The Function of Ethics and Financial Services - Essay Example

The Function of Ethics and Financial Services Question A1: Outline the frauds identified in the case and explain the inconsistencies with proper accounting treatment. Relate your answer to broad accounting concepts and accounting standards where relevant. (8 marks; approximately 800 words) Livent, Inc., a Toronto based company is a potent example of a company that encountered fraudulent schemes. Despite the company having a strong desire to succeed among other competitors, it was declared bankruptcy in Canada and the United States. After conducting a financial analysis, it was evident that the company had overstated its revenues in the year 1997 and 1998. During this era, some of its techniques were quite confusing and blatant. The company had excluded some of its expenses from its financial book. The case highlights various red flags such as an extreme growth-oriented management team and growing need for extra capital. With this, the auditors allowed themselves to be misled and missed the red flags that could have alerted them to dig and analyse their analysis more deeply. During the era 1990-1994, the company was involved in a fraud scheme whereby Gottlieb and Drabinsky received $7, 000, 000 directly or through the company owned by Gottlieb. Approximately $ 4, 000, 000 of the total amount was capitalized as the pre-production costs. Gottlieb and Drabinsky operated a kickback scheme with Livent vendors and took the mentioned amount from the company and took into their own pocket. To fully convince the company of the transaction, Gottlieb instructed the two vendors to present an invoice that could not expose their deal. After Livent agreeing to the deal, Gottlieb and Drabinsky received the payment for bogus services. In the mid 1990s, it became difficult for the company to attain its financial goals. Gottlieb and Drabinsky enjoyed their financial gain, and in turn, the company had to bear the loss. It became difficult for the company to raise additional capital to sustain its operation. Further, Gottlieb and Drabinsky manipulated the company by directing Livent’s accounting staff to obscure the company’s financial crisis. Some of the manipulations included erasing the accounting records that recorded the liabilities and expenses of the company at the end of each year. The Livent’s accounting staff engaged into an accounting scam of transferring the preproduction costs of existing show to shows that was in production. This transfer manipulated the company to comprehend the cost of the major items used in production. To reduce the costs of preproduction, Livent’s accounting team transferred the costs to fixed asset accounts. Eventually, the company started debiting salary expenses and operating expenses to long-term fixed assets accounts. Livent transferred the cost of the shows that were currently running to shows that never existed (Knapp & Knapp n.d, p10). In 1996, Gottlieb and Drabinsky conducted a scheme referred as the fraudulent revenue-generating. This fraud involved various multimillion-dollar transactions organized by Gottlieb and Drabinsky. Most transactions involved the rights to produce Show and Ragtime Boat in different U.S. theatres to Texas companies. The contract or agreement of this transaction obligated the need to have a non refundable fee. Specifically, the $11.2 million fee paid by the Texas company to Livent was non refundable. However, the Livent’s executives arranged a secret side agreement that guaranteed Texas Company a reasonable rate of return on every large investment they made. Despite the actual growth and earnings that the company achieved, the accounting staff benefited more while the company deteriorated at a high rate. The final Livent Fraud occurred in the late 1997, when Livent opened Ragtime in the Los Angeles Theatre. The company got into an agreement with the theatre of closing the show if the weekly sales fell less than $500, 000. During that period, Livent entered into various transactions purporting to present Livent shows in return for fees from the counter parties. To fully succeed, Livent’s executives established the need to open a Ragtime show on Broadway. The Executives believed that if the show failed to perform well in Los Angeles, then the show in Broadway could save them from the misfortune of terminating the show as per the set agreement. The company established the need to purchase many tickets to the shows regardless of not having a large audience. The fraud scheme misrepresented the company financially. For instance, in 1992, the company reported a $2.9 million pre-tax profit while the actual amount approximated to $100, 000. In 1996, the company reported a $14.2 million pre-tax profit while in the actual sense the company incurred a loss of $20 million. In 1997, the company documented that its total fixed assets were $200.8 million while in the reality it approximated $24 million (Archarya 2103, p1). The most troubling aspect about the Livent fraud is the manner in which the management team organized and conducted the fraud. The scheme involved much of the senior financial management. The management team regularly met to discuss the details and plans of the fraud and as a result, the company deteriorated at a high rate on its financial performance and growth. The auditors were also the victims of the vast schemed to misrepresent the financial growth and position of the company. Question B2: Comment on the adequacy of the disciplinary action taken against Messina. (5 marks; approximately 500 words) It was a well-documented fact that, the disciplinary action taken by the court against Messina was adequate (Hasselback 2013, p1). Messina publicly admitted that she was involved in the Livent Fraud. As a result, she was suspended from operating as a charted accountant for two years and fined $ 7, 500. The disciplinary action was adequate in that, Ms Messina failed to alert Deloitte and Touché staff after she realized the first accounting fraud at Livent in 1997. Indeed, this was a bad and difficult situation for Ms Messina to protect the fraud. In the court, Messina affirmed that she assisted Touche and Deloitte to adjust the company’s financial records. In this case, Messina was doing this to benefit from the actual results of the fraud. In facts, Messina failed to expose the fraud, but worked hard to protect those involved in the scandal. In the court, Messina testified that she did not expose the fraud until 1998, when the new investors emerged in the company. It is evident that Messina was much concerned with what she could attain, and could do anything to achieve it. However, when investors came in to manage the company, Messina established the need to expose the fraud since she knew that the new management team would detect the scandals. Messina testified that it was very difficult to detect the fraud in the company since auditors only tested various accounts payable, but failed to detect accounting problems. She also testified that one of the company’s biggest expenses was advertising costs, and with this, auditors tried to verify the amounts owed with that of the unpaid advertising. Messina affirmed told the trial that both Gottlieb and Drabinsky who were largely involved in the financial scandals had a good understanding of the company’s progress and account records. Additionally, Messina told the trial that the atmosphere at Livent was abusive and toxic (Beasley 2006, p22). With the mentioned facts in mind, it is obvious that Messina protected those involved in the fraud. Despite knowing what was going on in the company, Messina partnered with senior financial management team to deteriorate the company. When asked by the company to compile the company financials records, she did the best she could to present unrealistic figures. Often, she revealed how the company was growing tremendously while in the actual sense the company was operating in loss. Messina failed to perform her duties effectively as per accounting ethics that regard accountants to provide accurate analysis. According to Ketz (2006, p22), accountants and auditors should provide accurate financial data that do not exaggerate or underestimate the company’s growth. In most cases, Messina revealed how the company was making huge profits, less liabilities, and more expenses. As a result, the financial analysis presented could not help the company focus on the shortcomings. Even after joining Livent to serve as the company’s chief financial officer, Messina failed to perform her duties professionally. In her position, she had the right to report what was going in the company without protecting those involved in the fraud. Therefore, it was evident that she was involved in the fraud manipulation of the company. Bibliography Archarya,M 2103, Livent looks like our WorldCom, Retrieved from http://www.thestar.com/news/gta/2009/03/26/livent_looks_like_our_worldcom.html Beasley, M. S 2006, Auditing cases: an interactive learning approach, Upper Saddle River, N.J., Pearson/Prentice Hall. Hasselback, D 2013, It’s Livent — the Sequel, Retrieved from http://business.financialpost.com/2013/03/19/its-livent-the-sequel/ Ketz, J. E 2006, Accounting ethics, London, Routledge. Knapp, M.C., & Knapp, C.A., n.d, Livent, Inc.: An Instructional Case, Retrieved from http://aaahq.org/audit/midyear/03midyear/papers/livent.html Read More