The Phar-Mor case again involves a retail enterprise, inventory overstatements, and both fraudulent financial reporting and misappropriation of assets. The auditors completely failed to discover the fraud, missing the many warning signs and ignoring the high-risk elements of the engagement. Yet again, the scrupulous, yet dedicated, fraudsters showed that they were capable of fooling everyone for an extended period of time. Until recent years, remained one of the largest US corporate frauds of all time.
The low prices led to huge losses, which in turn spurred the accounting shenanigans. Under the guise of a growing, profitable retail venture, investors, such as Sears Roebuck & Co. and the Corporate Partners Investment Fund, willingly contributed capital to further the growth. However, 1987 was the last year the company would actually earn a
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profit. Earning its stripe as one of America’s classic frauds, the Phar-Mor case was widespread in the accounts it affected and significant in the amounts involved. Using both fraudulent financial reporting and misappropriation of assets, Phar-Mor committed the fraud by issuing fake invoices for merchandise purchases, making phony journal entries to increase inventory and decrease cost of sales, recognizing inventory purchases but failing to accrue a corresponding liability, and over-counting merchandise. While the company did have an audit committee, Monus spearheaded it and disbanded the internal audit department after they voiced their concerns over controls. Shapira, Monus, and Finn all maintained a “hands-off” management style that allowed each to maintain their business, while shutting others out. Although several members of senior management colluded on the fraud, Monus and Finn dominated the accounting, giving little access to others. In turn, Shapira chose not to inquire or interfere with their work. With prices that were too low, the company’s profit margins were quickly eroded, resulting in a loss of millions. Rather than announcing and recording the losses, Monus merely sought more time to correct the problems. Monus, along with the company’s CFO, Pat Finn, and two other executives, proceeded to cross out the correct figures and insert much inflated numbers on internal documents, setting the course for a series of lies to the company’s owners and financial statement users. After four months of similar actions, the Pat Finn, took over the task of altering the numbers from Monus, while also maintaining a sub-ledger, to keep track of the correct numbers. With losses totaling nearly $18 million, Phar-Mor tried to leverage its suppliers, seeking up-front, exclusivity payments. In fact, through such actions, the company collected $10 million alone from Coke. By June 1990, well into the fraud and with Monus refusing to raise prices, the CFO was regularly faxing phony reports to the board and to David Shapira, the CEO.
The collective effort of the senior executives resulted in financial statements that were misstated by over $500 million. “Phar-Mor’s executives had cooked the books and the magnitude of the collusive management fraud was almost inconceivable. The fraud was carefully carried out over several years by persons at many organizational layers, including the president and COO, CFO, vice president of marketing, director of accounting, controller, and a host of others” (Beasley Auditing 27).
Overstating inventory was at the heart of the Phar-Mor fraud. To hide the losses and make the books balance, inventory was grossly overstated. Accompanying the chain’s rapid expansion, inventory grew from a paltry $11 million in 1989 to $36 million in 1990 to $153 million in 1991. Despite the considerable growth and reflective of the company’s limited use of MIS, Phar-Mor did not utilize a perpetual inventory system. The company relied on the retail method to value
inventory. Typically the retail method is used by businesses that sell a large volume of items with relatively low unit costs. Inventory was shared between stores as the audit fieldwork progressed. Thus, the inventory overstatement was a result of being both incorrectly valued and incorrectly counted. When an inventory discrepancy arose in the audits, inventory would be appropriately credited to reduce the amount. However, rather than debiting the expense cost of goods sold, Phar-Mor debited a “bucket” account that collected all of the fraudulent entries. The “bucket” was then emptied at year-end by “allocating a portion back to the individual stores as inventory or some other asset” (35). These entries were labeled “Accrued Inventory” or “Alloc Inv” and, although both large and unusual, failed to draw the attention of the auditors.
Weld, L. G., Bergevin, P. M., & Magrath, L. (2004). Anatomy of a financial fraud. The CPA
Hanson, J. R. (n.d.). Fraud or confusion? RDH Magazine, 19(4). Retrieved 3 15, 2014, from http://www.rdhmag.com/articles/print/volume-19/issue-4/feature/fraud-or-confusion.html
Phar-Mor was known as one of the major discount chain retailers in the late 1980’s - early 1990’s. It was founded by Mickey Monus, a gambler in nature, who with the help of senior management was “cooking the books” for years to cover up his loses. The reason why senior management agreed to do this fraud is the belief in unique ability of their leader to fix everything later on. This case is known as one of the biggest accounting frauds in the corporate history of the U.S. This paper will analyze who was affected by this fraud, the motives behind it and what systems of control failed to prevent it.
Madura, Jeff. What Every Investor Needs to Know About Accounting Fraud. New York: McGraw-Hill, 2004. 1-156
The Hollate Manufacturing case provided by Anti-Fraud Collaboration has well illustrated how several common issues in an organization contributed to the fraud’s occurrence. These issues can be categorized into two major groups: ethical culture (internal aspect) and internal control system (external aspect). By taking effective actions to enhance these two aspects, an organization can protect itself against the largest frauds, which result in financial and reputational damage.
The fraud had started since 1999 to November 2006, somewhere around 78 retail owners and 131 retail employees had won lottery prizes which were worth around tens of millions of dollars (Marin, 2007). During the seven year period 200 out of 5,713 prizes were retailer wins. The OLG in 2004 found, that retailers would scratch the surface of the instant win tickets to see if they would win. The OLG found 67 scratched tickets from Oakville at one location (Richmond, 2007). Corporation was already familiar of the fact that customers with winning tickets could be cheated by retailers; they were in fact more disturbed about the media and they were setting a bad impression. According to the article “Report Rips OLG in Fraud”, to restore public trust
Wall Street's demand for high growth motivated Peregrine Systems' executives, to fraudulently inflate revenues and stock prices. According to the SEC, "Peregrine filed materially incorrect financial statements with the commission for 11 consecutive quarters." Steven Spitzer, a member of Peregrine's sales team admitted to meeting regularly with senior management near the end of the quarter to determine how much revenue was needed to exceed Wall Street's expectations. The primary fraud committed by Peregrine was done by inflating revenue by booking revenue when sales never occurred. By recognizing revenue from sales that never occurred, the accounts receivable balance and net income were fraudulently overstated; the accounts receivable would never be collected, because the merchandise was never sold. To cover up their high, outstanding, accounts receivable balance as a result of booking sales that did not occur, Peregrine fraudulently engaged in financial agreements with banks.
In modern day business, there can be so many pressures that can cause managers to commit fraud, even though it often starts as just a little bit at first, but will spiral out of control with time. In the case of WorldCom, there were several pressures that led executives and managers to “cook the books.” Much of WorldCom’s initial growth and success was due to acquisitions. Over time, WorldCom discovered that there were no more opportunities for growth through acquisitions when the U.S. Department of Justice disallowed the acquisition of Sprint.
fraud – three in the Rigas family, two other executives held, accused of mass looting. The
This shows how a lack of transparency in reporting of financial statements leads to the destruction of a company. This all happened under the watchful eye of an auditor, Arthur Andersen. After this scandal, the Sarbanes-Oxley Act was changed to keep into account the role of the auditors and how they can help in preventing such
Giroux, G. (Winter 2008). What went wrong? Accounting fraud and lessons from the recent scandals. Social Research, 75, 4. p.1205 (34). Retrieved June 16, 2011, from Academic OneFile via Gale:
The Firm’s testing to ensure accurate useful life and disclosure were inaccurate (10). The client did not maintain information on which customers correspond to the intangibles, which raised an existence question regarding the assets. The auditors should have used confirmation with these customers to figure who was listed as an asset. The auditors should have also used more professional skepticism on making sure these customers actually existed. Auditors often rely too much on what management tells them instead of investigating it themselves. The concern with this deficiency was the effectiveness of internal
They were committing fraud by creative accounting, acting illegally when using insider trading and shredding their documents relevant to the investigation. Next, consider the stakeholders. Anyone who owns stock in the company would suffer, along with every employee. Under the values bullet we can assume that they have none. Greed and power got the better of every one of them.
The Tyco accounting scandal is an ideal illustration of how individuals who hold key positions in an organization are able to manipulate accounting practices and financial reports for personal gain. The few key individuals involved in the Tyco Scandal (CEO Kozlowski and CFO Swartz), used a number of clever and unique tactics in order to accomplish what they did; including spring loading, manipulating their ‘key-employee loan’ program, and multiple ‘hush money’ payouts.
Due to such lack of monitoring, management continued to be unaware of such transactions that continued to impact the company negatively. This provided the Rigas family many opportunities to override controls since the lack of corporate governance enabled the decisions to be made by Rigas family without oversight. For example, the article “Adelphia Officials are Arrested, Charged with ‘Massive’ Fraud” discuses how Timothy Rigas had to limit himself to $1 million a month of compensation that was withdrawn from the company for personal use. All decisions were continuously made by such members of the family, in which case for Adelphia, was the team of management. With the lack of controls creating opportunity, they were free to do what they wished- which is something they took incredible advantage