Jamaica Water Properties Fraud - Case Study Example

Jamaica Water Properties Fraud Case Study A brief history of Jamaica Water Properties (JWP) Jamaica Water Services has had a long history as its current state has evolved from a number of corporate developments in the past. Originally, the firm was founded in 1887 under the company name of Jamaica Water Supply Co. Since that time JWP has gone through various changes and buyouts which led to its current state of operation. In 1902, it bought Jamaica Township Water Company and a few years later started generating revenue. It later bought out a few more companies and eventually changed the name to Jamaica Water Properties in 1976. This diversification later became a liability to the firm and the firm had to change its strategy. By 1980s, the firm was now making profits after a bad bout in 1978-79. When the firm started making more money, more diversification was then used, and the firm was to become now more diversified as it bought more firms at the beginning of the 1980s decade. In its bid to expand its span of business, the firm in late 80s and early nineties ventured into the computers and informational services sector by buying a number of information system resellers. This move later proved to be a wrong move as the firm had to deal with too much competition and an uncertain computing industry. This led to a loss of over six hundred million in the early 1990s. David Sokol, the CEO of the firm at the time, accused the finance department of fraud-like ways of doing accounting; he resigned after handling the SEC a report indicating that there was likely fraud in the firm. Internal and external auditor’s role in the fraud Internal auditors The internal auditors at Jamaica Water Properties were too afraid to question the actions of the CFO even though it was very clear that he was engaging in fraudulent accounting. The employees were too afraid that if they did question their boss, they would lose their jobs. Having to decide between doing what was right and suffered for it because they would have to lose their jobs and keeping quiet about the matter to keep their jobs was a difficult decision. Although it does not make their actions justifiable, it also points to an important issue about how the failure to have good whistle-blowing systems in a firm can lead to such dire situations. This issue is the fact that the firm did not have the right mechanism for a whistleblower to be able to do the whistle-blowing without risking their career. As a result of this condition, many of those who would have considered doing the right thing would think hesitate. First, even the whistle blowing would not have guaranteed that the behavior of their boss would have changed or that anything positive would have come out of it. In this regard, they decided that the best way be to keep quiet. External auditors’ role The external auditors were also responsible for what happened at the JWP. As Duska (2011) says, the role of the external auditor is to audit the books of the customer and recommend any course of action for any practice that is not being done right. This did not happen at the firm because the external auditors were too reluctant to do the right thing even though it was quite clear that the accountants at the JWP were being involved in fraud. Fraud actions Fraudulent use of purchase method of accounting for acquisitions One of the actions that the CFO and his co-conspirators used was the misuse of the purchase method to engineer the accounting books to make them appear the way they wanted them to look. The accountants would tweak accounting rules, especially about the purchase method, and this would help them to “cook” accounting books. This method is used to meddle with the way the books will look and therefore affect the outcome and the income statement of the firm. They used this method because they wanted the books to look favorable, and this could help them achieve their personal goals. Recording inexistent assets Accountants can include nonexistence assets in accounting books. Accounting records do not have a way to identify whether an asset exists or whether the books value coincides with the actual value of the assets recorded in them (Crawford, 2008). It allows a fraudulent accountant to insert creative figures and make the books look the way he or she wants them to look. It was one of the methods that the accountants and the CFO at JWP used as a way to trick the public and other stakeholders that the firm was doing so well. Misuse of the percentage-of-completion method The accountants at JWP also wrongly used the percentage-of-completion method when booking long-term contracts. It, therefore, become possible to achieve whatever they wanted to have about how they wanted the accounting books to look. In this regard, they were able to “cook” the books and cheat the stakeholders about the actual status of the firm about its financial performance. Improper accounting for Net Operating Loss Carry Over (NOLCO) The Net Operating Loss Carry Over is an accounting provision aimed at helping businesses to overcome losses (Campbell & Houghton, 2005). With this provision, a business can carry over its losses from as far back as three years prior to the year the Net Operating Loss Carry Over is being done. This provision is intended towards making sure that the business is not pushed out of the market due to having to pay taxes while it has made losses in the past years. However, it can also be abused by businesses if they want to trick the system and pay less tax (Ketz, 2006). This is what was happening in JWP where the accountants were hiding behind this provision and making improper Net Operating Loss Carry Over entries as a way to evade taxes. Reason for the fraud All accountants used fraud to inflate the company’s price stocks. They created overstated earnings, and this meant that they would be able to take home bigger bonuses than they could have done if they were to be more realistic with the books. The accountants used the fraud to make their pocket richer. Since most of these managers, especially the CFO are given performance-based bonuses, making the books look like they had performed better would help in ensuring that they would be able to get good bonuses. How it happened The CFO also had close personal relations with the external auditors from the Earnest and Young auditing company. Because of this, he would be able to go about this fraud without having to worry about being reported. The worst truth about this case was the fact that the Earnest and Young auditing company continued to give JWP a positive unqualified review for over six years while the firm was being involved in this kind of fraud. The non-qualified review is not necessary an official review. However, it does affect the way stakeholders such as investors look at the firm and thus affects the valuation of the firm, especially a firm whose shares are listed in the stock market. This behavior by the Earnest and Young auditors can also be considered as unethical behavior and he external auditors can be said to have participated in the fraud as well. Issues Managers’ role in preventing accounting fraud Internal managers also have a responsibility to deal with fraud issues and curb them before they affect the other stakeholders such as the shareholders and potential shareholders. It appears that this was not in place, and it was, therefore, easy for the managers to be able to behave unethically without anything to prevent them from doing so. Employees’ responsibilities Employees’ responsibilities when faced with a situation where their seniors are engaging in unethical behavior also come up in the case. It is necessary to know that such employees should be shielded from negative impacts when they report such cases. In this case, it appears that JWP did not have such mechanism that would make it possible for the employees to be able to deal this ethical dilemma without having to sacrifice their career. Recommended accounting policies at JWP It is not clear what accounting principles were put in place in order to help the firm not to be in the same situation again. However, it was very evident that the main issue that made the fraud to happen was because there was an unprofessional relationship between the external auditors and the employees, especially the internal managers. The auditors from the Earnest & Young did not hesitate to give JWP a positive unqualified audit report despite the fact that they were well aware of the fact that unethical and criminal activity was going on with regard to the way the firm presented its accounting books. As a result, one thing that would help JWP is to make sure that it has proper guiding principles that would help the firm to avoid such a scenario where the external auditors drop their professionalism. It will be achieved by having a background check for the managers at the firm as well as the appointed auditors from the external auditing firm (Feldmann, 2012). A background check would be necessary to ensure that there are no conflicting interests that exist between the external auditors and the internal managers (accountants and internal auditors). The other way to avoid a conflict of interests that arises from the external auditors being too close to the internal employees is by rotating the external auditors regularly. People have the potential of developing personal relationships the more they know each other and in professional circles, this can hinder their ability to act professionally. If the same auditors are attached to the same firm such as the JWP, it is possible for them to become personal with the employees at the customer. Such a situation will hinder their ability to act professionally and with an assertion. Rotating them so that the external auditing firm continues providing new faces will guarantee that this kind of scenario will not develop. Such a strategy can be very helpful in dealing with such a situation as was the case in JWP. It is also important for the firm to develop internal professional code of conduct that will guide internal employees on how to act in certain scenarios. For instance, the firm can delimit the kind of personal relationships that can exist between internal employees and external auditors (Feldmann, 2012). It will help JWP in guaranteeing that the employees do not get embroiled in a personal relationship with the wrong persons and then be affected in the way they can act professionally. It may not be hundred percent effective considering that it is not possible to completely hinder personal relationships between people who meet each other regularly. However, it might work as a guiding principle for employees, and the firm can educate them as to why this is necessary for their professional careers. The other measure that JWP can take is to create a system or process that would make it easier for internal accountants to be able to question their managers without having to risks their jobs. Everyone is supposed to act ethically at all circumstances. However, it is only expected that when an employee has so much to lose, they are likely to consider keeping quiet if they feel that they will have more to lose (Crawford, 2008). In a modern economy, good jobs are not easy to come by. An employee is, therefore, most likely to consider keeping quiet even when their conscious is telling them that something is not being done right because of the fear of losing their jobs. In light of this, it is indispensable to ensure that there are safe ways for employees to be able to deal with such ethical dilemmas. JWP should then seek to make this happen and therefore create a better platform where such fraud can be nabbed right in its bud. References: Campbell, T. & Houghton, K.A. (2005). Ethics and Auditing. New York, NY: ANU E Press. Crawford, M. (2008). CPAs Multistate Guide to Ethics and Professional Conduct (2008). New York, NY: CCH. Duska, R. (200). Accounting Ethics: Foundations of Business Ethics. Hoboken, NJ: John Wiley & Sons. Feldmann, D. (2012). Advances in Accounting Education: Teaching and Curriculum Innovations. New York, NY: Emerald Group Publishing. Ketz, E. (2006). Accounting Ethics: Theories of accounting ethics and their dissemination, Volume 2. New York, NY: Taylor & Francis. Read More