 locations around the world had more than 3,100 Tesla wall connectors installed.
Orders and Reservations
We typically carry a very limited inventory of our vehicles at our Tesla stores. The vast majority of our customers customize their vehicle by placing an
order with us via the Internet. To begin production or make a reservation, we require an initial payment which is collected once the customer has selected the
vehicle specifications and has entered into a purchase agreement. We require all remaining payment of the purchase price of the vehicle upon delivery of the
vehicle to the customer.
7
Marketing
Our principal marketing goals are to:
·
generate demand for our vehicles and drive leads to our sales teams;
·
build long-term brand awareness and manage corporate reputation;
·
manage our existing customer base to create loyalty and customer referrals, including through our referral programs; and
·
enable customer input into the product development process.
Historically, we have been able to generate significant media coverage of our company and our vehicles, and we believe we will continue to do so. To date,
media coverage and word of mouth have been the primary drivers of our sales leads and have helped us achieve sales without traditional advertising and at
relatively low marketing costs.
Vehicle Service and Warranty
Service
We provide service for our electric vehicles at our company-owned service centers, at our Service Plus locations or, in certain areas for an additional charge,
through Tesla Ranger mobile technicians who provide services that do not require a vehicle lift. We owned and operated 118 service locations as of December 31,
2015. We are continuing our plan to build a number of additional service centers in several markets worldwide.
Our vehicles are designed with the capability to wirelessly upload the data to us via an on-board system with cellular connectivity, allowing us to diagnose
and remedy many problems before ever looking at the vehicle. When maintenance or service is required, a customer can schedule service by contacting one of our
Tesla service centers. Our Tesla Rangers, or mobile service team, can also perform an array of services from the convenience of a customer’s home or other remote
location.
Our company-owned service centers enable our technicians to work closely with our engineers and research and developme…

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