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9. What is the proper audit procedure to ensure:
a. completeness of liabilities in the financial statements?
b. that all related parties have been included or disclosed in the consolidated financial statements?
Completeness is the most difficult assertion to prove in auditing financial statements. Looking
for missing liabilities or operations with related parties might be very challenging. The first
10. Do you think analytical procedures would aid the detection of fraud? What is the responsibility of
the auditor applying analytical procedures?
Applicable analytical procedures include comparisons to industry ratios and reasonability tests.
11. What should the 450 lending institutions have done to protect themselves from subsequent
lawsuit?
Lending institutions would be well-advised to create a due-diligence protocol/process for new
Useful Articles, Links, and Videos
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L.J. Brooks & P. Dunn, Cengage Learning, 2018
News about Rigas family, including commentary and archival articles.
C-Span and U.S. Department of Justice (Jul. 24, 2002). “Adelphia Executives Arrests ”
of millions and causing investor losses of $60 billion while in control of Adelphia
Communications.
NYSE (2017). Listed Company Manual, Section 303A.00 Corporate Governance Standards.
[The website’s search feature can be used if the link is not direct. The rules from the year of the
case are no longer available.]
U.S. Securities & Exchange Commission (July 24, 2002). “SEC Charges Adelphia and Rigas Family with
Business & Professional Ethics for Directors, Executives & Accountants, 8e
18. Tyco – Looting Executive Style (Chapter 5, pages 333–337)
What this case has to offer
Tyco International is one of the most widely known cases of pervasive fraud perpetrated by top
executives. Millions in company funds were misallocated, unreported and/or misrepresented by former
CEO L. Dennis Kozlowski, CFO Mark Swartz, and General Counsel Mark Belnick. Their personal misuse of
funds, lavish expenses, appetite for excesses, and flagrant denial of any wrong-doing are examples of
Teaching suggestions
In order to lay the groundwork on governance and the issues involved in the case and the questions
listed at the end, I ask the following questions, in order:
1. How closely should the actions of executives be monitored by the board of directors – very
closely, or with a great deal of trust? [Discussion of the role of the Board]
Discussion of important issues/questions
1. The pattern of illegal and improper conduct described above took place for at least 5 years prior to
June 3, 2002. What red flags or governance mechanisms should have alerted the following people to
this pattern:
a. Tyco management accountants?
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The board of directors, as part of their stewardship role, should demand from management a
complete picture of the company’s performance, including financial results, and of the actions of
The corporate governance mechanism relies upon policies to guide expectations for behavior,
and if these expectations are not met, the independence, objectivity, vigilance, skepticism, and
ethical behavior of accountants, auditors and directors should lead to finding and correcting the
problem. Therefore:
a. Management accountants should have raised their concerns about waste of resources
(no value for the company’s money) in lavish parties, unreasonable loans to executives
and excessive compensation. However, Tyco’s accountants might not raise any issues
because of fear to their bosses or because some of them were also involved at more
senior levels.
2. Identify and discuss the most important weaknesses in Tyco’s internal controls and governance
systems.
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Internal controls should provide reasonable assurance that fraud will be prevented or detected.
A strong control environment constitutes the most pervasive element to deter fraud. Control
environment includes integrity, ethical values and competence, management’s philosophy and
operating style, and the attention and direction provided by the board of directors. In Tyco’s
control environment, integrity, independence and separation of duties were seriously
compromised.
3. Would a post-Sarbanes-Oxley Act whistleblowing program to the Audit Committee of the board
have eliminated the improper and illegal actions? Why or why not?
Whistleblowing is one of the most common ways by which fraud is uncovered. Effective
whistleblowing programs should be:
• Independent
4. If you had been a professional accountant employed by Tyco during this time, and you wanted to
blow the whistle, who would you have gone to with your story?
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The first step is to discuss the accuracy of facts with your supervisor and try to escalate the issue
using the regular chain of command. If this does not work, you should consider talking to the
5. Why were so many Tyco employees willing to go along quietly with the looting by senior executives?
There was a combination of factors: lack of clear communication that unethical behavior will not
6. How many years in jail do you think Kozlowski should have received for his white-collar crimes?
Discussions on this topic are extensive and often involve contradictory ethical and legal
Additional Events
April 17, 2006. Drawbaugh, Kevin (April 18, 2006). “Tyco to pay $50 million to settle SEC fraud charges.”
Toronto Star, page C6.
Tyco to pay $50 million to settle SEC fraud charges related to the looting of the company.
May 13, 2006. Bloomberg News (May 13, 2006). “Tyco’s Kozlowski to pay millions to resolve tax case.”
Globe and Mail Report on Business, page B7.
Useful Articles, Links, and Videos
“The Rise and Fall of Dennis Kozlowski Cover Story].” (December 23, 2002). Business Week,
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“Tyco to pay 50 mil usd to settle SEC accounting fraud charges.” (April 18, 2006). Forbes,
Business & Professional Ethics for Directors, Executives & Accountants, 8e
19. HealthSouth – Can 5 CFOs Be Wrong? (Chapter 5, pages 338–343)
What this case has to offer
The HealthSouth case points out how key weaknesses in the corporate governance structure may allow
accounting fraud pass without detection, highlighting how difficult is to make CEOs and Directors
accountable for such fraud and for the ultimate loss of shareholder value. In spite of the apparently
overwhelming evidence of his involvement in the fraud, Richard Scrushy was acquitted, while the former
Teaching suggestions
I start by asking the students what is the nature and purpose of corporate governance – this is about
who controls corporations and why. Then I ask what are the benefits of separation between
management and ownership. Thirdly, I ask about management’s responsibility in taking accounting
decisions, i.e., who in the company is responsible for accounting choices, what should be the
involvement of CEOs and directors in the process of preparing a company’s financial statements, and
what should be an appropriate degree of accounting expertise for CEOs and directors.
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Discussion of important issues
1. What were the major flaws in HealthSouth’s corporate governance?
• Overall weak ethics environment/culture, and low ethical awareness and/or low moral
courage to report problems
2 & 5. What should HealthSouth’s auditors, Ernst & Young, have done if they had perceived these flaws?
What is the auditor’s responsibility in case of fraud?
Auditors should use a systematic approach to identify events or conditions that could be root
causes of a potential fraudulent action. Fraud is difficult to detect because it is generally concealed
3. How – in accounting terms – did the manipulation of HealthSouth’s financial statements take place?
On a quarterly basis, the company’s senior officers presented Scrushy with an analysis of
HealthSouth’s actual earnings compared with the analysts’ expected earnings. At these
meetings, referred as “family meetings”, senior accounting personnel discussed what false
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4. Why did all the people who knew about the irregularities keep quiet?
There was a combination of factors, including: lack of clear communication of wholesome
5. (See #2, above)
6. What are the proper audit procedures to ensure existence of assets in the financial statements?
What are the proper audit procedures to validate estimates?
Physical inspection is the basic audit procedure to ensure existence of assets such as property,
plant and equipment. This procedure may be used together with inspection of other
corroborative evidence, such as invoices or cheques paid to vendors. Auditors must ensure,
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7 & 8.What areas of risk can you identify in HealthSouth’s control environment before 2003? What areas
of risk can you identify in HealthSouth’s strategy before 2002?
• Business risk: An increased business risk gives rise to a higher probability that management
will overstate revenue or conceal losses by using incorrect or inappropriate accounting
9. What changes could be made in HeathSouth’s control system and corporate governance structure
to mitigate the risk of accounting fraud in future years?
In 2005, the company released restated results for the period from 2000 to 2003. HealthSouth
President and CEO, Jay Grinney, estimated that the restatement of the company’s financial
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10. Was Scrushy’s defense ethical?
Scrushy alleged he lacked accounting knowledge to understand the fraud and the implication of
the proposed journal entries. His defence used several potentially unethical tactics to convince a
local court that Scrushy, previously an investment banker, was unaware of the accounting
Useful Articles, Links, and Videos
Weidlich, Thom (April 23, 2010). “UBS to Pay $217 Million to Settle HealthSouth Case.” Bloomberg,
U.S. Securities and Exchange Commission (March 20, 2003). “SEC Charges HealthSouth Corp., CEO
Richard Scrushy with $1.4 Billion Accounting Fraud [Litigation Release].”
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This site provided the Scrushy indictment, trial details, press releases and SEC filings. [Link no
longer valid in 2017.]
This website provides “News about HealthSouth Corporation, including commentary and
archival articles published in The New York Times.” Articles range from 1996 to 2011.
Business & Professional Ethics for Directors, Executives & Accountants, 8e
20. Royal Ahold – A Dutch Company with U.S.-Style Incentives (Chapter 5, pages 343–346)
What this case has to offer
This case is interesting because it ties stock option compensation and accounting irregularities in a
European-based multinational company. Nevertheless, granting management stock options is a
common practice in North American companies and some research suggests it is a good mechanism to
Teaching suggestions
I start the class with a brief discussion about performance-based management compensation, and the
advantages and disadvantages of granting management stock as a way to improve a company’s financial
results.
• Key advantages of stock option compensation:
o Motivates managers to improve financial performance, aligned with the personal gain
derived from exercising stock options over the company’s shares
• Key disadvantages of stock option compensation:
o Motivates managers to produce short-term gains, disregarding long-term results
I then introduce the case, explain the background of the company, and ask the class to identify the risk
elements present before the fraud was uncovered.
I also ask about the two accounting issues, and depending upon the accounting foundations of the
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Discussion of important issues/questions
1. A vendor may offer a customer a rebate of a specified amount of cash or other consideration that is
payable only if the customer completes a specified cumulative level of purchases or remains a
customer for a specified period of time. When should the rebate be recognized as revenue? At what
value should the rebate be recorded as revenue?
Cash consideration received from a vendor is presumed to be a reduction in the prices of the
2. The SEC investigation found the individuals involved in the fraud “aided and abetted the fraud by
signing and sending to the company’s independent auditors confirmation letters that they knew
materially overstated the amounts of promotional allowance income paid or owed to U.S.
Foodservice.” Is the confirmation procedure enough to validate the vendor’s allowance amount in
the financial statements?
No. The confirmation process, if properly controlled by the auditor, can be a useful tool, but
3. The SEC investigation also revealed “a significant portion of U.S. Food Service operating income was
based on vendor payments known as promotional allowances.” How might irregularities have been
discovered through specific external audit procedures?
Interestingly, Ahold’s auditors, Deloitte & Touche insisted that they warned the firm about
problems in its U.S. unit. The auditors also pointed out that Ahold did not supply them with full
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See the answer to question 2. Irregularities may generally be discovered by detailed review of
transactions, particularly when fraud is suspected or the risk is considered high.
4. Royal Ahold made several changes in its corporate governance structure. Discuss how those changes
will mitigate the risk of accounting fraud in future years.
Ahold undertook several corporate governance changes to prevent future accounting
irregularities:
• Rotation of the members of the Board of Directors, paying special attention to
succession issues, targeting improving their overall independence, objectivity and skills
set required to oversee a complex organization;
Related Events
May 22, 2006. Sterling, Toby (Associated Press) (May 23, 2006). “Ex-Ahold executives fined for fraud.”
Toronto Star, page C4.
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personally as a result of the resulting overstatement of profits. The CEO is estimated to have
been worth 43 million euros.
Useful Articles, Links, and Videos
Mui, Yian (November 7, 2006). “Royal Ahold to Sell US Foodservice Unit.” Washington Post,
U.S. Securities and Exchange Commission (Oct. 13, 2004). “SEC Charges Royal Ahold and Three Former
Top Executives with Fraud; Former Audit Committee Member Charged with Causing Violations
Business & Professional Ethics for Directors, Executives & Accountants, 8e
21.The Ethics of Bankruptcy: Jetsgo Corporation (Chapter 5, pages 346–348)
What this case has to offer
This case presents a true story of firm that used deception and lies, called ‘white lies’ by the owner of
Teaching suggestions
Before discussing the details of the case, there should be two general discussions: the first on the nature
of bankruptcy and purpose of bankruptcy laws, and the second on the ethical aspects of lying.
Darwinian economics argues that bankruptcy is a natural event. Firms that cannot effectively compete
Lying is a lapse from moral idealism. Bok (1978) argues that when wrongdoing, such as lying, is excused
(for example, as in “Nobody is getting hurt and I can’t afford to do otherwise”), trivialized with a
euphemism (such as, “Everybody does it. It’s just the way the business world works”) or denied (as in,
“Nobody cares about this anyway”), then it may be an example of succumbing to pressure. The liar
must identify the pressures that are causing the person to be hypocritical. Bok also notes that what the
liar perceives to be harmless, a white lie, may not be so in the eyes of the one who is being deceived.
Discussion of ethical issues
1. For many organizations, bankruptcy protection is just another operational and financial strategy.
Discuss the ethical aspects of intentionally remaining silent, collecting money and then suddenly
announcing that the company is bankrupt?
Bankruptcy protection laws can be abused when solvent firms enter bankruptcy as a cost
effective strategy. The firm may use bankruptcy protection to:
• avoid making legitimate payments,
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Bankruptcy laws are not intended to help firms to entirely avoid their obligations. As such, a key
ethical aspect is to investigate whether all stakeholders are being treated fairly. These aspects
can be addressed by asking the following questions.
• Is the firm using the bankruptcy laws in ways in which they were not intended? Are
2. Do you accept that the little ‘white lie’ told to the pilots was justifiable?
A white lie is often used to protect the feeling of another. Complimenting someone’s hat or
3. Was it operationally wise for Jetsgo to keep the online reservation system open until the company
officially declared bankruptcy? Was it an ethically correct or incorrect decision?
Keeping the on-line reservation system open all day on March 20, when Leblanc knew it would
be permanently closed at midnight that evening was a deception and very unfair to many
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4. Should Leblanc have waited until the busy spring-break holiday period was over to then close down
operations?
Nash (1990) notes that unethical behavior and actions often occur because managers ask the
wrong questions.
model so that lying, deception and subterfuge are not part of the operating strategy of the firm.
Useful Articles, Links, and Videos
Bok, Sissela. 1978. Lying: Moral Choice in Public and Private Life (Random House)
Nash, Laura. 1991. Good Intentions Aside: A Manager’s Guide to Resolving Ethical Problems (Harvard
Business School Press).
“Jetsgo lost $55 million in 8 months, court told.” (March 11, 2005). CBC News,