Understanding Accounting And Financial Statements

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“Understanding Accounting and Financial Statements”. Accounting can be an involved process, but none the less is essential for the manager to understand. The purpose of this module is four-fold:

  1. To provide assistance in understanding some of the basic accounting principles and practices.
  2. Provide hands on practice.
  3. Provide real life examples

INSTRUCTIONS:

Watch three entertainin

Wheatley List of Accounts

PREPARING FINANCIAL STATEMENTS
As the accountant for Wheatley International, it is your job to prepare the company’s income statement and balance sheet. Use the accounts listed below to construct the statements. Assume that the tax rate is 25%.
List of Accounts for
WHEATLEY INTERNATIONAL
Accounts Receivable $120,600
Land $1,500,000
Notes Receivable $61,200
Insurance Expenses $54,000
Accounts Payable $45,000
Interest Expenses $24,600
Common Stock $1,896,000
Depreciation $400,000
Net Sales $1,053,000
Ending Inventory $126,600
Notes Payable (Long‑Term) $210,000
Beginning Inventory $154,800
Retained Earnings $1,459,800
Advertising Expense $90,000
Cash $72,000
Salaries $180,000
Short-Term Notes Payable $15,600
Merchandise Purchased (for Inventory) $316,800
Buildings $1,050,000
Rent $13,800
Utilities $8,400
Equipment & Vehicles $1,066,000
Goodwill $90,000
Bonds Payable $60,000

Wheatley Income Statement

The formula for the balance sheet is assets equal liabilities plus stockholders’ equity. To prepare a balance sheet, add the assets and liabilities. The difference between the two is stockholders’ equity. For the income statement, you subtract cost of goods sold from net sales (revenue). Then you subtract expenses to get gross income. From that, you subtract the income tax of 25% to get net income. (Note: The format of these statements may be slightly different from the format taught in an accounting course. The exact format is less important than understanding the overall concepts.)
WHEATLEY INTERNATIONAL
INCOME STATEMENT
FY 201X
REVENUES
Net Sales $1,053,000
COST OF GOODS SOLD
Beginning Inventory
Merchandise Purchased +
Cost of Goods Available for Sale $471,600
Less: Ending Inventory –
Cost of Goods Sold $345,000
GROSS PROFIT (GROSS MARGIN)
OPERATING EXPENSES
Selling Expenses
Salaries
Advertising
Total Selling Expenses $270,000
General Expenses
Insurance
Interest Expense
Rent
Utilities
Total General Expenses
Total Operating Expenses
NET PROFIT (INCOME) BEFORE TAXES
Less: Income Tax Expenses (25%)
NET INCOME (PROFIT) AFTER TAXES $252,900

Wheatley Balance Sheet

Complete the balance sheet. (Fill in the gray highlighted areas)
WHEATLEY INTERNATIONAL
Balance Sheet
December 31, 201X
ASSETS
Current Assets
Cash $72,000
Accounts Receivable
Notes Receivable
Inventory
Total Current Assets
Fixed Assets
Land
Buildings
Equipment & Vehicles
Depreciation – $400,000
Total Fixed Assets
Other Assets
Goodwill $90,000
Total Other Assets
TOTAL ASSETS $3,686,400
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current Liabilities
Accounts Payable $45,000
Short-Term Notes Payable
Total Current Liabilities $60,600
Long‑Term Liabilities
Notes Payable (Long-Term)
Bonds
Total Long‑Term Liabilities $270,000
Total Liabilities
Owner’s Equity
Common Stock
Retained Earnings $1,459,800
Total Owners’ Equity
TOTAL LIABILITIES AND
STOCKHOLDERS’ EQUITY $3,686,400

Acme Inc. Questions

You are considering investing in Acme Incorporated. The company has provided you with the balance sheet and income statement for the previous year. The current price of one share of stock is $46.25. Earning per share last year was $1.86.
Questions
1 Calculate the requested financial ratios
(IMPORTANT EXPLAIN WHAT THESE NUMBERS MEAN IN RELATION TO ACME)
a. Current ratio
b. Debt-to-equity ratio
c. Return on sales (use net income AFTER taxes)
d. Return on equity (use net income AFTER taxes)
e. Earnings per share (use net income AFTER taxes)
2 Would you invest in Acme Incorporated? Why or why not?

Acme Income Statement

ACME INCORPORATED
STATEMENT OF INCOME
FY 201X
REVENUES
Net Sales $4,090,970
Other Income + $104,227
Total Revenue $4,195,197
COST OF GOODS SOLD $2,673,129
GROSS PROFIT (GROSS MARGIN) $1,522,068
OPERATING EXPENSES
Total Selling Expenses $333,300
Total General Expenses + $306,036
Total Operating Expenses $639,336
NET INCOME BEFORE TAXES $882,732
Less: Income Tax Expenses (25%) $220,683
NET INCOME (PROFIT) AFTER TAXES $662,049

Acme Inc Balance Sheet

ACME INCORPORATED
Balance Sheet
December 31, 201X
ASSETS
Current Assets
Cash $280,928
Marketable Securities $514,800
Accounts Receivable $108,694
Notes Receivable $855,771
Inventories $218,156
Prepain Expenses and Other $88,237
Total Current Assets $2,066,586
Fixed Assets
Land $510,000
Plant and Building $304,096
Equipment & Vehicles $218,500
Total Fixed Assets $1,744,701
Other Assets
Goodwill, Net $49,930
Total Other Assets $49,930
TOTAL ASSETS $3,861,217
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current Liabilities
Accounts Payable $226,977
Accrued Expenses and Other $380,496
Current Portion of Finance Debt $382,579
Total Current Liabilities $990,052
Long‑Term Liabilities
Notes Payable (Long-Term) $228,772
Bonds $380,000
Other Long‑Term Liabilities $29,478
Total Long-Term Liabilities $638,250
Total Liabilities $1,628,303
Owner’s Equity
Common Stock $389,538
(342,196 Shares Outstanding)
Retained Earnings $1,843,377
Total Owners’ Equity $2,232,915
TOTAL LIABILITIES AND
STOCKHOLDERS’ EQUITY $3,861,217

Acme Inc Question Worksheet

Calculate the requested financial ratios. (Fill in the gray highlighted areas)
a. Current ratio. The current ratio is the ratio of the firm’s current assets to its current liabilities,
calculated as follows:
Current ratio =
Current assets or
Current liabilities
:1 Show the ratio
b. Debt-to-equity ratio. The debt-to-equity ratio measures the degree to which the company
is financed by borrowed funds that must be repaid. It is calculated as follows:
Debt-to-equity ratio =
$1,628,300 Show percentage or decimal format (e.g. .346 or 35%)
or $2,232,815
or %
c. Return on sales. Return on sales is calculated by comparing a company’s net income
with its total sales, calculated as follows:
Return on sales =
or
%
d. Return on equity. Return on equity measures how much was earned for each dollar invested
by owners. It is calculated by comparing a company’s net income with its total owner’s equity:
Return on equity =
Net income or
Owners’ equity $2,232,915
%
e. Earnings per share. Earnings per share measures the amount of profit earned by a company
for each share of common stock it has outstanding:
Earnings per share =
Net income or
Number of shares outstanding $342,196
$1.935 per share

Sheet3

g and informative video clips (3:30 minutes each) from The Center for Audit Quality (CAQ):

  • “Fight Fraud – Accounting Ethics” Provides an explanation why businesses sometimes commit fraudulent accounting acts and the importance of ethics and leadership.
  • “System of Investor Protection”: Understanding financial reporting and the team members in charge of ensuring reporting accuracy.
  • “Sarbanes Oxley – The Audit Committee”: Understanding the significance of the Sarbanes Oxley Act of 2002 and audit committee responsibilities. (Video credit: CAQorg.com)

Watch the video clip (1:07 minutes) entitled “Goodbye Training Wheels”. This is an example of a term called “Innovation Transfer” which means “ The transfer of a new idea or method for solving a problem from one group or individual to another, typically from a process improvement consulting group to a client business. Innovation transfer is an important part of Six Sigma and other best practice deployment approaches.” In this case, I am using this example of the young boy in the video learning to ride his bicycle as an analogy of you learning accounting principles: sometimes you just need a little practice and for someone to steady the bike and before long you are peddling on your own!!

(You can read more about innovation transfer at Business Dictionary.com. “Training Wheel Video credit: Andrea Dorfman. Music: Iron and Wine)

Complete the Excel workbook entitled Chpt 15 Critical Thinking Exercise – Accounting. This workbook consists of two problems (each worth up to 50 points each totaling the possible 100 points you can earn). The two problems are:

  1. Wheatley International – Preparing a Financial Statement
  2. Acme Incorporated – Calculating Financial Ratios

Both problems are in the same Excel workbook and are listed in six (6) tabs at the bottom of the spreadsheet when you open the file. Complete the work in the gray answer boxes for each assignment

 
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Institutional Affiliation:

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Running Head: INTERNATIONAL ACCOUNTING 1

Accounting Exercise 2

Accounting Exercise

Student’s Name:

Institutional Affiliation:

Exercise 4

The New York Stock Exchange (NYSE) provides a list of non-U.S. companies listed on the exchange on its Web site (www.nyse.com). (Hint: Search the internet for “NYSE List of Non-U.S. Listed Issuers.”)

Required:

a) Determine the number of foreign companies listed on the NYSE and the number of countries they represent.

There are about 529 New York Stock Exchange as well as NYSE MKT non United States companies which are listed in the NYSE; these foreign companies represent Issuers from 47 countries (Saudagaran, 2009).

b) Determine the five countries with the largest number of foreign companies listed on the NYSE.

Five countries with the largest number of foreign companies which are listed on the NYSE include, the Netherlands, Canada, the U.K, Brazil and not to forget, Bermuda (Saudagaran, 2009).

c) Speculate as to why non-U.S. companies have gone to the effort to have their shares listed on the NYSE.

Non-United States companies have actually made an effort of going a notch higher to have their shares listed on the NYSE mostly due to the fact that the NYSE is bullish and as such it tends to trade the highest number of shares, it also has an immense access to the wider European markets (Saudagaran, 2009).

Case 1. Besserbrau AG

Besserbrau AG is a German beer producer headquartered in Ergersheim, Bavaria. The company, which was founded in 1842 by brothers Hans and Franz Besser, is publicly traded with shares listed on the Frankfurt Stock Exchange. Manufacturing in strict accordance with the almost 500-year-old German Beer Purity Law, Besser-brau uses only four ingredients in making its products: malt, hops, yeast, and water. While the other ingredients are obtained locally, Besser-brau imports hops from a company located in the Czech Republic. Czech hops are considered to be among the world’s finest. Historically, Besserbrau’s products were marketed exclusively in Germany. To take advantage of a potentially enormous market for its products and expand sales, Besserbrau began making sales in the People’s Republic of China three years ago. The company established a wholly owned subsidiary in China (BB Pijio) to handle the distribution of Besserbrau products in that country. In the most recent year, sales to BB Pijio accounted for 20 percent of Besserbrau’s sales, and BB Pijio’s sales to customers in China accounted for 10 percent of the Besserbrau Group’s total profits. In fact, sales of Besserbrau products in China have expanded so rapidly and the potential for continued sales growth is so great that the company recently broke ground on the construction of a brewery in Shanghai, China. To finance construction of the new facility, Besserbrau negotiated a listing of its shares on the London Stock Exchange to facilitate an initial public offering of new shares of stock.

Required:

Discuss the various international accounting issues confronted by Besserbrau AG.

The various international accounting issues which were confronted by Besser-brau AG included reliable as well as comparable corporate reporting in a sense that by not incorporating or rather factoring this into mind, then it is quite simple for an organization to encounter financial discrepancies which may in the long run make Besser-brau to be less competitive in its parent country as opposed to its subsidiary in China (BB Pijio) which is doing significantly well (Saudagaran, 2009).

Exercise 7

As noted in the chapter, diversity in accounting practice across countries generates problems for a number of different groups.

Required:

Answer the following questions and provide explanations for your answers.

a) Which is the greatest problem arising from worldwide accounting diversity?

The greatest problem which arises from worldwide accounting diversity includes the basic fact that it creates a significant financial deficit when it comes to harmonizing the accounts of two different countries (Saudagaran, 2009).

b) Which group is most affected by worldwide accounting diversity?

The group which is most affected by worldwide accounting diversity are the low income earning countries.

c) Which group can most easily deal with the problems associated with accounting diversity?

The groups which can most easily deal with the problems which are associated with accounting diversity are the high income earning countries (Saudagaran, 2009).

Exercise 8

Various attempts have been made to reduce the accounting diversity that exists internationally. This process is known as convergence and is discussed in more detail in Chapter 3. The ultimate form of convergence would be a world in which all countries followed a similar set of financial reporting rules and practices.

Required:

Consider each of the following factors that contribute to existing accounting diversity as described in this chapter:

• Legal system • Taxation • Providers of financing • Inflation • Political and economic ties • Culture

a) Which factor do you believe represents the greatest impediment to the international convergence of accounting?

It ought to be understood that the factor which for the most part represents the greatest impediment to the international convergence of accounting tends to be legal system; this is due to the fact that the legal system in various countries tends to be quite different and as such, it becomes a bottle-neck to the international convergence of accounting (Saudagaran, 2009).

b) Which factor do you believe creates the smallest impediment to convergence? Explain your reasoning.

The factor which I believe creates the smallest impediment to convergence of accounting would be culture. This is because in any given culture, there exists ambitious individuals whom strive to be financially independent; this simply means that in retrospect, culture tends to cut through these given divides and as a result it becomes a perk when it comes to convergence of accounting.

Exercise 3

Cooper Grant is the president of Acme Brush of Brazil the wholly owned Brazilian subsidiary of U.S.-based Acme Brush Inc. Cooper Grant’s compensation package consists of a combination of salary and bonus. His annual bonus is calculated as a predetermined percentage of the pretax annual income earned by Acme Brush of Brazil. A condensed income statement for Acme Brush of Brazil for the most recent year is as follows (amounts in thousands of Brazilian real [BRL]):

Sales . . . . . . . . . . . . . . . . . . . . . . . . Expenses . . . . . . . . . . . . . . . . . . . . . Pretax income . . . . . . . . . . . . . . . . .

BRL10,000 9,500 BRL 500

After translating the Brazilian real income statement into U.S. dollars, the condensed income statement for Acme Brush of Brazil appears as follows (amounts in thousands of U.S. dollars [US$]):

Sales . . . . . . . . . . . . . . . . . . . . . . . . Expenses . . . . . . . . . . . . . . . . . . . . . Pretax income (loss) . . . . . . . . . . . . .

US$3,000 3,300

US$ (300

Required:

a) Explain how Acme Brush of Brazil’s pretax income (in BRL) became a U.S.-dollar pretax loss.

The Acme Brush of Brazil pre tax income in BRL became a United States dollar pretax loss because the dollar if financially stronger as compared to the BRL; this is the reason as to why it became a United States dollar pretax loss.

b) Discuss whether Cooper Grant should be paid a bonus or not.

Cooper Grant ought to be paid a bonus mostly due to the simple fact that as the wholly owned Brazilian subsidiary of the United States based Acme Brush and as such they ought to be paid a compensation which consists of both a bonus as well as a salary. Another factor is that they also tend to incur a pretax loss as a result of translating the Brazilian Real each time they are compensated without the bonus (Saudagaran, 2009).

Reference

Saudagaran, S. M. (2009). International Accounting: a User Perspective. Toronto: CCH.

 
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ACCT 2302 Unit 1

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1.  A corporation reports the following year-end balance sheet data. The company’s working capital equals:
Cash$51,000 Current liabilities$86,000 Accounts receivable 66,000 Long-term liabilities 46,000 Inventory 71,000 Common stock 111,000 Equipment 156,000 Retained earnings 101,000 Total assets$344,000 Total liabilities and equity$344,000

2.  Desjardin Landscaping’s income statement reports net income of $73,500, which includes deductions for interest expense of $10,600 and income taxes of $33,100. Its times interest earned is:

3. A corporation reports the following year-end balance sheet data. The company’s acid-test ratio equals:
Cash$45,000 Current liabilities$80,000 Accounts receivable 60,000 Long-term liabilities 20,000 Inventory 65,000 Common stock 105,000 Equipment 150,000 Retained earnings 115,000 Total assets$320,000 Total liabilities and equity$320,000

4. Refer to the following selected financial information from Shakley’s Incorporated. Compute the company’s times interest earned for Year 2.
Year 2Year 1 Net sales $ 481,500 $ 426,850 Cost of goods sold 276,900 250,720 Interest expense 10,300 11,300 Net income before tax 67,850 53,280 Net income after tax 46,650 40,500 Total assets 318,300 291,600 Total liabilities 178,400 167,900 Total equity 139,900 123,700

5. Use the following selected information from Wheeler, LLC to determine the 2017 and 2016 trend percentages for cost of goods sold using 2016 as the base.
2017 2016 Net sales$276,700 $231,500 Cost of goods sold 151,800  129,690 Operating expenses 55,140  53,140 Net earnings 28,120  19,920

6. A corporation reports the following year-end balance sheet data. The company’s debt ratio equals:
Cash$47,000 Current liabilities$82,000 Accounts receivable 62,000 Long-term liabilities 40,000 Inventory 67,000 Common stock 107,000 Equipment 152,000 Retained earnings 99,000 Total assets$328,000 Total liabilities and equity$328,000

7. Selected current year company information follows:
Net income$16,253 Net sales 715,855 Total liabilities, beginning-year 86,932 Total liabilities, end-of-year 106,201 Total stockholders’ equity, beginning-year 201,935 Total stockholders’ equity, end-of-year 126,351
The total asset turnover is (Do not round intermediate calculations.):

8. Refer to the following selected financial information from McCormik, LLC. Compute the company’s working capital for Year 2.
Year 2Year 1 Cash$39,000 $33,750 Short-term investments 105,000  67,500 Accounts receivable, net 93,000  87,000 Merchandise inventory 128,500  132,500 Prepaid expenses 13,600  11,200 Plant assets 395,500  345,500 Accounts payable 105,900  115,300 Net sales 718,500  683,500 Cost of goods sold 397,500  382,500

9.   Rajan Company’s most recent balance sheet reported total assets of $2.04 million, total liabilities of $0.73 million, and total equity of $1.31 million. Its Debt to equity ratio is:

10.   Martinez Corporation reported Net sales of $772,000 and Net income of $135,000. The Profit margin is:

11. Refer to the following selected financial information from McCormik, LLC. Compute the company’s current ratio for Year 2.
Year 2Year 1 Cash$37,800 $32,550 Short-term investments 93,000  61,500 Accounts receivable, net 87,000  81,000 Merchandise inventory 122,500  126,500 Prepaid expenses 12,400  10,000 Plant assets 389,500  339,500 Accounts payable 111,900  109,300 Net sales 712,500  677,500 Cost of goods sold 391,500  376,500

12, Use the following selected information from Wheeler, LLC to determine the 2017 and 2016 common size percentages for operating expenses using Net sales as the base.
2017 2016 Net sales$407,400 $333,800 Cost of goods sold 187,900  132,710 Operating expenses 68,440  65,960 Net earnings 34,540  24,540

13. A company reports basic earnings per share of $3.80, cash dividends per share of $1.40, and a market price per share of $64.90. The company’s dividend yield equals:

14.   Jones Corp. reported current assets of $202,500 and current liabilities of $144,500 on its most recent balance sheet. The current assets consisted of $59,800 Cash; $40,300 Accounts Receivable; and $102,400 of Inventory. The acid-test (quick) ratio is:

15. A corporation reported cash of $14,900 and total assets of $179,200 on its balance sheet. Its common-size percent for cash equals:

16. Selected current year company information follows:
Net income$17,753 Net sales 730,855 Total liabilities, beginning-year 101,932 Total liabilities, end-of-year 121,201 Total stockholders’ equity, beginning-year 216,935 Total stockholders’ equity, end-of-year 148,851
The return on total assets is (Do not round intermediate calculations.):

17. A corporation reports the following year-end balance sheet data. The company’s current ratio equals:
Cash$49,000 Current liabilities$84,000 Accounts receivable 64,000 Long-term liabilities 20,000 Inventory 69,000 Common stock 109,000 Equipment 154,000 Retained earnings 123,000 Total assets$336,000 Total liabilities and equity$336,000

18. Refer to the following selected financial information from McCormik, LLC. Compute the company’s acid-test ratio for Year 2.
Year 2Year 1 Cash$39,400 $34,150 Short-term investments 109,000  69,500 Accounts receivable, net 95,000  89,000 Merchandise inventory 130,500  134,500 Prepaid expenses 14,000  11,600 Plant assets 397,500  347,500 Accounts payable 103,900  117,300 Net sales 720,500  685,500 Cost of goods sold 399,500  384,500

19. Carducci Corporation reported Net sales of $3.55 million and beginning Total assets of $0.95 million and ending Total assets of $1.35 million. The average Total asset amount is:

20. Jones Corp. reported current assets of $185,000 and current liabilities of $133,000 on its most recent balance sheet. The working capital is:

 
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Ethics In Accounting Case: Parmalat: Europe’s Enron

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Ethics In Accounting Case: Parmalat: Europe’s Enron

Only answer the following questions base on the case: please (focus more on 1 and 2, in two pages) please finish before midnight today. THANKS

 

1. What are the main alternative actions or policies that might be followed in responding to the ethical issues in this case?

2. What are the major views on the ethical issues raised by this case?

3.  What facts are unknown or controverted that might be relevant to deciding this case (may require research to determine some facts).

Case 8-3 Parmalat: Europe’s Enron

After the news broke about the frauds at Enron and WorldCom in the United States, there were those in Europe who used the occasion to beat the drum: “Our principles-based approach to accounting standard-setting is better than your rules-based approach.” Many in the United States started to take a closer look at the principles-based approach in the European Community and that is used in International Financial Reporting Standards (IFRS), which relies less on bright-line rules to establish standards, as is the case in the United States, but may have loopholes making it relatively easy to avoid the rules. In the end, it was not the approach to setting rules that brought down Parmalat. It was a case of greed, failed corporate leadership, and sloppy auditing.

Background

Parmalat began as a family-owned entity founded by Calisto Tanzi in 1961. During 2003, Parmalat was the eighth-largest company in Italy and had operations in 30 countries. It was a huge player in the world dairy market and was even more influential within Italian business circles. It had a network of 5,000 dairy farmers who supplied milk products and 39,000 people who were directly employed by the company. The company eventually sold shares to the public on the Milan stock exchange. The Tanzi family always held a majority, controlling stake in the company, which in 2003 was 50.02 percent. Tanzi family members also occupied the seats of CEO and chair of the board of directors. The structure of Parmalat was primarily characterized by the Tanzi family and the large amount of control that it wielded over company operations. It was not unusual for family members to override whatever internal controls existed to perpetrate the accounting fraud.

The Parmalat scandal broke in late 2003, when it became known that company funds totaling almost €4 billion (approximately $5.64 billion) that were meant to be held in an account at the Bank of America did not exist. On March 19, 2004, Milan prosecutors brought charges against Parmalat founder Calisto Tanzi, other members of his family, and an inner circle of company executives for their part in the Parmalat scandal. After three months of investigation, the prosecutors charged 29 individuals, the Italian branches of the Bank of America, and the accountants Deloitte & Touche and Grant Thornton. The charges included market rigging, false auditing, and regulatory obstruction following the disclosure that €15 billion (approximately $21.15 billion) was found to be missing from the bank accounts of the multinational dairy group in December 2003. Former internal auditors and three former Bank of America employees have been jailed for their roles in the fraud. The judge also gave the go-ahead for Parmalat to proceed with lawsuits against the auditors. Parmalat’s administrator, Enrico Bondi, is also pursuing another lawsuit against Citigroup in New Jersey state courts. Despite all its troubles, Parmalat has recovered and today is a thriving multinational food group with operations in five continents through either a direct presence or through license agreements.

U.S. Banks Caught in the Spotlight

Parmalat had induced U.S. investors to purchase bonds and notes totaling approximately $1.5 billion. In addition, in August 1996 Parmalat sponsored an offering of American Depositary Receipts (ADRs) in the United States, with Citibank, N.A., headquartered in New York City, as depositary. Parmalat actively participated in the establishment of the ADR program. This activity made Parmalat subject to SEC rules. The SEC’s inquiries focused on up to approximately €1.05 billion ($1.5 billion) of notes and bonds issued in private placements with U.S. investors. The banks investigated included Bank of America, JP Morgan Chase, Merrill Lynch, and Morgan Stanley Dean Witter. Parmalat’s administrator, Enrico Bondi, helped the authorities identify all the financing transactions undertaken by Parmalat from 1994 through 2003. During the investigation, it was noted that Parmalat’s auditor from 1990 to 1999, Grant Thornton, did not have copies of crucial audit documents relating to the company’s Cayman Islands subsidiary, Bonlat. The emergence of a €5.16 billion (approximately $7.28 billion) hole at Bonlat triggered the Parmalat collapse. The accounting firm has since handed over important audit documents to investigators.

 

Accounting Fraud

 

One of the most notable fraudulent actions was the creation of a completely fictitious bank account in the United States that supposedly contained $5 billion. After media reports exposing the account surfaced, the financial institution at which the depositsupposedly existed (Bank of America) denied any such account. The company’s management fooled auditors by creating a fictitious confirmation letter regarding the account. In addition to misleading the auditors about this bank account, the company’s CFO, Fausto Tonna, produced fake documents and faxed them to the auditors in order to hide the fact that many of the company’s dealings were completely fictitious.

Parmalat’s management also used “nominee” entities to transfer debt and sales in order to hide them from auditors and other interested parties. A nominee entity is a company created to hold and administer the assets or securities of the actual owner as a custodian. These entities were clearly controlled by Parmalat and most existed only on paper.

Using nominee entities, the Parmalat management created a method to remove uncollectible or impaired accounts receivable. The bad accounts would be transferred to one of the nominee entities, thus keeping the bad debt expense or write-off for the valueless accounts off the Parmalat income statement. The transfers to nominee entities also avoided any scrutiny of the accounts by external or statutory auditors (in this case, Italian-designated auditors under the country’s laws).

Creating revenues was another scheme in which the nominee or subsidiary entities were used; if a non-Italian subsidiary had a loss related to currency exchange rates, management would fabricate currency exchange contracts to convert the loss to a profit. Similar activities were undertaken to hide losses due to interest expense. Documents showing interest rate swaps were created to mislead the auditors or other parties. Interest rate swaps and currency exchange contracts are both instruments usually used to hedge on the financial markets, and sometimes to diversify the risk of certain investments. Parmalat abused these tools by creating completely fictitious contracts after the fact and claiming that they were valid and accurate. The understatement of debt was another large component of the Parmalat fraud, as was hidden debt. On one occasion, management recorded the sale of receivables as “non-recourse,” when in fact Parmalat was still responsible to ensure that the money was collectible.

There were many debt-disguising schemes in relation to the nominee entities. With one loan agreement, the money borrowed was touted as being from an equity source. On another occasion, a completely fictitious debt repurchase by a nominee entity was created, resulting in the removal of a liability from the books, when the debt was still in fact outstanding. Parmalat management also incorrectly recorded many million euros’ worth of bank loans as intercompany loans. This incorrect classification allowed for the loans to be eliminated in consolidation when they actually represented money owed by the company to outsiders.

The fraud methods did not stop at creating fictitious accounts and documents, or even with establishing nonexistent foreign nominee entities and hiding liabilities. Calisto Tanzi and other management were investigated by Italian authorities for manipulating the Milan stock market. On December 20, 1999, Parmalat’s management issued a press release of an appraisal of the Brazilian unit. While this release appeared to be a straightforward action, what Tanzi and others failed to disclose were the facts relating to the appraisal itself. The appraisal came from an accountant at Deloitte Touche Tohmatsu and was dated July 23, 2008, nearly 19 months prior to the press release. This failure to disclose information in a timely and transparent manner demonstrates yet another way that Parmalat was able to exert influence and mislead investors.

Missing the Red Flags

The fraud that occurred at Parmalat is a case of management greed with a lack of independent oversight and fraudulent financial reporting that was taken to the extreme. As an international company, Parmalat management had many opportunities to take advantage of the system and hide the fictitious nature of financial statement items. As with many frauds, the web of lies began to untangle when the company began to run out of cash. In a discussion with a firm in New York regarding a leveraged buyout of part of the Parmalat Corporation, two members of the Tanzi family revealed that they did not actually have the cash represented in their financial statements.

At the beginning of 2003, Lehman Brothers, Inc., issued a report questioning the financial status of Parmalat. Ironically, Parmalat filed a report with Italian authorities claiming that Lehman Brothers was slandering the company with the intention of hurting the Parmalat share price.2 Financial institutions failed to examine the accusations thoroughly and continued to loan money to Parmalat due to the supposed strength and power wielded by the company throughout the world. As Luca Sala, former head of Bank of America’s Italian corporate finance division, observed, “When you have a client like Parmalat, which is bringing in all that money and has industries all over the world, you don’t exactly ask them to show you their bank statements.”3

Failure of Auditors

The external auditor during the fraud, primarily Grant Thornton, SpA, failed to comply with many commonly accepted auditing practices and thus contributed to the fraud. The largest component of Parmalat’s fraud that ultimately brought the company down was the nonexistent bank account with Bank of America. The auditors went through procedures to confirm this account, but they made one fatal mistake: They sent the confirmation using Parmalat’s internal mail system. The confirmation request was intercepted by Parmalat employees and subsequently forged by Tonna or an agent acting on his behalf. The forgery consisted of creating a confirmation and printing it on Bank of America letterhead and then sending it back to the auditors.

Parmalat accused Grant Thornton and Deloitte Touche Tohmatsu of contributing to its €14 billion collapse in December 2003. Parmalat filed suit against the auditors and other third parties, seeking $10 billion in damages for alleged professional malpractice, fraud, theft of assets, and civil conspiracy. Parmalat argued that the headquarters for both Grant Thornton and Deloitte had “alter ego” relationships with their Italian subsidiaries that tied them inextricably to the alleged fraud. According to the complaint, the relationships were highlighted by the firms’ own claims to being “integrated worldwide accounting organizations.” Judge Lewis Kaplan in U.S. District Court for the Southern District of New York granted a motion by Deloitte USA to dismiss Parmalat’s first amended complaint due to Parmalat’s failure to show that poor auditing of Parmalat USA was equivalent to fraud at Parmalat in Italy.

The frauds continued for many years due, in large part, to the failures of the auditors. Italian law requires both listed and unlisted companies to have a board of statutory auditors, as well as external auditors. Parmalat’s statutory board should have become suspicious of what might be happening when two CFOs departed within a six-month period during the fraud. Also, analysts were puzzled by the increasing debt levels. Yet the board just stood idly by even though it had received information about the scope of the problems. The board never reported any irregularities or problems, despite receiving complaints, because of the influence of the Tanzi family. After the fraud was discovered and resolution of the issues began, it became clear that the statutory audit board did nothing to prevent or detect the fraud.

Resolution of Outstanding Matters

Following an investigation, the founder of Parmalat, Calisto Tanzi, was sentenced in Milan to 10 years in prison in December 2008 for securities laws violations in connection with the Italian dairy company’s downfall in late 2003. Tonna, the CFO, was sentenced to 30 months in jail following a trial in 2005, and other officers reached plea bargain deals. Bank of America settled a civil case brought by Parmalat bondholders for $100 million.

Bondholders in the United States and Italy had alleged the U.S. bank knew of Parmalat’s financial troubles, but nevertheless sold investors Parmalat bonds that ultimately soured—allegations Bank of America denied. Both sides said the agreement cleared the way for future business between the companies. In a statement following the settlement, Bank of America stated that the record of court rulings in the case “makes it clear that no one at Bank of America knew or could have known of the true financial condition of Parmalat. We have defended ourselves vigorously in these cases and are satisfied with this outcome today.”

After the accounting and business problems surfaced, a court battle ensued regarding who was responsible for the audit failures. The umbrella entities of Deloitte and Grant Thornton, Deloitte Touche Tohmatsu, and Grant Thornton International, along with the U.S. branches of both firms, were included in a lawsuit by Parmalat shareholders. Questions were raised as to whether or not the umbrella entities could be held liable for the failures of a country-specific branch of their firm. The courts held that due to the level of control that the international and U.S.-based branches wielded over the other portions of the firm, they could be included in the lawsuit.4

Legal Matters with Bank of America

On February 2, 2006, a U.S. federal judge allowed Parmalat to proceed with much of its $10 billion lawsuit against Bank of America, including claims that the bank violated U.S. racketeering laws. Enrico Bondi was appointed as the equivalent of a U.S. bankruptcy trustee to pursue claims that financial institutions, including Bank of America, abetted the company in disguising its true financial condition. Bondi accused the bank of helping to structure mostly off-balance-sheet transactions intended to “conceal Parmalat’s insolvency” and of collecting fees that it did not deserve.

The lawsuit against Bank of America was dismissed. Parmalat appealed the dismissal of its lawsuits, accusing Bank of America and Grant Thornton of fraud. Bondi filed notice of Parmalat’s appeal to the U.S. Court of Appeals for the Second Circuit in New York. Bondi and the Parmalat Capital Finance Ltd. unit had accused Grant Thornton of helping set up fake transactions to allow insiders to steal from the company. Parmalat Capital made similar claims in a lawsuit against Bank of America. On September 18, 2009, U.S. District Judge Lewis Kaplan said Parmalat should not recover for its own fraud, noting that the transactions also generated millions of euros for the company. “The actions of its agents in so doing were in furtherance of the company’s interests, even if some of the agents intended at the time they assisted in raising the money to steal some of it,” Kaplan wrote. A Bank of America spokesman said in a statement: “It has been our view all along that Parmalat Capital Finance, a participant in the fraud, was not entitled to seek damages from Bank of America, which had no knowledge of the fraud and was damaged by it. We are pleased that the court has agreed.”5

The SEC Charges

The SEC filed an amended complaint on July 28, 2004, in its lawsuit against Parmalat Finanziaria SpA in U.S. District Court in the Southern District of New York. The amended complaint alleged that Parmalat engaged in one of the largest financial frauds in history and defrauded U.S. institutional investors when it sold them more than $1 billion in debt securities in a series of private placements between 1997 and 2002. Parmalat consented to the entry of a final judgment against it in the fraud.

The complaint includes the following amended charges:

1. Parmalat consistently overstated its level of cash and marketable securities by at least $4.9 billion at December 31, 2002.

2. As of September 30, 2003, Parmalat had understated its reported debt by almost $10 billion through a variety of tactics, including:

a. Eliminating about $6 billion of debt held by one of its nominee entities.

b. Recording approximately $1.6 billion of debt as equity through fictitious loan participation agreements.

c. Removing approximately $500 million in liabilities by falsely describing the sale of certain receivables as non-recourse, when in fact the company retained an obligation to ensure that the receivables were ultimately paid.

d. Improperly eliminating approximately $1.6 billion of debt through a variety of techniques including mischaracterization of bank debt as intercompany debt.

3. Between 1997 and 2003, Parmalat transferred approximately $500 million to various businesses owned and operated by Tanzi family members.

4. Parmalat used nominee entities to fabricate nonexistent financial operations intended to offset losses of operating subsidiaries; to disguise intercompany loans from one subsidiary to another that was experiencing operating losses; to record fictitious revenue through sales by its subsidiaries to controlled nominee entities at inflated or entirely fictitious amounts; and to avoid unwanted scrutiny due to the aging of the receivables related to these sales: The related receivables were either sold or transferred to nominee entities.

In the consent agreement, without admitting or denying the allegations, Parmalat agreed to adopt changes to its corporate governance to promote future compliance with the federal securities laws, including:

· Adopting bylaws providing for governance by a shareholder-elected board of directors, the majority of whom will be independent and serve finite terms and specifically delineating in the bylaws the duties of the board of directors.

· Adopting a Code of Conduct governing the duties and activities of the board of directors.

· Adopting an Insider Dealing Code of Conduct.

· Adopting a Code of Ethics.

The bylaws also required that the positions of the chair of the board of directors and managing director be held by two separate individuals, and Parmalat must consent to having continuing jurisdiction of the U.S. District Court to enforce its provisions.

Accounting in the Global Environment

Accounting and auditing standards and regulation of the accounting profession often are country specific. In addition to complying with any locally applicable rules, however, Deloitte firms follow general professional standards and auditing procedures promulgated by Deloitte Touche Tohmatsu. Member firms regularly cross-check each other’s work to ensure quality, and they cooperate and join together under the direction of a single partner to provide audit services for international clients.

Accounting firms often assert that their foreign affiliates are legally separate, thus limiting the asset pool available to investors who file suit. They typically argue that you can’t pursue the worldwide organization because one unit fails to meet its audit responsibilities. However, a closer look at what is done in reality presents a different view.

Partners and associates of member firms participate in global practice groups and attend Deloitte Touche Tohmatsu meetings. Although disclaimers on the firm’s website assert the legal separateness of Deloitte Touche Tohmatsu and its members, Deloitte Touche Tohmatsu’s goal is known to be to provide clients with consistent seamless service across national boundaries. Similar to other Big Four international firms, member firms use the Deloitte name when serving international clients in order to project the image of a cohesive international organization.

Questions

 

1. What were the failings of ethical leadership and corporate governance by management of Parmalat? How do you think these deficiencies contributed to the fraud?

 

Top management is ultimately to blame for the fraud. They created and maintained misleading information and documents on nonexistent bank accounts. The management and company had a duty or obligation to honest and reliable financial reporting. They also had a duty to all the shareholders and investors, not just to the Tanzi family. Top management cannot blame the other parties; that is like saying, “if the other parties had said something or caught the fraud, we would have stopped.” The auditors had a duty to perform the audit with objectivity, due care and professional skepticism. They did not perform the audit with due care and skepticism and may have been responsible for the perpetuation of the fraud by not being more diligent. How many were affected by the auditor’s inaction and poor audit procedures? How much did it cost the stakeholders?

Top management used Parmalat resources for their own benefit. This was not a secret at Parmalat. Others in the company probably believed the culture did not promote ethics and they may have been less concerned whether the financial statements presented financial position, results of operations, and changes in cash flow in conformity with accepted accounting principles.

The leadership at Parmalat might have created ethical dissonance for those whose ethics were high while the organization’s was low. There is no indication that the culture fostered openness and transparency, two essential elements in creating an ethical environment. Parmalat’s leadership was inauthentic as it did not promote an ethical organization environment.

The deficiencies in the control environment contributed to the fraud because the board of directors was not actively involved in the corporate governance system. The Parmalat board of supervisors never did anything about the reported fraud because of the influence of the Tanzi family. With only three members of the board, it was highly unlikely that shareholder interests could have been well represented.

[An interesting article in Wharton Finance and Investment on the Parmalat fraud and U.S. frauds is: How Parmalat Differs From U.S. Scandals at: http://knowledge.wharton.upenn.edu/article/how-parmalat-differs-from-u-s-scandals/]

 

2. Explain the accounting and financial reporting techniques used by Parmalat to commit accounting fraud with respect to Schilit’s financial shenanigans.

 

Parmalat engaged in shenanigan number 2, recording bogus revenue, and shenanigan number 5, failing to record or improperly reducing liabilities. Parmalat created revenues through a nominee entity and it was accomplished by backdating and fabricating currency exchange contracts to convert a real loss related to currency exchanges rates at the different subsidiary into a profit for the parent company. Similarly, to hide losses due to interest expenses, backdating and fabricating of interest swaps were created at a different nominee entity. Parmalat also kept uncollectible accounts/bad debt expenses off its books to make earnings look better than they really were by transferring these amounts to a nominee entity. Even though it may not fit into a specific shenanigan category, it clearly is an attempt to manage earnings.

3. Do you believe the auditors should have detected the accounting manipulations described in question 2? Critically evaluate whether the firms adhered to generally accepted auditing standards given the information in the case. Was this a case of “poor auditing,” as characterized by Judge Kaplan, or fraud?

 

The auditor has an obligation to plan and perform the audit to detect material misstatements. This would require that the auditor adhere to ethical standards including to be independent both in fact and appearance, objective (skeptical), perform the work with due care, and follow relevant technical standards. The external auditor during the fraud failed to comply with many commonly accepted auditing practices and thus contributed to the fraud.

The largest component of Parmalat’s fraud which ultimately brought the company down was the nonexistent bank account ($5 billion) with Bank of America in the U.S. The auditors went through procedures to confirm this account, but they made one fatal mistake; they sent the confirmation using Parmalat’s internal mail system. The confirmation request was intercepted by Parmalat employees and subsequently forged by Tonna or an agent acting on his behalf. The forgery consisted of creating a confirmation and printing it on Bank of America letterhead then sending (or faxing) it back to the auditors. The auditors could have at least checked the fax number on the print-out to verify that the country and area code was correct for the Bank of America branch. The auditors were clearly guilty of ordinary negligence and a case can be made for gross negligence as well since they not only failed to carry out an essential audit procedure but they also allowed the client to utilize its own system to process the confirmations, which is a step that attentive auditors would never permit.

4. Given our discussion in  Chapter 5  of the PCAOB’s desire to gain access to audit workpapers of Chinese units of U.S. firms that audit Chinese companies listing in the United States, does it seem reasonable for a U.S. firm such as Deloitte to argue it has no liability for the actions of a network firm in Parmalat? What common characteristics might you look for in these alliances to assess overall firm liability?

 

Background Reading

The following is from an opinion piece written by Francine McKenna in re: The Auditors. She is a frequent critic of the accounting profession and Big 4 firms in particular. While it goes beyond the scope of the question, it does raise questions about global networks that work with Big 4 firms and what the ethical and professional liabilities are for the Main Big 4 firm.[footnoteRef:1] [1: http://retheauditors.com/2013/12/10/call-of-duty-who-has-the-last-word-on-network-audits-of-us-listed-companies/.]

The PCAOB has been highly critical over the lack of full and effective use of a consultation process by the audit firms with respect to the supervision and review of significant portions of foreign audits. The PCAOB also recognizes that investors want to know more about who actually does the audit of multinationals, in particular when significant portions may be audited in countries where the PCOAB has no inspection rights.

To that end the PCAOB had issued a proposed rule on October 11, 2011, Improving the Transparency of Audits: Proposed Amendments to PCAOB Auditing Standards and Form 2 , that also included a proposal for audit partners to sign audit reports in their own names. The proposed rule describes the problem for investors of significant portions of audits done by non-US firms as such. This proposal has not been adopted as yet.

In many public company audits, the accounting firm issuing the audit report does not perform 100 percent of the audit procedures. This may be especially common in, but not limited to, audits of companies with operations in more than one country. In these situations, audit procedures on, or audits of the company’s foreign operations are performed by other accounting firms or other participants in the audit not employed by the auditor.

Additionally, some accounting firms have begun a practice, known as off-shoring, whereby certain portions of the audit are performed by offices in a country different than the country where the firm is headquartered. For example, an accounting firm could establish an office in a country with a relatively low cost of labor and employ local personnel to perform certain audit procedures on audits of companies located in the country of the accounting firm’s headquarters or in a third country.

The PCAOB proposed amendments that would require the auditor to disclose in the audit report the name of other independent public accounting firms and other persons not employed by the auditor that took part in the most recent period’s audit. The proposed amendments would require disclosure when the auditor (a) assumes responsibility for or supervises the work of another independent public accounting firm or supervises the work of a person that performed audit procedures on the audit; and (b) divides responsibility with another independent public accounting firm. Specifically:

Disclosure when assuming responsibility or supervising – The auditor would be required to disclose the name, location, and extent of participation in the audit of (i) independent public accounting firms for whose audit the auditor assumed responsibility pursuant to AU-C sec. 543, Part of Audit Performed by Other Independent Auditors, and (ii) independent public accounting firms or other persons not employed by the auditor that performed audit procedures on the most recent period’s audit and whose work the auditor was required to supervise pursuant to Auditing Standard No. 10, Supervision of the Audit Engagement.

Disclosure when dividing responsibility – The auditor would be required to disclose the name and location of another independent public accounting firm that audited the financial statements of one or more subsidiaries, divisions, branches, components, or investments included in the financial statements of the company, to which the auditor makes reference in the audit report on the consolidated financial statements and, when applicable, internal control over financial reporting.

Deloitte Touche Tohmatsu (“DTT”) uses its global internal inspection program to assess and monitor the quality of the audit work of its member firms. However, the specific results of the inspections of member firms or practice offices are not disseminated to the Firm’s partners. Under DTT’s practices, a U.S. engagement partner would be notified of a deficiency in a specific practice office or member firm only if there was a finding from a global internal inspection on the work performed by the foreign affiliate on that U.S. partner’s issuer audit client. Accordingly, the global internal inspection program does not routinely provide a U.S. engagement partner with a basis for assessing a foreign office’s qualifications and familiarity with U.S. GAAP, PCAOB standards, and SEC reporting requirements.

In addition to its National Accounting Research and Quality Assurance groups, Deloitte also has a group like PwC GCMG specifically for servicing China-based companies that are listed or want to be listed in the US.

“Deloitte’s Chinese Services Group (CSG) coordinates with the Deloitte Touche Tohmatsu member firm in China and the appropriate subsidiary of Deloitte LLP to assist U.S. companies investing and operating in China. Whether contemplating market entry, M&A or optimization of existing operations, the CSG, in collaboration with the member firm in China, can help U.S. companies implement cross-border investment strategies and navigate the associated risks.

The CSG also co-ordinates with the China firm and the appropriate subsidiary of Deloitte LLP to assist Chinese companies seeking to access U.S. markets – expanding operations, raising capital and/or engaging in M&A. The Deloitte national network of bilingual professionals works closely with colleagues in China to deliver seamless service to globalizing Chinese companies.”

But let’s look instead at the “reality” that the SEC and the audit firm lawyers are portraying. If China companies and their audit firms – as well as law firms – have closed the drawbridge – all work is done locally, access to client information like workpapers limited to local staff, no emails or data sent out of country – what does that say about ability of SEC or PCAOB to enforce laws for US listings including multinationals with significant operations?  It says the audit firms have convinced regulators they are untouchable and above scrutiny in China. It says the SEC and PCAOB are impotent to enforce US laws or protect US investors if problems like accounting fraud or FCPA violations occur in their Chinese-based investments or in the China-based operations of US multinationals. It says the SEC and PCAOB cannot hold accounting firms that audit US listed companies or major operations of US listed companies in China or parts of Europe accountable if fraud or illegal acts occur under their watch and they are negligent or complicit in those acts.

It is interesting to note the statement made on Deloitte’s website about global network firms:

“Deloitte” is the brand under which tens of thousands of dedicated professionals in independent firms throughout the world collaborate to provide audit, consulting, financial advisory, risk management, tax and related services to select clients. These firms are members of Deloitte Touche Tohmatsu Limited, a UK private company limited by guarantee (“DTTL”).  Each DTTL member firm provides services in particular geographic areas and is subject to the laws and professional regulations of the particular country or countries in which it operates.   Each DTTL member firm is structured in accordance with national laws, regulations, customary practice, and other factors, and may secure the provision of professional services in its territory through subsidiaries, affiliates, and other related entities.  Not every DTTL member firm provides all services, and certain services may not be available to attest clients under the rules and regulations of public accounting. DTTL and each DTTL member firm are legally separate and independent entities, which cannot obligate each other.  DTTL and each DTTL member firm are liable only for their own acts and omissions, and not those of each other.  DTTL (also referred to as “Deloitte Global”) does not provide services to clients.     The DTTL member firm in the United States is Deloitte LLP.

It does seem that the firm considers each unit in foreign countries as separate from the global entity and each has its own liability for following appropriate standards in each country. The question is whether the firm wants it both ways – benefitting from a global affiliation while not taking responsibility for the actions of global network firms under the same name as the U.S. firm.

 

Ethical Obligations and Decision Making in Accounting, 4/e 2

© 2017 by McGraw-Hill Education.  All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

 
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