Phar-Mor: Case Study
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The major groups that were directly affected are investors, employees, and suppliers. Here we should make the distinction between different types of investors. There are two major types of investors: insiders and outside investors. Insiders are the investors who know the information that is not known publicly and may benefit them in some way. Outside investors are the investors who only know publicly known information. In our case, outside investors was the group that lost the most. On the other hand, insiders, notably Mickey Monus and David Shapiro, were the one that gains millions on IPO. The group who suffered was employees of Phar-Mor. After the scandal was revealed, most of the stores were closed to cover up losses. As a result, thousands of employees got fired. Another party that was damaged by the scandal was Coopers&Lybrant, the firm that did the audit for Phar-Mor, lost its reputation as a firm who does an audit with integrity. The secondary effect of the scandal was the overall mistrust among investors. They thought that if a giant retailer can forge its accounting books, why smaller companies wouldn’t do the same. As a result, investors became reluctant in investing into businesses that caused harm to the economy as a whole. The last but not least group that was affected by the scandal is Phar-Mor’s suppliers. Mickey Monus was fiercely fighting with them to make the chipset deals to cover up his losses, sometimes using inappropriate pressure and causing suppliers making unprofitable deals. In additions, Monus forced them to pay fees and sponsor his basketball League using buyer power of his company. In addition, a lot of bills for supplies were unpaid for months by Phar-Mor. Some suppliers said that they hated doing business with Phar-Mor, but had no choice since it had an access to vast amount of customers.
Who was in charge of a $500 million accounting fraud? Primarily, Mickey Monus, Patt Finn and senior management were the most involved participants of the fraud. It is quite rare that the whole management group is the part of the fraud. In case of Phar-Mor, this happened because of the personality of Mickey Monus. Mickey Monus with his gambling spirit and persuasive skills was able to assure everyone that what they are doing can be easily corrected, but they need some time to do it. In this story psychological factor played one of the major roles. People really believed that they can fix everything in a matter of months. In addition, they were afraid to argue with Monus fearing they will lose their jobs or, as Stan Cherinstein said, be “physically harmed”. It is hard to surely say why Mickey Monus didn’t stop. Probably, he was too confident in himself. He thought that he can do everything because he founded Phar-Mor, or he didn’t realize how much harm his actions can cause.
In order to compete with Wal-Mart and other major discount-retailers, Phar-Mor cut its prices so low that the stores wouldn’t make profit anymore. When Mickey Monus found out about this news, instead of revealing his losses, he decided to use “creative accounting” to buy some time. The fraud was revealed by one of the investors who happened to be the owner of a travel agency that got a check from Phar-Mor for services that were not related to the course of the Phar-Mor’s business. Later on, auditors found out that Mickey Monus was using company’s money to pay for his Basketball League, his house, engagement rings etc.
So, how was this fraud possible and where were the auditors? As in the case with Enron, auditors didn’t do their jobs. In this case, the auditing company was Coopers&Lybrant. In order to realize the fraud, Mickey Monus and other had to put all their losses into expense accounts and come up with the way of boosting their asset accounts. They came up with an idea of inflating inventory. This wouldn’t be possible to do if Coopers&Lybrant wouldn’t do their job negligently. As video states, they were the lowest bid on Phar-Mor’s case, so they didn’t want to spend too much money on their audit. As a result, they checks only 4 stores out of 129. Moreover, they told Phar-Mor’s management in advance which stores will be checked.
So, using diagrams, this is what happened:
I. Inflation of Inventory:
What happened: Millions of dollars in losses were split among the 129 stores and put as an expense on each stores balance sheet ->. In order to balance the expenses, management had to boost its assets by inflating inventory -> The auditor Coopers&Lybrant checked only 4 stores out of 129 in order to safe their money. In addition, they told senior management which stores they will check -> Phar-Mor prepared the inventory in accordance with its balance sheet -> The auditing firm was unable to uncover the fraud.
The proper way: Coopers&Lybrant should have checked more stores and not tell the management in advance which one they would check. -> According to Inventory counting procedures listed in chapter 6, the counting should have been done by employees who do not have responsibility for the inventory -> there should be a second count by another employee -> Inventory tags should be used and all tags should be accounted for -> Supervisor should check that all the inventory items are tagged or scanned and that no items have been double-counted -> after physical inventory is taken, the quantity of each kind of inventory should be listed on inventory summary sheets.
Another failure of detecting fraud belongs to the system of internal control that should have checked the payees that were getting companies money.
II. System of Internal Control for writing checks:
What happened: Expense checks were written out not to pay for transactions that didn’t belong to the ordinary course of Phar-Mor’s business including trips to Vegas, funding the Basketball League etc. -> This created serious problems with cash flow and eventually became a cause for fraud uncover
The proper way: In accordance with the Purchase on Account diagram, the System of Internal Control must: receive invoice -> have authorization to order from senior management -> purchase order -> have purchase order approved and signed -> receive goods -> check the order is correct with proper amount and goods -> this then moves to the accounting department to overview the invoice -> match with approved purchase order -> have confirmation the order was received -> write expenses check to pay for goods.
There have always been leaders and followers in a company. Sometimes, leaders tend to make unpopular and even illegal decisions. Sometimes the power of leader is so strong that followers can’t resist and go along with him/her. That’s why it’s so important to have a will to stop these actions from the very beginning since it would be extremely hard to do so later. Therefore, the question of integrity among managers as well as Auditing firms should be the top priority. That’s why it’s so important to force businesses to go along with the acts such as Foreign Corrupt Practices Act (FCPA) of 1977 and Sarbanes Oxley Act (SOX) of 2002. With effective System of Internal Control, properly working Auditing Firms and ethical management it is possible to build environment where investors can trust financial information that’s been published. Taking into account Enron Case and current sub-Prime Mortgage Crisis it’s clear that financial and auditing integrity is still a vital question that is difficult to solve. Nevertheless, with help of governmental policies and company’s integrity it’s still possible to do. The most important thing to remember is that money is not the most important thing in this world.