Drabinsky and Gottileb: Accounting - Case Study Example

?Accounting Case Study Table of Contents Question A1 3 Question A2 5 Corporate ethical culture at Livent Inc 5 Effect of this culture on the employeebehaviour 7 PART B 9 Question B1 9 Question B2 13 Reference List 15 PART A Question A1 Drabinsky and Gottileb operated a kickback scheme from 1990 to 1994. In the kickback scheme two Livent vendors are appointed who helped Drabinsky and Gottileb, siphon millions of dollars from the company directly into their own pockets. This is an illegal activity since both Drabinsky and Gottileb are the major shareholders of the company, but their rights for the share comes after clearing the dues of the other shareholders. Since the company was incurring heavy losses, so the two devised this kickback scheme that would help them gain a significant share of profit before paying dues of other shareholders. The vendors supplied Livent with inflated bills. There was in fact no activity that can be regarded as reasons for the inflated bills. As a result of the kick-back schemes and huge losses, Livent Inc started fudging the real data with false data. In order to make the company look financially sound and profitable, the two conspirators decided to create software that will help to create a systematic way of manipulating the financial data. These points to another instance of fraud scheme at Livent. The manipulation involves simple erasing from the accounting records expenses and liabilities that occur at the end of each quarter. In accounting standards this is illegal, since this inflates the profit artificially. In order to decrease the expenses the reproduction costs from a currently running show are transferred to an ongoing show. In accounting standards this cannot be done, since only those costs can be realized that have incurred and not those that are yet to occur (Bajaj, 2001). This allowed the amortization of costs indefinitely. This is also illegal since certain costs can be amortized for certain period only. Livent accountants transferred the costs to fixed asset accounts to enjoy long term of amortization periods, for as long as forty years instead of the usual 5 years. This is not allowed in accounting standards since prepaid expenses can be capitalized as assets but cannot be amortized over a period of forty years. The Livent accountant debited the salary expenses and operating expenses to long term fixed asset accounts, although the same cannot be done under the accounting standards and rules. The scope of considering prepaid expenses as asset is restricted and involves only few items like rent expenses, power bill expenses, stationary items expenses. The massive manipulations did not serve the purpose they were supposed to serve in the first pace itself. So Livent executives devised more elaborate fraud schemes like “fraudulent-revenue generating schemes”. In this particular fraud scheme, the production rights owned by Livent were sold to third parties. The contract indicated that under no circumstances the fee of $1.2 paid by a Texas based company is refundable (Bonaccorsi and Daraio, 2009). In reality a secret pact was signed that indicated Livent would indemnify the Texas Company in case of losses by agreeing a reasonable rate of return. In accounting standards although the fee received can be treated as revenue but the deliberate way in which the expenses related to the payment of interests (in case of loss) undermines the expenses to the business. Thus, the profit is inflated in an artificial way. Livent inflated the box office results for key productions. In order to make sure that the revenue generated from Broadway does not fall below the anticipated level, the company illegally paid two vendors to buy all the tickets at Los Angeles. The payment made to the vendors are not considered as expenses but charged to fixed assets. If they are to be charged to the fixed assets, they have to be treated as prepaid expenses, although the expenses can never be treated as prepaid expenses in the first place itself. So this is another instance of gross manipulation orchestrated by Levint Inc. A software programme was developed that replaced the original financial data and journal entries with falsified data. Thus, no paper trails can be established from the original journal entries and thus there remained no evidence. The auditors and investors were presented with the fudged data. Only the top executives of Livent have the knowledge and access to the original journal entries. The auditors are supposed to be entrusted with unrestricted access to the original data for completing the due diligence checks. Intentionally withholding the auditors from accessing crucial data accounts to a culpable offense and this exactly what is done by Livent. In another instance Livent was involved in a major deal with a real estate firm for $7.4 million (Chrol, 2011). The agreement stated that if the real estate firm wishes then it can put an end to the agreement as and when it wanted to. In accounting standards when a contract involves either part to call off the deal any monetary exchanged till then cannot be regarded as revenue unless and until the deal is finalised and closed. In order to consider the payment as revenue, Livent executives sent a forged letter addressed to Livent itself in the name of the real estate stating that the put agreement has been cancelled. This amounts to culpable offense since this is a case of forgery. Question A2 Corporate ethical culture at Livent Inc The corporate ethical culture in Livent Inc was not plagued by treachery, incompetency and utter lack of self respect. If an in depth analysis of the corporate ethical culture needs to be done, then it must be mentioned that there are certain aspects of the organizational culture. The aspects are rights and ceremonies, stories and myths, power relationship, control systems, organizational structure and symbols. Analysis of each and every factor will help to perform an in depth analysis of corporate ethical culture. Livent has a practice of seriously undermining the rights of the employees. Under the corporate governance code, an employee is free to express his or her points of view in matters of company affairs, which would be beneficial to the company. The corporate governance code also states that that any employees has the right to notify the management or the immediate superior or to the person who is in a more superior position about any irregularities in the operations. The management is bound to take actions upon receiving such information. It must be mentioned that there are instances when employees at Livent who are in subordinate positions, have approached the management to report irregularities, only to be rejected and turned away (Clark and Mathur, 2011). In some instances the management would get on with verbal abuses to deter the employees from approaching the management with any idea that does not fall in the work responsibilities and roles. The verbal abuses hurled at the employees by the executives of Livent, showed that the management had no intention to uphold the self respects of the employees and nurture it. Maria Messina indicated that the accountants of Livent were common targets for abuses by Drabinsky and others. The employees were literally told that the main objective and reason for which the employees are kept are to make sure that they did what they are asked to do without asking any questions. This is in case of employees who are in subordinate levels. Even partners like Robert Webster when tried to access the accounts data and other critical information could not do so since the Gottileb and Drabinsky made it absolutely impossible to access such kind of information. This pointed that there is utter lack of transparency in the corporate culture. Utter lack of transparency that led to the development of lies, forgery and misrepresentation. Thus, in one word it can be said that Livent Inc lacked any shred of ethics (Das, Quelch and Swartz, 2000). Robert Webster’s request to get unrestricted access to the accounting records of the company was met with a barge of criticism. There were virtually no control systems at Livent Inc. Any kind of control system needs to access to raw data or information without which control measures cannot be formed. The control systems that Livent had were mainly two types, one is the external control system and the other one is the internal control system. The internal control systems were under the vigilance of CFO Maria Messina. While the external control lay under Robert Webester. Though Maria happened to be the CFO, and like Robert was supposed to keep an unbiased view of the accounting procedures. In reality she was under influence of both Gottileb and Drabenski. Robert was independent and not under the influence of any one, but his efforts to access the financial data did not meet with any success. This point to the fact that there seems to be no internal control procedure in Livent and thus corruption beseeched the company from inside to outside. Thus, it can be said that the organization culture of Livent Inc was not at all congenial for the proper development of the employee morale. Rampant corruption, violation of rights and outright abuses is detrimental for the development of the employee morale. Lack of ethics and ethical practice made it a tough to work in. This is evident from the various instances where Maria Messon indicated that the work pressure was significantly more than that she faced at Deloitte& Touche. Thus, within 3 years of joining Livent, Messina’s life was in complete disarray. The corporate ethical culture of Livent Inc can be described as power culture in short. In this type of culture the whole power to control or influence emanates from the centre (Flint, Woodruff and Gardial, 2002). Thus, the culture is severely weighed down by political influence, i.e. the reign of the organization rested on few peoples only and thus they made all the vital decisions, just like the way politicians make the decisions for the country. Although this kind of culture serves the purpose of the figure head or the leader which is exactly is in case of Livent Inc. Effect of this culture on the employee behaviour The unhealthy corporate culture of Livet has a detrimental effect on the employees. The organizational leaders are supposed to help in transforming the employees through transformational leadership. This kind of leadership skills helps management in transforming employees, so that they can see beyond small individual gains and work for the whole organization. Instead of leading the path towards development, the organizational leaders led the employees to a state where the organization can suffer a breakdown. The employees were constantly badgered with disrespect and abuses. This made the employees lose their morale. After an employee loses the morality, the ability to justify between right or wrong is lost or the ability to distinguish between legal and illegal is lost (Garrick, 2011). The employees of Livent have someway gone through the same phase; constant abuse had almost made them oblivious to the kind of corruption that seeps through the veins of the company. Thus, at some of time the employees stopped complaining about the corrupt practices and in fact considered the same as norm and usual. The executives and the senior management of Livent would subject the employees to extreme verbal abuses. This kind of verbal abuse created a feeling of dissent and unworthiness among the employees. For an organization the employees are the greatest source of resources, who can be trained to achieve high productivity and this in turn increases the operational efficiency of the company. Livent never considered increasing the productivity of the employees, so they were always kept on a leash. If employees feel that they are on a leash then the sense of being dutiful and diligent does not arise. If the sense of being dutiful and diligent does not arise then the employees can never cross the limitations of the job and bring innovation and new ideas to the process. This exactly was the case with the employees of Livent Inc. The managers did not regard the employees as human resource rather just as part of the system only. Thus, the employees are being kept just for the purpose of doing what needs to be done and not for thinking out-of-the-box or for thinking beyond the purview of the job responsibilities and roles (Ger, 2000). There are instances that indicate the ways the employees are verbally abused and deterred for taking the initiative to think beyond what their roles and responsibilities permit them to do. This kind of aggravation from the executives of Livent Inc made sure that the employees came to be used as only pawns in the illegitimate process of data fudging and misrepresentation. PART B Question B1 Maria Messina was at the cross roads of her career, when she decided to join the Livent Corporation. After joining the Livent Corporation, she instantly realized that joining the corporation might not have been the best of the interests. The work pressure she faced at her new work place at Livent was more than what she faced in her former work place Deloitte & Touche. At the time when Messina joined the Livent corporation, where the perpetrated fraud took place she was at the cross roads of her career decision. She was not being able decided whether to leave the coveted position, she as yearned for years at Deloitte & Touche with moderate pay or join highly paid “back office” job at Livent. The case presents a detailed description of how Garth Drabinsky and Myron Gottileb masterminded the whole fraud scheme, but there are few instances that point the direct involvement of Messina in the fraud case. The subtle ways in which she protested against the fraudulent practices, proved to be in effective and thus, it did not make any dent in the fraud process and the same continued unabated. It can be argued that if Messina had really been steadfast in exposing the fraudulent practices at Livent Inc, then she could have approached the right authority. In order to indicate how Messica became involved in the fraud case need to be mentioned. After joining Livent Inc as partner in 1995, Messina came to realize that one of the primary responsibilities she is entrusted by the management of Livent Inc is to conceal the Livent fraud from the Deloitte auditors. On several occasions when Messina confronted the management on matters of accounting irregularities, she was hushed by the management. Messina decided not to take up the matter with higher authorities. If Messina has been really concerned about the accounting irregularities in Livent, she should have reported the matter to higher authorities (Gina, 2013). Although, there are as no prima facie evidence that points out that Messina hesitated to report the matter to the higher authorities, but her inactions prove otherwise. So her actions indicate that she unwillingly encouraged the perpetrators to carry out the fraudulent activities. Thus, in an indirect way Messina became complicit in the frauds. This is only one of the examples that indicate how Messina came to be associated with the frauds. There is another important factor that must be noted in the case. Robert Webster was appointed as the executive vice president of Livent by Ovitz. Subsequently Webster was given a wide range of responsibilities and the most important role among them is monitoring Livent’s accounting and finance functions for the new management team of Ovitz. In order to perform the roles and responsibilities, Robert Webster approached Maria Messina on matters related to accounting and due diligence. Messina was reluctant to discuss accounting matters with him. Messina was the chief financial officer of Livint and she has the most comprehensive knowledge about the accounting procedures and protocols followed at Levint. Messina’s reluctance on discussing matters of accounting indirectly encouraged both Drabinsky and Gottileb to continue the fraudulent practices unabated (Lev and Thiagarajan, 2013). If Messina had taken Robert Webster into confidence to revel and discuss the way financial data are forged then the damage to the investors would have not been such astonishingly high. This fact is in support of the argument that knowingly or unknowingly, reluctantly or not, Messina got herself in the complicit of the frauds. In order to understand how Messina became involved in the fraud case, the Fraud Triangle concept will be used. There are three main pillars or vertices of the fraud triangle which are pressure, opportunity and rationalization. One of the prime reasons why frauds are committed are due to social pressures and general aptitude of mankind to live a more lucid and material life. In order to live an extravagant and lucid life, money is needed and turning to forgery and scams are the easy way to get what is yearned for. In this case, Messina seemed to have realized the need for greater monetary gain. This is the same reason for which she quit her moderate paying job at Deloitte & Touche and joined Kivent Inc, in an apparent search for more monetary gain and the glitz and glamour. Livent Inc was into show business and glitz and glamour is something that is churned day in and day out in the company. Messina wanted to be part of the glitz and glamour of the show business. So for this reason she quit Deloitte & Touche and joined Livent Inc. Though it is not revealed anywhere directly that Messina was in dire needs of money and so she took the job at Livent Inc. It is indicated that Messina received the respect and admiration of the family and friends for being promoted to a partner level with US based Deloitte & Touche, LLP. With the new promotion, Messina became eligible for a higher tax bracket since there was significant increase in payments (Lipe, 2006). If Messina would have been satisfied with the kind of payment and job role she had at Deloitte & Touche, then she would not have changed her job. The prospect of earning coupled with extrinsic and intrinsic reward was the motivational factor that made Messina to change her employment status. Thus, she came to be associated with Livent Inc. It can be argued that monetary gains and other non monetary gains has been one of the underlying factors behind her involvement in the fraud scheme. There second important part of the fraud triangle is the rationalization of the illegal activity. Rationalization helps a person to differentiate between good and bad, detrimental or beneficial and legal and illegal. The person involved in a fraudulent activity may start considering the activity to be justified and just. Messina joined the Livent incorporation in 1995 and remained to be an active member of the firm till 1999, since after 1999 she was charged for being involved with the fraudulent activities. She became aware from the beginning that Livent is forging the financial data. It would be illogical to assume that for a person to raise an issue and bring it to the notice of the supreme authority can take 4 years. Messina’s actions prove otherwise and it does seem that despite being aware of the fraudulent activities, Messina seemed to continue her association with the company. She took comfort in the fact that she is not participating directly in any such fraudulent activities. The case study does not mention any fact about the way Messina rationalized her actions but Messina took solace in the fact that she is trying to dissuade her subordinated from indulging in fraudulent practices. Apart from that, she also desisted from signing the letter of representation for the audits of 1996 and 1997. Messina tried to rationalize her association with Livent as just by taking solace in the fact that she is taking an indirect stance against the forgery and scams. The third pillar of the fraud triangle is presence of opportunity. This is perhaps the most important of all the factors. This is because of the reasons that most of the frauds that occur in organizations was due to serious lack of internal control procedures and is plagued by poor organizational culture. Livent Inc was headed by Gottileb and Drabinsky. Both Drabinsky and Gottile have showed utter reluctance to improve the organizational culture. Moreover, their attitude towards the employees was not professional in nature. Thus, a poor organizational culture created a negative feeling among the employees and lack of motivation created the perfect breeding ground for involving in activities that will be detrimental for the organization. This is one of the factors, although its direct influence on Messina is not as much as other factors. Organizational leaders like Gottileb and Drabinsky themselves made it absolute necessary that there is no need of any internal control procedures. Thus, they encouraged the use of forged financial data. These circumstances prompted Messina to think that since the organizational leaders themselves are supporting practice of fraudulent activities, so even if she continues to be associated in an indirect way, she will be safe and could not be implicated. This prompted Messina to be indirect participant to frauds and scams. Question B2 Messina was fined $7500 and was suspended from practicing as a chartered accountant for two years. Till date so far SEC has not formally sanctioned Maria Messina for her role in the Livent fraud. It must be mentioned in the first glance that the punishment hurled upon Messina is light in nature. It must be noted that the participation of Messina in the fraud case has been under coercion and pressure. It also must be noted there are various instances when Messina and others accounting officers have been forced to work with limited access to financial data and information. On being asked for increased access to financial data, the employees have been verbally abused and deterred from asking such. On account of the charges brought against Messina, she responded in her defense by saying that she attempted to desist the executives of Livent from using the false data, to increase the company’s revenues and profits. This indicates that Messina though being seriously undermined by Drabinsky and Gottileb did her best to stop the fraud from spiralling any further. There is although no mention of any fact where employees with whom Messina had such interaction testified in the court of law that would uphold the statement given by Messina and prove the same to be true. Thus, the statement given by Messina that she did her best remains a matter that needs further investigation. In the court of law nothing suffices as much as evidence can, so the lack of evidence to support Messin’s statement makes it null and void. Another important fact that must be noted is the fact Messina purportedly met her old colleagues at Deloitte in an attempt to put an end to the trickeries and aggressive revenue recognition policies used by the management of Livent. In another instance Messina showed her standing in support of the right and just by refusing to sign the letter of representations for the 1996 and 1997 audits. If these papers would have been signed by Messina then it would indicated that Messina is acknowledging the fact that the financial statements were prepared following due diligence of the accounting standards. Messina’s refusal to sign the papers showed her stand against the use of forged data and prepared hoax financial statements (Clark and Mathur, 2011). These points are all prima facie evidence of the fact that Messina did act on her accord to deter the Livent management from taking the use of forged financial data any further. Although this must be mentioned that these acts of valour cannot be regarded as the standard procedure that Messina should have adopted to stop the process of forgery. The efforts to deter subordinate employees and discussing with Deloitte colleagues and subsequent refusal to sign the audit papers of 1996 and 1997 cannot be regarded as the right decision taken to nub the on-going fraud. Thus, in this sense it must be mentioned that despite all facts pointing to the apparent disassociation of Messina with the frauds and scams, the self proclaimed ways adopted by Messina to act against fraud amounted to serious non compliance issue (Garrick, 2011). 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