Accounting Practices

1. List accounting practices that were used to fabricate the numbers in the financial statements.

The unrealistic sales targets and abusive management style created a pressure cooker that drove managers to cook the books or perish. And cook they did—booking shipments as sales, manipulating reserves and simply fabricating figures—to maintain the illusion of unbounded growth even after the industry was hit by a severe slump. They also booked returns as inventory, carried obsolete parts and scrap from the old year’s inventory on next year’s books, packaged approximately 6,100 disk drives that had been contaminated in order to inflate inventory, intentionally shipped the same goods several times to enlarge accounting receivable.

2. Comment on the internal accounting control of MiniScribe, specifically the reasons for its ineffectiveness in preventing fraudulent financial reports.

Internal accounting control is crucial to internal control in a company. Accounting control is the methods and procedures for authorizing transactions, safeguarding assets and ensuring the accuracy of the financial records. I think the most important reasons of the totally failure of internal control to prevent fraudulent financial reports in MiniScribe Corporation was the autocracy of the chairman and dereliction of auditors. MiniScribe Corporation afforded too much freedom and authorization to chairman and managers. At the same time, the audit committee, Coopers & Lybrand Corporate, could not meet its duties. The chairman chased excessively high sales, so he forced managers to enhance sales.

However, the managers could not attain the sales, so they had to directly tell accountants to inflate the figures. This situation was so common in the company, totally violated the accuracy principle of the financial records. What’s more, the large amount of inventory which used for attracting assets was eventually proven to be spurious. The money borrowed from creditors and shareholders was all used to offset the hidden loss.

Therefore, the assets surely could not be safeguarded. At last, it was too late for the CEO, auditors, creditors, suppliers and public to realize the fraud, while the loss was so large and the lies lasted so long, which was really hard for them to prevent. They also could not admit that they were lying, it would lead to bankrupt. Finally, the internal administrators could not control it anymore and no one kept confidence on the company. It is obvious to find from these facts that the internal accounting control of MiniScribe Corporation was totally failed.

3. To what extent are each of these parties responsible for the fraudulent reports (i) the CEO, (ii) the independent accountants and (iii) the board of directors? How does your answer compare with the actual penalty imposed on them?

(1) The CEO on a company has responsibility for the integrity and objectivity of the financial information presented in financial statement, properly arrange and control procedures for the company. The reason why the fraudulent reports appear is that the CEO decides to lie to public when there is something wrong with the finance of the company, but not faces it. Thus, the CEO should be mostly responsible for the fraudulent reports. The board of directors consists of the audit committee of a company.

The audit committee is responsible for recommending the Board for the independent auditing firm retained for the coming year, subject to stockholder ratification. What’s more, they meet the independent auditors, the company’s internal auditors, and management periodically and privately to review accounting, auditing, internal control structure and financial reporting matters.

They could not find the fraud earlier which made them should be secondarily responsible for the fault. Independent accountants just serve for the company. However, when they realized something wrong with the figures and the transactions, they should tell the company administrators and auditors. Therefore, I think the independent accountants just took little responsibility on the fraudulent reports. In this case, the CEO of MiniScribe Corporation obviously violated these rules.

He forced managers to do exactly as what he said and made the honest managers leave company. The employees had to lie on financial statements to meet the requirement of the CEO. The CEO had too much freedom and authorization on company. Moreover, the audit committee of MiniScribe Corporation could not found the fraud earlier. The board of directors lost much because their own mistake. While, actually, the board of directors paid most in the case. Although the CEO had the mostly responsibility, he paid less than the board of directors but also the second. The independent accountants finally lost their jobs because of the bankruptcy and would also be punishment for the loss of professional ethics.

4. Based on the stock price behavior before and after the disclosure of fraud, comment on the importance of accurate financial statement in valuing a firm. The accurate financial statements are very important in valuing a firm. If a company can honest to the public, when it faces crisis, its stock price will not fall a lot suddenly because the company does not lie to the shareholders, and shareholders would keep confidence on the company and the creditors and shareholders will also continue to borrow money to the company.

In the MiniScribe case, it is obviously that the value of MiniScribe Corporation stock tumbled from a high of $15 a share to less than $3 after the exposure of the fraud, but the company had benefited insiders by inflating its stock. At last, holders of the company’s common stock did not receive anything from the bankruptcy estate. After the company overcomes the crisis, creditors and shareholder can receive interests and dividends. It makes a beneficial cycle. The company will be able to value itself.