Dana Turet

AIM 6201
9/28/10

Homework Assignment #3
Miniscribe

1. List accounting practices that were used to fabricate the numbers in the financial statements

• In order to inflate sales revenue, Miniscribe falsely recognized sales by shipping more inventory
than had been ordered by distributors and reporting them as sales.

• The company also recognized freight shipments of inventory from Singapore prematurely, did
not recognize the loss of sales from returned and defective merchandise, and booked shipments to
company-owned warehouses as sales when the inventory had not been ordered or purchased by
customers.

• Some company officials even went to the lengths of shipping bricks to distributors and
recording them as sales, and then when the shipments were returned they added the amounts to
their inventory.

All of these practices had the effect of falsely inflating their sales revenue on their income
statements.

• To falsely boost their inventory levels and therefore assets on their balance sheet, Miniscribe
gathered obsolete parts and scrap and valued them as workable inventory (valued at $3.5 million).

• Miniscribe announced its earnings before their auditing firm had made adjustments that reduced
their income, and then created additional adjustments to offset the auditors’ findings.

• Additionally, some company officials were accused of even breaking into auditors’ workpapers
and changing inventory values.

2. Comment on internal accounting control of Miniscribe, specifically the reasons for its
ineffectiveness in preventing fraudulent financial reports.

The company had very poor internal accounting control, due largely to the organizational
restructuring implemented by CEO Q.T. Wiles. He broke the company up into separate divisions
that each had its own staff and managers who were in charge of setting their own budgets, sales
quotas, incentives and work rules. Despite his claim that the restructuring was to create
accountability, this created many opportunities for poor checks and balances within the company.

More specifically, the Miniscribe’s internal controls most likely failed to uphold the following
guidelines:
They did not have reliable personnel to begin with – when officials and managers were faced with
extreme pressure to reach sales quotas, many succumbed to deceitful practices in order to
maintain the appearance of success. The various divisions likely did not adhere to proper
authorization policies, procedures or documentation in order to hold their financial reports
accountable. Finally, their reviews by outside auditors were obviously not up to adequate
standards, as made evident by the liability charged to Coopers & Lybrand.
3. To what extent are each of these parties responsible for the fraudulent reports i) the CEO, ii)
the independent accountants and iii) the board of directors?

i) Miniscribe CEO, Q.T. Wylie was largely responsible for the fraudulent reports, due
to the fact that his executive management tactics likely dictated the majority of the
resulting fraudulent behavior of his company officers. His relentless focus on
reporting profits and hitting sales quotas pressured managers to falsely report
numbers. Additionally, he failed from a managerial standpoint to maintain internal
control of his company’s accounting reports, and did not question the unrealistic and
suspicious numbers being reported. His penalty of just over $6 million dollars seems
light compared to the amount of deception and fraud that he allowed to take place
within the company under his management.
ii) Miniscribe’s independent accountants, Cooper & Lybrand failed in their
responsibility to detect and report any red flags or suspicious accounting practices
within the company. As an outside, neutral party, and especially an accounting firm,
they had no valid excuse for not uncovering most of the fraudulent actions of the
company. Their responsibility was to examine Miniscribe’s financial statements and
internal control structure, and to provide adequate tests of accounting procedures and
records. Based on the gross deceptions and erroneous financial statements provided, I
would say that Cooper & Lybrand failed in their responsibility to the company. For
that reason, I think their penalty of $95 million dollars is a fair amount of liability.
iii) The board of directors is also liable for the fraud committed because they are
responsible for not only recommending the independent auditing firm used by the
company (clearly a poor choice in this case), but also to provide a measure of checks
and balances for the internal management’s accounting practices, internal control
structure and financial reports. The fact that they failed to detect or report any of the
red flags and suspicious financials being reported shows a failure to uphold their
responsibility to the company and its shareholders.

4. Based on the stock price behavior before and after the disclosure of fraud, comment on the
importance of accurate financial statements in valuing a firm.

The stock value of Miniscribe dropped from a high of $15 per share to only $3 per share after the
discovery of fraud. Investors clearly felt they had been cheated and lied to about the sales and
overall profitability and value of the company, causing them to assess the company as a huge risk
and unreliable investment – basically, the company could no longer be trusted. Having accurate
financial statements plays a significant role to investors in valuing a company, as this is how
financial analysts determine how the company compares in regards to the industry and worth of
the company.