Jane is unhappy with her current salary and is considering doing a two-year MBA. For simplicity assume the MBA starts today (i.e., in t=0). Tuition is $25,000 per year payable at the beginning of a year. Jane must additionally buy books and supplies worth $5,000 per year which are again payable at the beginning of a year. If Jane pursues the MBA she expects to get a job right after graduation. The job entails a signup bonus of $10,000 immediately when she starts the job and a starting salary of $86,000. Jane expects this salary to grow at a rate of 6% annually. Salaries are paid at the end of a year. Regardless of whether she pursues the MBA or stays in her current job Jane expects to retire in 38 years from today. Does it pay for Jane to do an MBA? Perform NPV calculation.

Organizational Effectiveness and Development Scenario (Human Resources)

A small, family-run organization has always pursued a differentiation strategy that emphasizes quality and customer service. The CEO decides to retire and sell the business to a mid-sized competitor who has always employed a cost leadership strategy. As part of the sale agreement, the CEO insists that all current employees be retained. Within four months of the acquisition, the VP of HR sees that almost 40% of the acquired employees have left the organization, taking critical knowledge with them. If this continues, it will affect customer service.

1. What type of OED( Organizational Effectiveness and Development) intervention should the VP of HR consider first? ( support the answer with appropriate reasoning as per the above scenario with 100 words)

On March 12, 2009, a former chief of the New York Stock Exchange pled guilty to one of the largest financial frauds in history. Bernie Madoff, founder of his own financial firm and active philanthropist, had been swindling thousands of private investors—many of whom were close friends—out of billions of dollars. Madoff had achieved a degree of personal financial success few individuals ever attain, though he will be spending the rest of his life in prison. Would you consider Madoff an intelligent person? What role might emotional intelligence have played in his decision making?

For this Discussion, you define intelligence and detail its components. You also take a position on whether or not emotional intelligence is an accurate measure of intelligence.

With these thoughts in mind:

Post

a brief definition of intelligence, including the main components of intelligence.

Then provide your position on whether or not emotional intelligence is an accurate measure of intelligence.

Justify your response.

What incentives do local and national governments have to attract manufacturers? What incentives can a government provide?

In the beginning, at least, “I think we were all definitely rooting for the U.S.,” said Rich Juchniewicz, a product developer at Thorley, which markets its baby line under the 4moms brand.For years, the U.S. has ceded more and more of its manufacturing to lower-cost corners of the global economy. No one expects the U.S. to again make most of the electronic gadgets, tools, toys, furniture, lighting and other household products that tally more than $500 billion a year in imports.But some companies contend the U.S. has renewed its attraction. Wages are stable, for example, while China’s have soared. The U.S. energy boom has reduced natural gas prices and kept a lid on electricity costs. Plus, more companies want to protect designs from overseas copycats, keep closer tabs on quality control and avoid potential disruption in supply chains that span oceans.AdvertisementAs China’s cost advantages shrink, the U.S. has the potential, with investments in automation, to retrieve a share of such imported household products as TVs, vacuum cleaners and toasters, said Hal Sirkin, a Chicago-based senior partner at Boston Consulting Group. U.S. firms will do it “not to be patriotic,” he said, “but because they can make money.”Any shift, no matter how small, may well depend on the experience of such companies as Thorley, which plans to begin selling its new infant car seat later this year.A dozen Thorley managers began their quest with a tour of prospective U.S. factories in four states to find a manufacturer—a mission undertaken by other pioneering companies. K’Nex Brands LP, a family owned toy maker in Hatfield, Pa., several years ago returnedmost production of its plastic building toys to the U.S. from China, for example. Unlike Thorley, K’Nex already had a U.S. manufacturing plant, making it easier to bring work home.But K’Nex struggled to find a U.S. maker for Lincoln Logs, the toy it produces in China under license from Hasbro Inc. Michael Araten, chief executive of K’Nex, found that some U.S. wood factories were geared only for furniture and other large products; others couldn’t shape the small wooden toy at high volumes.

PrideSports LLC, a maker of golf tees, contacted K’Nex in 2013 after seeing an article in The Wall Street Journal mentioning the search. PrideSports said its factory in Burnham, Maine, had equipment for golf tees that could also make toy logs. The made-in-U.S. Lincoln Logs will hit the market this year.Capital Brands LLC of Los Angeles, maker of the Nutribullet and Magic Bullet blenders, is considering moving production to the U.S. from China. But Colin Sapire, chief executive, said his Chinese partners have engineering skills and a work ethic that could be hard to match in the U.S. He said the company has sold more than 20 million of the Chinese-made blenders in the past two years.Even so, Mr. Sapire said, his company would continue to search for opportunities to make products in the U.S.More U.S. companies would shift production from abroad if they analyzed the costs of overseas production to include such things as the shuttling of executives abroad and holding large inventories as a hedge against supply disruptions, said Harry Moser, founder of the Reshoring Initiative, an industry-funded nonprofit that promotes U.S. manufacturing.Willy Shih, a professor at Harvard Business School, is less optimistic. “China has really captured the whole electronic supply chain,” he said, and that is unlikely to return to the U.S.Instead of trying to make established products in the U.S., Mr. Shih said, “we’re going to have to focus on next-generation technologies” in, for example, advanced pharmaceuticals.Some of the hurdles are practical. The U.S. needs to rebuild its supplier base, as well as invest in more efficient manufacturing equipment. The average age of industrial equipment in the U.S. has passed 10 years old, the highest since 1938, according to estimates by Morgan Stanley & Co. economists.Wal-Mart Stores Inc. has beefed up efforts to buy more U.S.-made goods but finding U.S.-made electrical devices is difficult. The retailer sells electric fans produced by Lasko Products Inc., a family-owned company based in West Chester, Pa. But Lasko, like other U.S.-based manufacturers, can no longer find domestic suppliers of small electric motors.Billions of these motors are made abroad every year, said Alex Chausovsky of IHS Technology, a research firm. They require manual labor, one reason the industry shifted to Asia decades ago. Even if wages in Asia climb, he said, production isn’t likely to move back to the U.S.

“It’s not the labor-cost advantage. It’s the economies of scale,” said Mr. Chausovsky. “We’re talking about absolutely enormous quantities.”A few big companies have returned some production to the U.S., including Whirlpool Corp. , hand mixers; Caterpillar Inc., excavators; and Ford Motor Co. , medium-duty commercial trucks.But many U.S.-based designers of consumer products over the past two decades have grown comfortable contracting with overseas manufacturers. Some doubt they can get the same expertise, efficiency and flexibility in the U.S.The 10-year-old Thorley company, which has annual sales of about $50 million, had little experience with U.S. manufacturing, except for its infant bathtub, which is molded in Erie, Pa. Its automatically folding stroller, motorized baby swing and playpen are made in China.

In its early days, Thorley relied partly on Chinese partners to figure out how to make the gadgets it designed. The company has about 165 U.S. employees in such areas as engineering, design and marketing.One of Thorley’s main manufacturers in China is Jetta Co., which makes more than 100 products for foreign firms, including robotic toys, vacuum cleaners and American Girl dolls. At Jetta’s factory complex in Guangzhou’s Nansha district, halls are piled high with parts-filled plastic boxes headed for dozens of production lines. On a recent day, a train of carts loaded with 4moms boxes rumbled toward a warehouse. Women on a production line assembled the 250 or so parts making up the 4moms mamaRoo infant seat.“You come up with a good idea, we can make it happen,” said C.S. Wong, Jetta’s director of engineering.But labor costs are rising as much as 20% a year. Jetta workers in Nansha typically earn around 3,300 yuan, about $537, a month. Those with more specialized skills earn more. The median wage of assembly workers in the U.S. is about $2,600 a month, according to government data.Jetta and Kin Yat Industrial Ltd., which also makes Thorley’s 4moms products, are adding automation to cut labor costs. At Kin Yat’s plant in Shenzhen, near Hong Kong, a woman in a green cap and a green-and-orange blouse drops bolts into a housing, then holds it up to a round machine that tightens seven at once. “This used to take five people by hand,” said Vincent W.C. Fung, executive director of Kin Yat. “Now it’s taking just one.”

ENLARGERob Daley, chief executive of Thorley Industries, a Pittsburgh-based company that designs and makes the 4moms baby line, plans to launch a new baby car seat with electronic controls this year. China, where most of the company's products are manufactured, has ‘this unbelievable ecosystem that supports manufacturing that's hard to duplicate,’ he said. JEFF SWENSEN FOR THE WALL STREET JOURNALThough Chinese factories are known for flexibility, Jetta and Kin Yat officials said it was getting harder to ramp up production to meet spikes in demand. Workers are harder to find. “Years ago, we could hire 5,000 to 6,000 workers within a month, just put out the word,” said Jetta CEO Kenneth Wong. “But that’s all changed.”Jetta still varies its workforce considerably. The Nansha factory swings from around 4,500 workers to 8,500 at peak times.Most of Jetta and Kin Yat’s suppliers are within an hour’s drive. In China, “there’s just this unbelievable ecosystem that supports manufacturing that’s really hard to replicate,” said Thorley’s chief executive, Rob Daley.Mr. Daley assigned David Yanov, his chief operating officer, to scout potential U.S. manufacturers for the new baby seat. Mr. Yanov, who joined Thorley in 2012, had spent two

decades at a company that made medical devices, a job that involved overseeing factories in China and the Philippines.Unlike China, the U.S. doesn’t have large numbers of so-called contract manufacturers that specialize in producing finished consumer goods. Mr. Yanov and his colleagues set up visits to potential partners in Pennsylvania, Ohio, Illinois and Kentucky. Three companies bid on the project. Thorley also got bids from manufacturers in China.Once shipping and other expenses were calculated, Thorley discovered it would cost about the same to make the baby seats in the U.S. as in China. The decision became, Mr. Juchniewicz, the product developer, said: “Who do we want to work with?”Mr. Daley, the CEO, thought it would be easier to monitor production and maintain quality control with a local factory. “You burn a lot of time,” he said, in trips to China.ENLARGEThe front desk of Thorley Industries in Pittsburgh displays some of the high-tech infant seats sold under the company's 4moms brand. JEFF SWENSEN FOR THE WALL STREET JOURNALOn the other hand, Mr. Yanov said, his company knew what to expect from Thorley’s Chinese partners, who expertly managed frequent changes in design and specifications for new products. “Our model is, ‘Oops, we just thought of something else we’d like to add,’ ” he said. Thorley executives worried that a U.S. firm might take weeks to respond to such changes. “The clock speed is faster in China,” Mr. Yanov said. Because of the 13-hour time difference, he said, he can email a Chinese factory at the end of his workday and get an answer overnight. “It’s a quasi-24-hour day,” he said.The new car seat requires electronics parts from Asia, as well as imported fabric. Mr. Yanov knew his Chinese partners were good at integrating the electronics with other parts, but, he said, he wasn’t sure what to expect from a U.S. factory.“Who points the finger at whom if the electronics don’t work?” Mr. Yanov said. Mr. Daley, the CEO, said U.S. assembly of electronic parts from overseas “was just going to be that much more complicated to manage.”After reviewing the Chinese and U.S. bids, Thorley decision makers began debate in the afternoon and finished around 8 p.m. They would make the car seats in China.“I think the Chinese were trying a little harder” to get the business, Mr. Juchniewicz said

U.S. Foodservice: A Case Study in Fraud and Forensic Accounting

Maria H. Sanchez

Christopher P. Agoglia^[1]

Ahold’s audit committee ordered investigations at the parent company and at 17 Ahold operating and real estate companies to look for accounting errors, irregularities, and other issues as well as assess internal controls and management integrity (Ahold, 2003a).   After a forensic audit, Ahold eventually reported that the overstatement of U.S. Foodservice’s earnings was more than $850 million (Ball, 2003). A large component of the overstatement resulted from improper recognition of promotional allowances. Several U.S. Foodservice employees and vendors either admitted to or were convicted of playing a role in the fraud. In this case, students will gain insights into the proper accounting for and disclosure of promotional allowances and also the risk of over-reliance on third party confirmation as an audit procedure. Students will also distinguish between a financial statement audit and a forensic audit.

Accounting for cash consideration from vendor rebates, also known as “promotional allowances,” was at the center of the U.S. Foodservice’s earnings restatement. Rebates of this type are common in the grocery and foodservice industries and are frequently material in amount, sometimes exceeding 5% of sales. Vendors can offer rebates to customers in exchange for favorable display space in stores, or they may give volume rebates to provide an incentive to a retailer to increase sales of the vendor’s products, with the rebate percentage increasing as the retailer’s sales volume increases. However, these rebates are problematic in several respects. At the time of U.S. Foodservice’s accounting irregularities, there was no standardized accounting treatment of these rebates. Companies have accounted for them differently, and there have been differing levels of disclosure regarding their amounts. The investigation at U.S. Foodservice revealed that determination of rebates receivable can be problematic.

WHAT HAPPENED AT U.S. FOODSERVICE

            U.S. Foodservice was acquired by Ahold in 2000. Prior to this, U.S. Foodservice used KPMG as their auditor. After the acquisition, U.S. Foodservice was audited by Deloitte &

Touche, Ahold’s auditor. During their 2002 audit of Ahold’s financial statements, as part of their confirmation process at U.S. Foodservice, Deloitte discovered that certain accrued vendor allowance receivable balances were overstated. Deloitte uncovered a series of accounting irregularities at U.S. Foodservice and other Ahold subsidiaries and also improper accounting for certain of Ahold’s joint ventures (Parker, 2003). Deloitte immediately withdrew their audit opinions for 2000 and 2001 and suspended work on the 2002 audit.  

            There appeared to be a confluence of economic conditions, managerial “inventiveness,” and failures of internal controls that led to the accounting irregularities at U.S. Foodservice.

Company sales for the year 2002 had been decreasing. In last quarter of 2002, upper management held a conference call with its divisional managers advising them that their annual bonuses were at risk if sales were not boosted. According to testimony provided by those inside the company, in that conference call, the company’s chief operating officer described an

“initiative” that would increase the likelihood of managers receiving their bonuses and help the company achieve its sales target for the year. Quite simply, the strategy was to order large amounts of inventory and immediately recognize the vendor rebates that accompanied them. The rebates were in many cases substantial and, according to some sources, ranged from 8.5% to 46% of the purchase price. Divisional managers stated that they were told by upper management that if they did not place orders for additional inventory, then it would be done for them. These managers reported that it was made clear that if they did not go along with the “initiative,” not only were their bonuses in jeopardy, but perhaps their jobs were as well (Stecklow, Raghavan, & Ball, 2003).

Soon the warehouses at U.S. Foodservice were overflowing with inventory of foodrelated items and paper products. The amount of inventory the company purchased was so large that it had to rent additional space and refrigerator trucks to store it. As purchases increased, the vendor rebates to which U.S. Foodservice were entitled also increased. Supplier rebates increased from approximately $125 million in 2000 to about $700 million in 2003 (Bray, 2006). These rebates were recognized immediately as products were purchased in an attempt to boost earnings. The excess inventory was so immense, however, that even after the announcement of the earnings restatement, it was questionable whether the company would be able to sell it. In an effort to unload the massive amount of product in its warehouses, the company had to reduce its selling price below its original cost in some cases (Stecklow, Raghavan, & Ball, 2003).

During the audit of U.S. Foodservice, third party confirmations of rebates receivable had been provided by the vendors’ salespeople, not their accounting departments. According to complaints filed by the SEC, employees at U.S. Foodservice urged their vendors to complete and return to the auditors false confirmation letters with dollar amounts intentionally overstated, sometimes by as much as millions of dollars. Some vendors were pressured, some were provided with secret “side letters” assuring the vendors that they did not owe the amounts listed on the confirmations (Securities and Exchange Commission, 2006b).

In a span of several months, the “initiative” proposed by the company’s COO unraveled. Rather than helping the company out of its economic doldrums, the scheme instead resulted in earnings restatements, plunging stock price, several high-level managers losing their jobs, regulatory investigation of the company’s accounting practices, and allegations that officials in both the U.S. and Dutch offices had criminal intent to deceive and defraud the investing public

(Stecklow, Raghavan, & Ball, 2003). In July 2003, Dutch officials raided Ahold’s headquarters and began a criminal probe (Sterling, 2003). One year later, in July 2004, U.S. officials announced that two former U.S. Foodservice executives were being formally charged with conspiracy, securities fraud, and making false filings. Prosecutors also announced at the same time that two other U.S. Foodservice managers had admitted to their roles in the same alleged scheme of overstating earnings (McClam, 2004).

THE FORENSIC AUDIT

After the irregularities were uncovered by the external auditors, a criminal investigation was launched by the U.S. Department of Justice. In addition, Ahold appointed a team of forensic accountants from PricewaterhouseCoopers to work alongside the SEC. The forensic accountants had to sort through tens of thousands of documents (Datson, 2003). A U.S. federal grand jury issued subpoenas for Ahold documents for as far back as January 1, 1999 (Buckley and Chaffin, 2003).  

The forensic audit revealed fraud at U.S. Foodservice totaling over $850 million, with over $100 relating to 2000, over $200 million relating to 2001 and the rest relating to 2002. The fraud related to fictitious and/or overstated vendor allowance receivables and improper or premature recognition of vendor allowances and an understatement of cost of goods sold (Ahold, 2003a). Numerous U.S. Foodservice employees were involved in the fraud, and it was discovered that the fraud went back as far as 2000. U.S. Foodservice employees were found to have been using inflated recognition rates for vendor allowances and intentionally misapplying both Dutch and U.S. GAAP. Deloitte’s audit testing using third party confirmations failed to detect management’s misrepresentation of the reduction in cost of sales resulting from these manufacturer rebates (Bryan-Low, 2003).

The probe of U.S. Foodservice expanded to investigate several of the company’s suppliers, including Sara Lee and ConAgra Foods, to determine if they might have been complicit in U.S. Foodservice’s intent to misrepresent certain financial statement assertions. The investigation revealed that U.S. Foodservice employees asked salespeople at their vendors to sign false documentation for Deloitte and that some vendors cooperated with this fraudulent scheme. Three salespeople at Sara Lee admitted that they had signed off on, and forwarded to

U.S. Foodservice’s external auditors, erroneous documents that reflected inflated amounts owed to the company by Sara Lee (Callahan, 2003b). Similarly, at ConAgra Foods two salespeople also admitted to signing off on inflated amounts for manufacturer rebates due to U.S. Foodservice. ConAgra Foods claimed, however, that the erroneous confirmation amounts were discovered and that U.S. Foodservice’s external auditor was notified before news of the accounting scandal broke (Callahan, 2003a). The forensic examination at U.S. Foodservice also revealed numerous weaknesses in internal controls, including failure to properly record and track vendor allowances, inadequate accounting and financial reporting systems for vendor allowances, and failure to follow GAAP (Ahold, 2003a).

The investigation revealed fraud at not only U.S. Foodservice, but also at several other Ahold subsidiaries and the parent company. It was discovered at one subsidiary that fictitious invoices were used to conceal payments, and in some cases, payments were improperly capitalized rather than expensed. It was also discovered that the consolidation of certain joint ventures into Ahold’s financial statements was in error and that secret side letters had been concealed from Ahold’s audit committee and external auditors. Further, accounting irregularities and earnings management were uncovered at other subsidiaries and at the parent company.

Overall, more than 750 separate items related to internal control weaknesses and accounting issues were identified at Ahold and its subsidiaries (Ahold, 2003a). This extensive forensic examination led to a lengthy delay in the announcement of 2002 audited earnings numbers. Ahold’s 2002 annual report was released October of 2003, which included restatements for the years 2000 and 2001.

The total fraud at Ahold was revealed to be over $1 billion. Of this, approximately $856 million related to U.S. Foodservice. Upon conclusion of the forensic investigation, Ahold announced the creation of a task force reporting to the audit committee to address the internal control weaknesses and improper accounting practices uncovered during the investigation. (Ahold, 2003b). Ahold announced in their 2002 annual report that the internal audit department would now report directly to the CEO and the audit committee, rather than solely to the CEO, as was the case previously (Ahold, 2002a).

According to press releases from Ahold, after the accounting scandal, U.S. Foodservice made “substantial improvements in the company’s financial systems and controls, as well as its financial organization, to strengthen financial monitoring and reporting” (Ahold, 2004). They also established a new office of governance, ethics and compliance.

LESSONS LEARNED: AUDIT CONFIRMATIONS

            In designing the tests to be performed during an audit, an auditor must obtain adequate assurance to address audit risk. The greater the risk of a particular financial statement assertion (e.g., the existence and amount of vendor rebates), the more evidence an auditor should gather to support the assertion. Statement on Auditing Standards (SAS) No. 67 states that, “confirmation is the process of obtaining and evaluating a direct communication from a third party in response to a request for information about a particular item affecting financial statement assertions” (AICPA, 1992, SAS 67.06, AU 330). According to SAS No. 67, confirmation from an independent source is generally viewed as having greater reliability than evidence obtained solely from client personnel. Confirmation with a third party helps the auditor assess the financial statement assertions with respect to all five of management’s assertions: existence or occurrence, completeness, rights and obligations, valuation or allocation, and presentation and disclosure. The auditor may design a third party confirmation to address any one or more of these assertions (AICPA, 1992). However, existence is usually the primary assertion addressed by confirmation of receivables.

Even though evidence obtained by a third party confirmation is generally viewed as being more reliable than evidence provided by the entity being audited, SAS No. 67 cautions that an auditor should maintain a healthy level of professional skepticism. The auditor should consider information from prior years’ audits and audits of similar entities. Further, an auditor has an obligation to understand the arrangements and transactions between the audit client and the third party so that the appropriate confirmation request can be designed. SAS No. 67 states that “[i]f information about the respondent’s competence, knowledge, motivation, ability, or willingness to respond, or about the respondent’s objectivity and freedom from bias with respect to the audited entity comes to the auditor’s attention, the auditor should consider the effects of such

information on designing the confirmation request and evaluating the results, including determining whether other procedures are necessary” (AICPA, 2002, SAS 67.27). The statement allows for the possibility that the party responding to the confirmation may not be completely objective or free from bias and requires the auditor to use other evidence to confirm financial statement assertions in such cases (AICPA, 1992).

Confirming accounts receivable is a generally accepted auditing procedure and is required unless the amount involved is immaterial, a confirmation would be ineffective, or if the auditor can substantially reduce the level of audit risk of the financial statement assertion through the use of other substantive and analytical tests. Accounts receivable, for the purpose of SAS No. 67 (AU 330), represent claims against customers that have arisen in the normal course of business and loans held by financial institutions (AICPA, 1992). The Statement does not specifically address confirming a receivable that arises when a vendor owes a rebate to a reseller, a situation that differs substantially from the typical trade accounts receivable from a customer. Confirming vendor rebate receivables give rise to different risks that likely were not envisioned when the Statement was adopted in 1992.

In adopting SAS No. 67, two (of the seventeen) Board members, while assenting to the Statement, expressed a reservation that the language used in the Statement usurped the freedom of the auditor in exercising professional judgment in how best to confirm accounts receivable and that the language might also lead auditors to place undue reliance on third party confirmation when circumstances might suggest that the auditor choose a more effective test (AICPA, 1992). With the benefit of hindsight it is clear that the auditors of U.S. Foodservice could have, and should have, designed a more “effective test,” one that would have helped overcome the inherent weakness that existed in this situation where parties providing the confirmation may have either been uninformed about the existence and/or amount owed to the retailer or may have had a vested interest to overstate the amount that was owed to U.S. Foodservice. While some practitioner literature has made reference to biases of confirmation respondents (e.g., Simunic 1996), scant attention has been given to this particular concern regarding responses to auditor confirmations by vendors’ sales personnel.

THE AFTERMATH

In 2004, Timothy J. Lee and William F. Carter, both former purchasing executives for U.S. Foodservice, pleaded guilty to participating in the scheme and to conspiring with suppliers to mislead the company’s auditors. They later agreed to pay approximately $300,000 in civil penalties (Reuters, 2005).

More than a dozen U.S. Foodservice vendors pleaded guilty from 2003 to 2006 to criminal charges related to the fraud, admitting that they submitted false confirmations to the auditors (Bloomberg, 2006). Many other U.S. Foodservice employees and vendors have faced civil charges from the SEC, and most have agreed to pay fines without admitting guilt (Sterling, 2007).

In 2009, the SEC dropped the charges against the two former KPMG auditors charged with having engaged in improper conduct during the 1999 audit of U.S. Foodservice (SEC, 2009).

The auditors had been charged by the SEC in 2006 (SEC, 2006b).

PLEASE WRITE A CONCLUTION FOR THIS CASE STUDY RELATED TO THE AUDIT FAILURE.

U.S. Foodservice: A Case Study in Fraud and Forensic Accounting

Maria H. Sanchez

Christopher P. Agoglia^[1]

Ahold’s audit committee ordered investigations at the parent company and at 17 Ahold operating and real estate companies to look for accounting errors, irregularities, and other issues as well as assess internal controls and management integrity (Ahold, 2003a).   After a forensic audit, Ahold eventually reported that the overstatement of U.S. Foodservice’s earnings was more than $850 million (Ball, 2003). A large component of the overstatement resulted from improper recognition of promotional allowances. Several U.S. Foodservice employees and vendors either admitted to or were convicted of playing a role in the fraud. In this case, students will gain insights into the proper accounting for and disclosure of promotional allowances and also the risk of over-reliance on third party confirmation as an audit procedure. Students will also distinguish between a financial statement audit and a forensic audit.

Accounting for cash consideration from vendor rebates, also known as “promotional allowances,” was at the center of the U.S. Foodservice’s earnings restatement. Rebates of this type are common in the grocery and foodservice industries and are frequently material in amount, sometimes exceeding 5% of sales. Vendors can offer rebates to customers in exchange for favorable display space in stores, or they may give volume rebates to provide an incentive to a retailer to increase sales of the vendor’s products, with the rebate percentage increasing as the retailer’s sales volume increases. However, these rebates are problematic in several respects. At the time of U.S. Foodservice’s accounting irregularities, there was no standardized accounting treatment of these rebates. Companies have accounted for them differently, and there have been differing levels of disclosure regarding their amounts. The investigation at U.S. Foodservice revealed that determination of rebates receivable can be problematic.

WHAT HAPPENED AT U.S. FOODSERVICE

            U.S. Foodservice was acquired by Ahold in 2000. Prior to this, U.S. Foodservice used KPMG as their auditor. After the acquisition, U.S. Foodservice was audited by Deloitte &

Touche, Ahold’s auditor. During their 2002 audit of Ahold’s financial statements, as part of their confirmation process at U.S. Foodservice, Deloitte discovered that certain accrued vendor allowance receivable balances were overstated. Deloitte uncovered a series of accounting irregularities at U.S. Foodservice and other Ahold subsidiaries and also improper accounting for certain of Ahold’s joint ventures (Parker, 2003). Deloitte immediately withdrew their audit opinions for 2000 and 2001 and suspended work on the 2002 audit.  

            There appeared to be a confluence of economic conditions, managerial “inventiveness,” and failures of internal controls that led to the accounting irregularities at U.S. Foodservice.

Company sales for the year 2002 had been decreasing. In last quarter of 2002, upper management held a conference call with its divisional managers advising them that their annual bonuses were at risk if sales were not boosted. According to testimony provided by those inside the company, in that conference call, the company’s chief operating officer described an

“initiative” that would increase the likelihood of managers receiving their bonuses and help the company achieve its sales target for the year. Quite simply, the strategy was to order large amounts of inventory and immediately recognize the vendor rebates that accompanied them. The rebates were in many cases substantial and, according to some sources, ranged from 8.5% to 46% of the purchase price. Divisional managers stated that they were told by upper management that if they did not place orders for additional inventory, then it would be done for them. These managers reported that it was made clear that if they did not go along with the “initiative,” not only were their bonuses in jeopardy, but perhaps their jobs were as well (Stecklow, Raghavan, & Ball, 2003).

Soon the warehouses at U.S. Foodservice were overflowing with inventory of foodrelated items and paper products. The amount of inventory the company purchased was so large that it had to rent additional space and refrigerator trucks to store it. As purchases increased, the vendor rebates to which U.S. Foodservice were entitled also increased. Supplier rebates increased from approximately $125 million in 2000 to about $700 million in 2003 (Bray, 2006). These rebates were recognized immediately as products were purchased in an attempt to boost earnings. The excess inventory was so immense, however, that even after the announcement of the earnings restatement, it was questionable whether the company would be able to sell it. In an effort to unload the massive amount of product in its warehouses, the company had to reduce its selling price below its original cost in some cases (Stecklow, Raghavan, & Ball, 2003).

During the audit of U.S. Foodservice, third party confirmations of rebates receivable had been provided by the vendors’ salespeople, not their accounting departments. According to complaints filed by the SEC, employees at U.S. Foodservice urged their vendors to complete and return to the auditors false confirmation letters with dollar amounts intentionally overstated, sometimes by as much as millions of dollars. Some vendors were pressured, some were provided with secret “side letters” assuring the vendors that they did not owe the amounts listed on the confirmations (Securities and Exchange Commission, 2006b).

In a span of several months, the “initiative” proposed by the company’s COO unraveled. Rather than helping the company out of its economic doldrums, the scheme instead resulted in earnings restatements, plunging stock price, several high-level managers losing their jobs, regulatory investigation of the company’s accounting practices, and allegations that officials in both the U.S. and Dutch offices had criminal intent to deceive and defraud the investing public

(Stecklow, Raghavan, & Ball, 2003). In July 2003, Dutch officials raided Ahold’s headquarters and began a criminal probe (Sterling, 2003). One year later, in July 2004, U.S. officials announced that two former U.S. Foodservice executives were being formally charged with conspiracy, securities fraud, and making false filings. Prosecutors also announced at the same time that two other U.S. Foodservice managers had admitted to their roles in the same alleged scheme of overstating earnings (McClam, 2004).

THE FORENSIC AUDIT

After the irregularities were uncovered by the external auditors, a criminal investigation was launched by the U.S. Department of Justice. In addition, Ahold appointed a team of forensic accountants from PricewaterhouseCoopers to work alongside the SEC. The forensic accountants had to sort through tens of thousands of documents (Datson, 2003). A U.S. federal grand jury issued subpoenas for Ahold documents for as far back as January 1, 1999 (Buckley and Chaffin, 2003).  

The forensic audit revealed fraud at U.S. Foodservice totaling over $850 million, with over $100 relating to 2000, over $200 million relating to 2001 and the rest relating to 2002. The fraud related to fictitious and/or overstated vendor allowance receivables and improper or premature recognition of vendor allowances and an understatement of cost of goods sold (Ahold, 2003a). Numerous U.S. Foodservice employees were involved in the fraud, and it was discovered that the fraud went back as far as 2000. U.S. Foodservice employees were found to have been using inflated recognition rates for vendor allowances and intentionally misapplying both Dutch and U.S. GAAP. Deloitte’s audit testing using third party confirmations failed to detect management’s misrepresentation of the reduction in cost of sales resulting from these manufacturer rebates (Bryan-Low, 2003).

The probe of U.S. Foodservice expanded to investigate several of the company’s suppliers, including Sara Lee and ConAgra Foods, to determine if they might have been complicit in U.S. Foodservice’s intent to misrepresent certain financial statement assertions. The investigation revealed that U.S. Foodservice employees asked salespeople at their vendors to sign false documentation for Deloitte and that some vendors cooperated with this fraudulent scheme. Three salespeople at Sara Lee admitted that they had signed off on, and forwarded to

U.S. Foodservice’s external auditors, erroneous documents that reflected inflated amounts owed to the company by Sara Lee (Callahan, 2003b). Similarly, at ConAgra Foods two salespeople also admitted to signing off on inflated amounts for manufacturer rebates due to U.S. Foodservice. ConAgra Foods claimed, however, that the erroneous confirmation amounts were discovered and that U.S. Foodservice’s external auditor was notified before news of the accounting scandal broke (Callahan, 2003a). The forensic examination at U.S. Foodservice also revealed numerous weaknesses in internal controls, including failure to properly record and track vendor allowances, inadequate accounting and financial reporting systems for vendor allowances, and failure to follow GAAP (Ahold, 2003a).

The investigation revealed fraud at not only U.S. Foodservice, but also at several other Ahold subsidiaries and the parent company. It was discovered at one subsidiary that fictitious invoices were used to conceal payments, and in some cases, payments were improperly capitalized rather than expensed. It was also discovered that the consolidation of certain joint ventures into Ahold’s financial statements was in error and that secret side letters had been concealed from Ahold’s audit committee and external auditors. Further, accounting irregularities and earnings management were uncovered at other subsidiaries and at the parent company.

Overall, more than 750 separate items related to internal control weaknesses and accounting issues were identified at Ahold and its subsidiaries (Ahold, 2003a). This extensive forensic examination led to a lengthy delay in the announcement of 2002 audited earnings numbers. Ahold’s 2002 annual report was released October of 2003, which included restatements for the years 2000 and 2001.

The total fraud at Ahold was revealed to be over $1 billion. Of this, approximately $856 million related to U.S. Foodservice. Upon conclusion of the forensic investigation, Ahold announced the creation of a task force reporting to the audit committee to address the internal control weaknesses and improper accounting practices uncovered during the investigation. (Ahold, 2003b). Ahold announced in their 2002 annual report that the internal audit department would now report directly to the CEO and the audit committee, rather than solely to the CEO, as was the case previously (Ahold, 2002a).

According to press releases from Ahold, after the accounting scandal, U.S. Foodservice made “substantial improvements in the company’s financial systems and controls, as well as its financial organization, to strengthen financial monitoring and reporting” (Ahold, 2004). They also established a new office of governance, ethics and compliance.

LESSONS LEARNED: AUDIT CONFIRMATIONS

            In designing the tests to be performed during an audit, an auditor must obtain adequate assurance to address audit risk. The greater the risk of a particular financial statement assertion (e.g., the existence and amount of vendor rebates), the more evidence an auditor should gather to support the assertion. Statement on Auditing Standards (SAS) No. 67 states that, “confirmation is the process of obtaining and evaluating a direct communication from a third party in response to a request for information about a particular item affecting financial statement assertions” (AICPA, 1992, SAS 67.06, AU 330). According to SAS No. 67, confirmation from an independent source is generally viewed as having greater reliability than evidence obtained solely from client personnel. Confirmation with a third party helps the auditor assess the financial statement assertions with respect to all five of management’s assertions: existence or occurrence, completeness, rights and obligations, valuation or allocation, and presentation and disclosure. The auditor may design a third party confirmation to address any one or more of these assertions (AICPA, 1992). However, existence is usually the primary assertion addressed by confirmation of receivables.

Even though evidence obtained by a third party confirmation is generally viewed as being more reliable than evidence provided by the entity being audited, SAS No. 67 cautions that an auditor should maintain a healthy level of professional skepticism. The auditor should consider information from prior years’ audits and audits of similar entities. Further, an auditor has an obligation to understand the arrangements and transactions between the audit client and the third party so that the appropriate confirmation request can be designed. SAS No. 67 states that “[i]f information about the respondent’s competence, knowledge, motivation, ability, or willingness to respond, or about the respondent’s objectivity and freedom from bias with respect to the audited entity comes to the auditor’s attention, the auditor should consider the effects of such

information on designing the confirmation request and evaluating the results, including determining whether other procedures are necessary” (AICPA, 2002, SAS 67.27). The statement allows for the possibility that the party responding to the confirmation may not be completely objective or free from bias and requires the auditor to use other evidence to confirm financial statement assertions in such cases (AICPA, 1992).

Confirming accounts receivable is a generally accepted auditing procedure and is required unless the amount involved is immaterial, a confirmation would be ineffective, or if the auditor can substantially reduce the level of audit risk of the financial statement assertion through the use of other substantive and analytical tests. Accounts receivable, for the purpose of SAS No. 67 (AU 330), represent claims against customers that have arisen in the normal course of business and loans held by financial institutions (AICPA, 1992). The Statement does not specifically address confirming a receivable that arises when a vendor owes a rebate to a reseller, a situation that differs substantially from the typical trade accounts receivable from a customer. Confirming vendor rebate receivables give rise to different risks that likely were not envisioned when the Statement was adopted in 1992.

In adopting SAS No. 67, two (of the seventeen) Board members, while assenting to the Statement, expressed a reservation that the language used in the Statement usurped the freedom of the auditor in exercising professional judgment in how best to confirm accounts receivable and that the language might also lead auditors to place undue reliance on third party confirmation when circumstances might suggest that the auditor choose a more effective test (AICPA, 1992). With the benefit of hindsight it is clear that the auditors of U.S. Foodservice could have, and should have, designed a more “effective test,” one that would have helped overcome the inherent weakness that existed in this situation where parties providing the confirmation may have either been uninformed about the existence and/or amount owed to the retailer or may have had a vested interest to overstate the amount that was owed to U.S. Foodservice. While some practitioner literature has made reference to biases of confirmation respondents (e.g., Simunic 1996), scant attention has been given to this particular concern regarding responses to auditor confirmations by vendors’ sales personnel.

THE AFTERMATH

In 2004, Timothy J. Lee and William F. Carter, both former purchasing executives for U.S. Foodservice, pleaded guilty to participating in the scheme and to conspiring with suppliers to mislead the company’s auditors. They later agreed to pay approximately $300,000 in civil penalties (Reuters, 2005).

More than a dozen U.S. Foodservice vendors pleaded guilty from 2003 to 2006 to criminal charges related to the fraud, admitting that they submitted false confirmations to the auditors (Bloomberg, 2006). Many other U.S. Foodservice employees and vendors have faced civil charges from the SEC, and most have agreed to pay fines without admitting guilt (Sterling, 2007).

In 2009, the SEC dropped the charges against the two former KPMG auditors charged with having engaged in improper conduct during the 1999 audit of U.S. Foodservice (SEC, 2009).

The auditors had been charged by the SEC in 2006 (SEC, 2006b).

read the above REAL WORLD AUDITING case study and provide an overview of the facts of the case (in your own words);  discuss the theoretical principles applicable to the case.

Tyco International, the conglomerate whose former chief was convicted of looting the company, would pay $US50 million to settle accounting fraud charges, United States authorities said yesterday. The penalty was for an alleged $US1 billion overstatement of Tyco results between 1996 and 2002 in an accounting fraud "orchestrated at the highest levels of the company", the US Securities and Exchange Commission said. The lurid details of how former chief executive Dennis Kozlowski spent Tyco's money -on a $US2 million birthday party for his wife in Sardinia and a $US6000 shower curtain for his $US18 million Manhattan apartment, for instance - came to symbolise corporate excess during a time of scandals. Kozlowski was sentenced for stealing more than $US150 million from Tyco in a case that also led to the conviction of former chief financial officer Mark Swartz. The Bermuda-based Tyco said the $US50 million SEC settlement, the cost of which it had previously reported, closed the agency's probe of its former officials' accounting

practices. Tyco neither admitted nor denied wrongdoing, as is customary in SEC settlements. The SEC said Tyco inflated profit by at least $US500 million through improper accounting of some of the acquisitions it made from 1996 to 2002. Required: a. In this Tyco’s case highest level of company executives were involved in criminal activities and stole from the company. Suggest steps & guidelines to prevent unacceptable practices. b. Do you think management of company has an ethical and moral responsibility towards shareholders? Comment briefly.

Internet giant Zoidle, a U.S. company, generated sales of £2.5 billion in the United Kingdom in 2013 (approximately $4 billion in U.S. dollars). Its net profits before taxes on these sales were £200 million, and it paid £6 million in corporate tax, resulting in a tax rate of 3 percent. The corporate tax rate in the United Kingdom is between 20 percent and 24 percent.

The CEO of Zoidle held a press conference stating that he was proud of his company for taking advantage of tax loopholes and for sheltering profits in other nations to avoid paying taxes. He called this practice “capitalism at its finest.” He further stated that it would be unethical for Zoidle not to take advantage of loopholes and that it would be borderline illegal to tell shareholders that the company paid more taxes than it had to pay because it felt that it should. Zoidle receives significant benefits for doing business in the United Kingdom, including tremendous sales tax exemptions and some property tax breaks. The United Kingdom relies on the corporate income tax to provide services to the poor and to help run the agency that regulates corporations. Is it ethical for Zoidle to avoid paying taxes? Why or why not?

Describe how you would advise the company to act in the following situation. Please be sure to describe your ethical reasoning process.

On January 1, 2020 (the first day of its fiscal year) Vaughn Ltd. acquired a patent which gave the company the right to use a production process. The process met the six criteria for capitalization as an intangible asset. Below is a listing of the events relating to the patent over the five fiscal years from 2020 through 2024:

Prepare all journal entries related to the patent for the production process Vaughn will record from January 1, 2020 to December 31, 2024, using the cost recovery impairment model.

On January 1, 2020 (the first day of its fiscal year) Wildhorse Ltd. acquired a patent which gave the company the right to use a production process. The process met the six criteria for capitalization as an intangible asset. Below is a listing of the events relating to the patent over the five fiscal years from 2020 through 2024:

record entry for

Jan 1, 2020

Dec 31,2020

Dece 31,2021

Dec 31, 2022

Dec 31, 2023

Dec 31, 2024 (to record amortization expense)

Dec 31, 2024 (to record loss on impairment)