An Analysis of Financial Statement Fraud

Issues

Corporate fraud is extremely costly in the United States and costs corporations and consumers millions of dollars annually in lost revenues, increased consumer prices, and litigation expenses. The 2008 study by the Association of Certified Fraud Examiners estimated the U.S. loses approximately seven percent of its GPD each year. (Albrecht, 2011) That amount is staggering, over $994 billion. This analysis will examine the MiniScribe Corporation's financial statement fraud from 1985 until its collapse in 1990 and highlight what the auditors failed to uncover before it was too late.

There are six different categories of fraud such as those committed against a corporation, on behalf of a corporation, consumer, investment, management, financial statement, etc. The fraud committed by the senior management of MiniScribe was clearly management fraud committed on behalf of the corporation. It was the intent of the new CEO, Q.T. Wells, to turn the company around and make it a billion dollar company although sales in 1984 were only $124M. (Zhemin Wang, 1997) He set very high goals for sales managers to meet and did not tolerate failure. His aggressive leadership style and overbearing management tactics led to the collapse of the company in 1990 when it filed for bankruptcy with $257.7M in liabilities and only $86.1 million in assets.(Albrecht, 2011)

Facts

MiniScribe was a disc storage products company founded in Longmont, Colorado in 1980. In 1985 the company was facing financial trouble due to a recession and Quentin Thomas Wiles was appointed CEO and director of the company in order to turn it around. His management style was confrontational and those under him were expected to perform. He held quarterly meetings where those with under-performing numbers were banished to a penalty box and sometimes fired while managers that performed very well were rewarded on the spot. (Carson, 2009)

The climate at MiniScribe was one of fierce competition and extraordinary effort to achieve results at any cost. (WSJ, 1989) This fierce environment and the desire to please Wiles led to the accounting fraud that auditors failed to uncover, or simply overlooked, on the financial statements. In the first year of misstated statements, MiniScribe managers actually broke in to the auditors files and increased inventory numbers in order to misstate inventory levels on hand. (Albrecht, 2011) . In the two years following, the techniques to overstate the financial statements grew more outrageous. For example, managers would ship boxes of bricks and record them as sells of hard drives. (Albrecht, 2011) In order to increase assets on hand, manager would grossly overstated inventory levels and one instance they returned scrape parts to the warehouse and added them to good inventory.

Many of the generally accepted accounting principles (GAAP) were not adhered to. Revenue was recorded when shipments of disc drives were shipped from the manufacturing plant in Asia to company owned warehouses instead of when customers actually ordered them. Managers also undervalued the amount of uncollected accounts to 1% whereas the industry average was between four and ten percent. (Zhemin Wang, 1997) Moreover, the overall industry was reporting losses and cutting production during the ongoing recession at the same time MiniScribe was reporting dramatic increases in sales and profits. This is even after MiniScribe had lost several major customers including IBM and Apple Computer. (Albrecht, 2011)

Reasoning

There are many reasons why people commit fraud and thousands of techniques have been employed while committing it. Fraud, unlike robbery, is usually committed by better educated, more religious, and those less likely to abuse substances or have a criminal record. (Albrecht, 2011) There are three fundamental concepts common to all fraud according to the Fraud Triangle from Fraud Examination 4th Edition. First there has to be some