Case 5-7 Diamond Foods: Accounting for Nuts
Diamond Foods, based in Stockton, California, is a premium snack food and culinary nut
company with diversified operations. The company had a reputation of making bold and
expensive acquisitions. Due to competition within the snack food industry, Diamond developed
an aggressive company culture that placed high emphasis upon performance. The company’s
popcorn (2008) and Kettle potato chips (2010), became the focus of an SEC investigation after
The Wall Street Journal raised questions about the timing and accounting of Diamond’s
payments to walnut growers. The case focuses on the matching of costs and revenues. At the
heart of the investigation was the question of whether Diamond senior management adjusted the
accounting for the grower payments on purpose to increase profits for a given period.
expense against revenue from the sale of walnuts.
An investigation by the audit committee in February 2012 found payments of $20 million to
walnut growers in August 2010 and $60 million in September 2011 that were not recorded in the
correct periods. The disclosure of financial restatements in November 2012 and audit committee
investigation led to the resignation of former CEO Michael Mendes, who agreed to pay a $2.74
walnut grower accounting, and accounts payable timing recognition. The company announced
efforts to remediate these areas of material weakness, including enhanced oversight and controls,
leadership changes, a revised walnut cost estimation policy, and improved financial and
operation reporting throughout the organization.
An interesting aspect of the case is the number of red flags, including unusual timing of
multiple acquisitions, added earnings during the period.
Another red flag was that while net income growth is generally reflected in operating cash flow
increases, at Diamond, the cash generation was sluggish in FY2010, when earnings were strong.
This raises questions about the quality of earnings. Also, in September 2010, Mendes had
promised EPS growth of 15 percent to 20 percent per year for the next five years. In FY2009,
FY2010, and FY2011, $2.6 million of Mendes’s $4.1 million in annual bonus was paid because
Diamond beat its EPS goal, according to regulatory filings.
As for the role of Deloitte in the fraud, the SEC charged that Neil misled them by giving false
and incomplete information to justify the unusual accounting treatment for the payments. The
SEC’s order against Mendes found that he should have known that Diamond’s reported walnut
cost was incorrect because of information he received at the time, and he omitted facts in certain
representations to Deloitte about the special walnut payments. One problem was Neil did not
document accounting policies or design the process for which walnut grower payments and the
Ethical Obligations and Decision Making in Accounting, 4/e 3
Questions
1. Use the fraud triangle to analyze the business and audit risks that existed at
Diamond Foods during the period of its accounting fraud.
The fraud triangle helps to clarify issues that may lead to fraud including
pressures/incentives to commit fraud, the opportunity to do so, and rationalizations
provided for the act. The following is a brief look at these factors at Diamond Foods.
Pressures/Incentives
“Bigger is better” culture created an aggressive approach to acquisitions and pressure to
keep up the expanding results and look of a high performance company.
Ambitious earnings growth plans; pressure to increase profits each year.
False reports in conference calls to analysts to make things seem better than they really
were.
Opportunity
2. Answer the following:
1. Did Diamond Foods commit an illegal act? Explain.
Diamond Foods was not accruing for crop payments or cost of goods sold in the
correct year. For example, the 2010 almond crop purchased from farmers should have
Ethical Obligations and Decision Making in Accounting, 4/e 4
2. Evaluate the control environment at Diamond Foods.
The facts of the case indicate the following.
• As a result of the audit committee investigation and the subsequent analysis
and procedures performed, the company identified material weaknesses in
three areas: control environment, walnut grower accounting, and accounts
payable timing recognition.
• The company announced efforts to remediate these areas of material
weakness, including enhanced oversight and controls, leadership changes, a
revised walnut cost estimation policy, and improved financial and operation
reporting throughout the organization.
3. Based on the facts of the case, do you think the auditors from Deloitte could have
done more to identify the fraud at Diamond Foods? Were there any apparent
deficiencies in their audit procedures and evaluation of the risk of material
misstatement in the financial statements of Diamond Foods? Explain.
The SEC ruled that management of Diamond Foods misled the Deloitte auditors by
giving them false and incomplete information to justify the unusual accounting treatment
for the payments. Michael Mendes, the CEO, had omitted facts in certain representations
Ethical Obligations and Decision Making in Accounting, 4/e 5
The role of the auditor is to opine on the client’s financial statements based on an audit in
accordance with GAAS. This includes exercising the proper level of professional
skepticism; not accepting management’s representations uncritically, but with a
questioning mind; asking probing questions and having an objective mindset; and
exercising due care. Applying these standards to Deloitte in the Diamond Foods case
comes down to: Should the auditors be held responsible for not detecting a fraud because
management went to great lengths to deceive them including not providing sufficient and
reliable evidence so that auditors can verify financial statements assertions?