CASE 1.15
LIVENT, INC.
Synopsis
Similar to most financial frauds, the Livent, Inc. fraud was masterminded by a few individuals,
primarily Garth Drabinsky and Myron Gottlieb. However, numerous individuals were eventually
management to track the company’s fireal” financial data and the data that had been distorted by
fraudulent manipulations. The accounting software also allowed Livent’s executives to more readily
conceal the fraud from the company’s Deloitte auditors. The second troubling feature of the Livent
fraud was the matter-of–fact manner in which the company’s executives organized and carried out
the fraud.
Following the collapse of Livent, the company’s independent auditors were criticized for failing
to discover that the company’s financial statements had been grossly misstated. Much of this
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Livent, Inc.—Key Facts
1. Garth Drabinsky and Myron Gottlieb founded Livent in 1989 after they had been forced to
relinquish control of Cineplex Odeon following charges of irregularities in that company’s
accounting records.
2. Drabinsky was the creative genius behind Livent’s impressive string of Tony Award-winning
3. Livent was based in Toronto but the company received SEC approval to begin trading its stock
on the NASDAQ stock exchange in 1995.
4. Serious financial problems stemming from huge cost overruns on Livent’s extravagant
6. Subsequent investigations by the SEC and other law enforcement authorities revealed that
7. Livent employees who participated in the fraud included several accountants who had
8. The SEC discovered that Livent’s accounting staff had developed computer software that
9. A second disturbing feature of the fraud was that company executives regularly met with their
accounting staff to discuss fiadjustments” needed to improve Livent’s financial data.
10. The fiaccounting manipulations” used by Livent officials included simply erasing expenses and
12. Deloitte was named as a defendant in multiple civil lawsuits stemming from the Livent fraud; to
settle one such case Deloitte reportedly made a multimillion dollar payment to a restitution fund
established for Livent’s former creditors.
Instructional Objectives
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3. To examine the issues raised when independent auditors accept key accounting positions with
former clients.
4. To illustrate the difficulty of uncovering financial frauds masterminded by top client executives
that involve the collusion of key members of the given entity’s accounting staff.
Suggestions for Use
In responding to Question 1, students are required to identify the audit risk factors posed by
companies in the entertainment industry. Consider expanding Question 1 and making it a more
comprehensive exercise. After organizing your class into groups of four to six students, require each
In discussing Maria Messina’s plight (while responding to Question 6), some students are prone
to suggest that she should have simply reported the fraud to the appropriate officials as soon as she
became aware of it. I attempt to goad my students into recognizing that although revealing the fraud
would certainly have been the best decision for Messina to make in retrospect, it would not have
been an easy decision. Encourage students to place themselves in Messina’s position. The young,
Suggested Solutions to Case Questions
1. The fientertainment industry” is very diverse and fragmented. In fact, there is little consensus
among financial analysts on which specific companies belong to this industry. Video game
manufacturers, movie production companies, publicly-owned sports franchises, and sporting goods
manufacturers are a just a few examples of the types of companies that are involved in fientertaining”
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the public. Nevertheless, I would suggest that many companies in the entertainment industry pose
the following general inherent risk factors:
•Entertainment companies tend to have more volatile operating results than more generic
companies. Why? Because most companies in this industry rely heavily on discretionary
spending by consumers, which fluctuates with changes in the overall health of the economy.
Listed next are a few examples of finon–standard” audit procedures that might be applied during
an audit of a company involved in live theatrical productions.
•Internal control tests would be necessary to ensure that cash receipts generated by live shows
are being processed properly. Likewise, related tests would be needed to reconcile head counts
with cash receipts—to investigate the possibility that ticket-takers/ticker-sellers are being
figenerous” with their friends and relatives.
•Theatrical companies defer development costs for new productions. These deferred assets can
accumulate to material amounts. Auditors would need to develop appropriate tests to ensure
that these deferred costs are, in fact, assets and are properly valued. Such tests might include
corresponding with industry experts or analysts to investigate the likelihood that the given
shows will ultimately fiopen” and have a reasonable firun.”
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2. The work roles of an audit partner and CFO of a large public company are probably more
similar than they are different. Both an audit engagement partner and a CFO have to fisign off” on
1934. Both audit partners and CFOs supervise numerous subordinates and assume responsibility for
the work product of those subordinates, have an obligation to fistay current” regarding key technical
developments within the accounting and financial reporting domain, and face potential civil and
criminal sanctions if they fail to carry out their responsibilities. Despite holding high-ranking
positions within their organizations, both audit partners and CFOs must fianswer” to superiors. An
audit partner’s performance is regularly reviewed and evaluated by his or her managing partner
and/or a committee of peers, while a CFO’s performance is typically reviewed by the CEO and/or
the board of directors. One responsibility that audit partners assume that CFOs do not is practice
development, that is, audit partners typically spend a significant amount of their time attempting to
obtain new clients for their firms.
3. Most corporate executives are honest and insist that their accounting subordinates be honest and
diligent in maintaining a company’s accounting records and in preparing its periodic financial
statements. As a result, corporate executives often perceive that an audit contributes nothing to the
quality or reliability of their companies’ financial statements. In other words, they conclude that the
annual independent audit is effectively a fiwaste of time.” Of course, the reality is that independent
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audits—although a potential nuisance to individual companies—are extremely necessary and useful
from a society-wide or economy-wide perspective.
4. The relevant technical material in this context is included in AU Section 625, fiReports on the
Application of Accounting Principles,” of the PCAOB’s Interim Standards. (Notes: Recognize that
when the technical material included in AU Section 625 was originally adopted in 1986, the PCAOB
did not exist. At that time, AU Section 625 was a part of the AICPA Professional Standards. In the
ficlarified” AICPA Professional Standards, the technical material previously included in AU 625 of
Note: AU 625.10 describes in detail the form and content of a fireport on the application of
accounting principles,” while AU 625.11 provides an example of such a report.
5. The revenue recognition principle is the key accounting concept that is relevant to this context.
Generally, the revenue recognition principle dictates that revenue must be both fiearned” and
firealized” before it can be recorded. fiEarned” means that the relevant earnings process must be
6. Messina did not feel directly responsible for the accounting irregularities. However, because
she had chosen to work for an organization that was replete with fraudulent conduct, she apparently
fiabsorbed” some measure of guilt or responsibility for those irregularities.
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One approach to addressing this type of open-ended question is to ask a student to explain what
7. AU Section 634 of the PCAOB’s Interim Standards provides general guidance for accountants
to follow when performing a wide range of due diligence engagements, including such engagements
that involve common fiacquisition transactions.” (AU 634.05). [Note: Since due diligence
investigations are not audits, the term fiaccountants” is used to refer to the individuals completing