Directions: Read the following case information andanswer the question(s). Prepare your answer forthis discussion topic which will be due for class on Monday, April10, 2017. Your answer should be at least 1/2 page double-spaced andin your own words. Be prepared to discuss the topic with yourclassmates also. No one student will be expected to carry thediscussion. All students will be expected to participate in orderto receive full credit.
When auditing payables and other liabilities, the auditor is notas concerned with existence as they are with completeness. This isbecause an understatement of liabilities can be used to exaggeratethe financial strength of a company just as easily as anoverstatement of assets can. It can be much more difficult thoughto find amounts that are not recorded than to verify the existenceof an amount that is recorded. The omission of an entry is muchmore difficult to detect. Consider the following case that involvedthe drug store chain, Rite Aid.
The SEC found that Rite Aid overstated its income in everyquarter from May 1997 to May 1999, by massive amounts. When thewrongdoing was ultimately discovered, Rite Aid was forced torestate its pre-tax income by $2.3 billion and net income by $1.6billion, the largest restatement ever recorded. Rite Aidperpetrated the fraud through a number of fraudulent transactionsincluding the following:
Reversals of Actual Expense - In certainquarters, Frank Bergonzi, CFO for Rite Aid, directed that RiteAid's accounting staff reverse amounts that had been recorded forvarious expenses incurred and already paid. These reversals werecompletely unjustified and, in each instance, were put back on thebooks in the subsequent quarter, thus moving the expenses to aperiod other than that in which they had actually been paid. Theeffect was to overstate Rite Aid's income during the period inwhich the expenses were actually incurred. For example, Bergonzidirected entries of this nature which caused Rite Aid's pre-taxincome for the second quarter of FY 1998 to be overstated by $9million.
"Gross Profit" Entries -- Bergonzi directedRite Aid's accounting staff to make improper adjusting entries toreduce cost of goods sold and accounts payable in every quarterfrom the first quarter of FY 1997 through the first quarter of FY2000 (but not at year end, when the financial statements would beaudited). These entries had no substantiation, and were intendedpurely to manipulate Rite Aid's reported earnings. For example, asa result of these entries alone, Rite Aid overstated pre-tax incomeby $100 million in the second quarter of FY 1999.
Vendor Rebates -- On the last day of FY 1999,Bergonzi directed that Rite Aid record entries to reduce accountspayable and cost of goods sold by $42 million, to reflect rebatespurportedly due from two vendors. On March 11, 1999 -- nearly twoweeks after the close of the fiscal year -- Bergonzi directed thatthe books be reopened to record an additional $33 million incredits. All of these entries were improper, as Rite Aid had notearned the credits at the time they were recorded and had no legalright to receive them. Moreover, due to Rite Aid's pass-throughobligations in agreements with its own customers, Rite Aid wouldhave been obligated to pass $42 million out of the $75 millionthrough to third parties. The $75 million in inflated incomeresulting from these false entries represented 37% of Rite Aid'sreported pre-tax income for FY 1999.
Using the accounts payable audit procedures described onpages 581-583, describe how the fraud perpetrated by Rite-Aid mighthave been uncovered. It was discovered during the investigationthat Rite-Aid employees who complained about the fraud were givenmoney to keep quiet. Do you think that paying off employees wouldhave caused the fraud to be less likely to be detected by theauditors? Were internal controls likely to have prevented theRite-Aid fraud?
Sources â http://www.sec.gov/news/press/2002-92.htm
