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4 Devastating Accounting Disasters

Posted on 8/2/2016 by Pearl Insurance in accountants professional liability insurance
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When you cook the books, you pay the price.

The word disaster often brings forces of nature to mind: hurricanes assaulting coastal cities, tornadoes wreaking havoc across the Midwest, and earthquakes shaking foundations of skyscrapers. The truth is, humans create plenty of damage on their own.

Manmade destruction often involves lies, greed, and ego. And when business leaders ask their best financial minds to cook the books, the devastating results look like these four accounting disasters.

Accounting Disaster #1 – Toshiba

What happens when you’re a Japanese electronics giant, you frequently delay your reporting losses, and you overstate your operating profit by ¥224.8 billion ($1.9 billion)1 over the course of seven years? If you’re Toshiba, and you’ve done all of these things, you’re fined ¥7.37 billion ($60 million) by regulators.

News of Toshiba’s accounting scandal broke in 2015, and CEO Hisao Tanaka resigned shortly afterward. Since at least fiscal year 2008, Tanaka and former Vice Chairman Norio Sasaki forced the company’s accountants to twist numbers, take unethical measures to please shareholders, and create a false image of profitability.

Accounting Disaster #2 – Enron

Even though Enron’s stock prices climbed in the early 2000s, they faced a swift plummet when the ugly truth emerged. Enron was an energy company based out of Houston, TX, and their executives asked accountants to leave sizable debt off the balance sheets. As if that wasn’t bad enough, they hid losses in special purpose entities. Enron filed for bankruptcy on December 2, 2001, and shareholders collectively lost over $63 million.2

4,000 Enron workers found themselves unemployed, and former CEO Ken Lay was convicted on 10 counts of fraud and conspiracy in May 2006. He died in Colorado before serving jail time. CEO Jeff Skilling, who replaced Ken Lay in 2001, was also convicted of federal felony charges. He’s currently serving 14 years of his 24-year prison sentence.

Arthur Andersen, an accounting firm that had been in business for 89 years, gave up their CPA licenses based on how they handled Enron’s financial audits. Arthur Anderson ignored glaring discrepancies on Enron’s statements, and they destroyed incriminating evidence in emails, company files, and physical documents. Due to their complicity in the fraud, Arthur Andersen was convicted of obstruction of justice, and 85,000 of their employees lost their jobs.2

Citigroup and J.P. Morgan Chase were collectively fined $255 million for their involvement in the Enron scandal, because “each institution helped Enron mislead its investors by characterizing what were essentially loan proceeds as cash from operating activities.”3

Accounting Disaster #3 – Xerox

Xerox, a pioneer of the copy machine, faced difficult times in the late ‘90s. Their competitors developed cost-effective technology and excellent price points to entice customers. As they battled mounting challenges, Xerox asked their accountants to get creative with the bottom line.

In 2000, the Securities and Exchange Commission (SEC) launched an investigation of Xerox’s Mexico subsidiary. Soon, the SEC’s eye turned to the entire Xerox operation and the misdeeds of CFO Barry Remeril. To make matters worse, former Xerox Assistant Treasurer James Bingham filed an unlawful termination lawsuit against the company in 2000.

Bingham turned over damning information to authorities. Bingham said “Xerox had improperly booked $447 million in pretax income over the previous six years using the understated discount-rate assumptions when booking leases, primarily in Latin America.”4

The SEC charged Xerox with securities fraud and fined the company $10 million.

Accounting Disaster #4 – KIT Digital

If a film crew documented your business failures for the whole world to see, would you learn from your mistakes?

Kaleil Isaza Tuzman and his tech company, govWorks Inc., were the subject of a documentary called Startup.com. After burning through venture capital and fighting the dot-com bust of 2000, govWorks Inc. went belly-up. The company sold out to First Data Corporation in 2001.  

In 2007, Tuzman reentered the tech world. He purchased a controlling interest in ROO Group, an online video management company, and renamed it KIT Digital. Soon, KIT Digital started buying out competitors left and right. 

Unfortunately, history would repeat itself for Tuzman. He left KIT Digital in 2012 and, the company declared bankruptcy in 2013.

In 2015, Tuzman and former KIT Digital CFO Robin Smyth were arrested and charged with accounting fraud. Smyth pled guilty to the charges in March 2016, and he admitted to helping Tuzman overstate KIT Digital’s revenue from 2010 to 2012.

To bolster its fraudulent profits, KIT Digital disguised $2 million of offshore investments as cash and cash equivalents.5 To make matters worse, the company recognized revenues for products that hadn't been delivered to buyers.

The Lesson

Animals are the first to react right before a storm hits. Whether they flee or find hiding places, they take action to ensure their safety. If you work at a company that ignores accounting ethics, trust your instincts and take off. Don’t wait for disaster to strike.

This article is for general information purposes only.

ONLINE REFERENCES

1Fukase, Atsuko. “Toshiba Accounting Scandal Draws Record Fine From Regulators.The Wall Street Journal. 23 May 2016.

2Brown, Ken and Dugan, Ianthe Jeanne. “Arthur Andersen’s Fall From Grace Is a Sad Tale of Greed and Miscues.The Wall Street Journal. 23 May 2016.

3SEC Settles Enforcement Proceedings Against J.P. Morgan Chase and Citigroup.U.S. Securities and Exchange Commission. 23 May 2016.

4Butala, Amy and Khan, Zafar. “Accounting Fraud at Xerox Corporation.ResearchGate. 23 May 2016.

5SEC Charges Video Management Company Executives With Accounting Fraud.U.S. Securities and Exchange Commission. 23 May 2016.

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