Forensic Accounting: Assignment

ZZZZ Best had started operations in the year of 1982 as a small, door-to-door carpet cleaning operation. A sixteen-year-old young talented entrepreneur, Barry Minkow who is the founder of the company, initially runs it out of his parents’ garage. ZZZZ Best experienced tremendous growth in both revenues and profits during the first several years of its existence. During the period from 1984 to 1987, the company’s net worth poured from less than $200,000 to more than $5 million on revenues of $50 million. Barry Minkow was introduced to the carpet cleaning industry at the age of twelve by his mother, who helped make ends meet by working as a telephone solicitor for a small carpet cleaning firm. Although there are many companies doing carpet cleaning industries out there, it is relatively easy to enter to the business as it requires minimal entrance for someone like Minkow.

There are no barriers to entry such as no apprenticeships to be served, no licensing requirements and only a minimal amount of start-up capital needed. A simple business as this, Minkow had no problem to start his business as early as the age of sixteen. Minkow quickly realized that carpet cleaning was not an easy way to earn a livelihood. The fierce competitions in the industry with marginally profits restrain him to expand and to survive with his business. Bad checks, nagging vendors and customer complaints demanding payment obscured the young talented person. The challenge begins when he hardly had sufficient working capital and gaining loans from banks because of his age and the condition of his business. These situations turned up that the young entrepreneur came up with his own smart and innovative ways to finance his business by credit card forgeries, staging of thefts and check kiting to fleece his insurance company. Later on, his ‘creativity’ widens when his company indulges in the business relating to the insurance restoration projects.

Introduction

It was all begun when Barry Minkow widens his business into Insurance Restoration Project, where he gained a contact from an extensive social network of friends and acquaintances. These relationships he developed are mostly from the Swanky Los Angeles health club. The conspiracy started soon after becoming a friend of Tom Padgett, an insurance claims adjuster, came to seek for his help to grant and to confirm over the telephone to banks and any other interested third parties that Minkow’s company was the recipient of occasional insurance restoration contracts. All of the activities were totally fictitious. It was a method that Minkow falsified to generate fake paper profits and revenues to convince bankers to loan him money for his evil purposes, and he expanded his operations by opening several carpet cleaning outlets across the San Fernando Valley. The projects that he got from the approval from Padgett, were easily obtained because his friend was the insurance claim adjuster and pretty well trust Minkow in doing his business with integrity.

When he realized that his ‘profitable’ insurance restoration contracts became enormously successful, soon his business switched and became the major source of revenue on the ZZZZ Best financial statements. The fraudulent activities were concealed and were not discovered by the first auditor, George Greenspan who audited ZZZZ Best Company’s Financial Statements. Minkow somehow not only confirmed the existence of the insurance restoration jobs but also obtained and reviewed copies of all key documents regarding those jobs, after spending millions of dollars to remove the trace, in which he obtained funds from his investors. However, the trouble comes in when the second auditor, Ernst & Whinney a year after, audited the first few months of engagement. Despite of concerning and questioning integrity of ZZZZ Best’s management, they resigned and that was where the assurance of the Financial Statement was being prejudiced.

5)The fifth term of reference in the matter of the output is the customers’ satisfaction. The ZZZZ Best Company’s best risk of the purported contracts failed to identify the insureds, the insurance companies, or the location of the jobs. Customers’ satisfaction is first derived as a measure of how products and services supplied or offered by a company meet or surpass customer expectation. In other words, it is one of the key performance indicators within business and is often part of a key element of business strategy. In this case, ZZZZ Best is actually do not have any customer (at all) as the contract is totally fictitious, as to generate paper profits and revenues to convince bankers to loan and to fund the company. It is the strategy of Ponzi Scheme. This scheme is a fraudulent investment operation that pays return to its investors from their own money or the money paid by subsequent investors.

The process of this scheme entices new investors by offering higher returns compared to the market. Perpetuation of the high returns requires a relatively high flow of money from new investors to keep the scheme going and paid off the old investors and this scheme keeps on continuing until it deeply collapse. Another cause of problem to this is that, Minkow misused the trust given by his networking friend, Tom Padgett, an insurance claim adjuster, to confirm over the telephone banks and other parties to obtain loans and credit grant. This is one the familiarity threats because of close relationship with the officers when the person becomes too sympathetic to the interests of others. And this will affect the customers’ satisfaction for the bankers and investors as they took part in such fraudulent act. Another cause of problem is that, a large California Bank relied upon the review report issued by Ernst & Whinney. Because of it, they did not suspect ZZZZ Best’s financial statement fraudulent and fictitious activities. The new auditor hardly received cooperation with the old auditor, obstacle them to conduct their true and fair view of the financial statement.

6) The sixth term of reference for the output is the detection, correction and rehabilitation actions taken by or to the company. In detecting the possible risk to the company by the fire and water damage, proper selection of testing and choices of method are crucial in giving assurance of the financial statement. The purported contracts failed to identify the insureds, the insurance companies, or the locations of the job were some of the analytical procedures that need to be taken from the auditor. It is a sort of proper documentation, evidence and test of balances to detect the existent of the company’s asset and also their activities that have been conducted.

Although independent auditor of ZZZZ Best, Greenspan performed various analytical procedures to confirmed the existence of insurance restoration jobs, the only mistake that he had done was that he did not inspect thoroughly any of the insurance restorations sites as one of the detection measures. It is important to testify and verify the existent of such projects which allocated more than 90% of the revenues in the company. Next, the new auditor, Ernst & Whinney did not communicate properly with the old auditor regarding to the restoration contracts as for improvement and understanding and corrections for the standard operating procedures of ZZZZ Best. This results in lack of knowledge of the client’s entity. This is enormously affecting the critical part of the assurance of the auditor where they did not disclose such material and importantly, will lead to misstatement that affect the judgment of the decision making process.

The plan of actions that can be taken for the customers’ satisfaction term of reference is that the clerk assistant in the administration department needs to confirm cash or credit card receivables from the customers, in this case from the banks and loans. It must be approved by the General Clerk, which is the highest and only authority that confirms and authentic the receivables. Once the cash is received, the clerk assistant needs to check for the customer’s details thoroughly, and trace and track back to the original source of document for validation. Once the work can be verified, the amount transferred to the account need to be confirmed by another people. This is where segregation of duties takes part. When the clerk assistant has successfully transferred to the bank, the accounts general will confirm and validate those accounts. This is to ensure that there are no people in the same department will overtake both jobs.

And thus, the outcome is that the physical asset can be verified and proved, and at same time analyzed with those credit balances in those accounts related. Another thing that can protect the customer is that the company should always keep the bill with its details and prohibits balance billing. It is for the customer references and also from preventing the company to add up fictitious and malicious unnecessary bills. Next, the plan of actions that can be taken for the detection, correction and rehabilitation actions is to tightening the procedure of engagement letter of the auditor where the old auditor needs to disclose all of their findings that is material such as assertions identified with fraud risk factors, significant accounting estimates and judgments, highly complex transactions, application of new accounting standards and others.

This includes all relevant information needed about their client in obtaining sufficient audit evidence and the assessment of risk is appropriated. The independent (external) auditor should be executor where it will be observed by Securities Exchange Commissions (SEC). The outcome for this exposure is that auditor can understand more on the nature of the business and its operations. This gives extra benefits for the auditor too in giving more assurance of the credibility of the financial statement audited by the external auditor and more audit evidence can be gathered. This also promotes the objectivity of the auditor, which means that any material misstatement should be disclosed in the financial statement without clashing the conflict of interest between the independent auditor and the company as a whole.