Numerous scandals have surfaced both in the private sector as well as the public sector. The basic underlying factor is that they happen in the eyes of auditors and other overseers charged with the responsibility of ensuring integrity in the accounting procedures. Cunning manager liaise with crafty accountants to produce fictitious financial statements which when put under the normal public eye, appear flawless and help the perpetrators embezzle funds at the institution or post favorable results to cheat the public. Attempts to use the normal audit procedures to unearth the well thought-out and planned schemes are ineffective. This paper discusses the concept of forensic accounting and analyses the case of Healthsouth healthcare providers in the light of the use of forensic accounting to unravel and prosecute the case.
Forensic accounting is a form of accounting or auditing biased towards acceptability in court. The term ‘forensic’ means ‘usable in court’. Forensic accounting combines investigative skills with accounting and auditing skills to bring out evidence of fraud that is admissible in a court of law. While normal accounting focuses on the numbers, forensic accounting looks behind the numbers. It incorporates ideas of business realities in judging the authenticity of some critical transactions. It incorporates litigation support as well as investigative accounting. Critical areas of application are in fraud detection, claims analysis, damage computation and expert witness testimony (Larry, 2003, Par 3-6).
The scandal involving Healthsouth accounting amazed the Americans. The institution is one of the largest healthcare providers focusing on rehabilitation services. It has over 1900 health facilities in the US, Australia, Canada and Puerto Rico. It offers in-patient and out-patient rehab services as well as surgery. The number of hospitals worldwide stands at 330. HealthSouth’s stock trades on the New York Stock Exchange (NYSE). On June 8, 2009 the closing price was $12.76 meaning that the company has a market capitalization of about $1.1 billion (Leonard, Peter, & Lorraine, 2009, Par4).
In the year there were findings that the company had consistently overstated its income since 1986. The then chief executive Richard Scrushy was charged with fraud. As the company rose, Scrushy had become one of the highest paid CEO’s in the US earning $8.5 million in salary, $23 million in bonuses, $4.8 million in stock option awards and $700000 in compensations. His shareholding value rose to over $287 million. In May, 2002, Scrushy sold some $75 million worth of shares and another $25 million in June. In the year 2002, the CEO was strongly advised to tackle the issue of the massive overvaluations accumulated over the years. Later he sought to use an illegal method to correct an existing illegality. He stated that the changes instituted in Medicare could lower reimbursements, a statement which caused a more than half fall in the share prices with allegations that the CEO used applied insider information in selling the stocks (HealthSouth press release, 2003, Par 4).
The Security Exchange Commission had to institute a civil case against the company. Preliminary findings of forensic investigations showed that the company had been inflating revenues and incomes. The intention of overstating the incomes was to increase stock earnings. The Practice is said to have started just after the company went public but the table below shows some intentional misstatements between year 1999 and 2002 (Department of Justice, 2003).
Income (Loss) before Income Taxes and Minority Interests (in $ millions)
As can be seen, the accountants deliberately increased profits from a loss of $191 millions to $230 in the year 1999. In the year 2000 a profit of $194 million was increased to $559 million. For year a paltry $9 million profit was hiked to $434 million. These are very significant alterations which under normal circumstances would not pass the auditors eye but it did. This continued to happen even after an employee wrote to the auditors indicating areas which could have problems.
HealthSouth’s 1999 provision for doubtful accounts was completely incomparable to other years’ bad-debt expense. A complete lack of consistency existed in terms of annual write-offs for uncollectible receivables. This indicated that HealthSouth used bad-debt reserves to manipulate earnings
Scrushy led the group named ‘the family’ within the company to fix accounts to meet expectations. The group regularly held meetings to find ways of inflating quarterly earnings and making adjustments. They utilized their knowledge of the Generally Acceptable Accounting System applicable in the US. A critical requirement is that any increase in earnings must be in tandem with increases in net assets for the balance sheet to balance and the stock values to go up.
In this case, the company increased earnings and at the same time overstated the value of assets while understating liabilities. In doing this, the accountants used some selected accounts which offered leeway for easier manipulation.
One way commonly used was by reducing the contractual adjustment account. This account estimates the difference between the amount billed to patients and that paid by the insurers. Due to the fact that the account is an estimate, it was difficult to verify the truth in the numbers presented. Statements to give credit to estimates were used.
In trying to balance the balance sheet, the accountants falsified assets and liabilities. The fixed assets accounts were mostly used with the Plant, Property and Equipment (PP&E) account being the most inflated. Thousands of phony assets were invented to feed the PP&E. Accounts marked as ‘AP summary’ and recorded with different values as well as below the thresholds used by auditors in determining which accounts to investigate. To ensure the additions were not detected, they kept them within reasonable thresholds. They also faked relevant documents such as invoices and inflated inventory accounts at the many facilities by different values hence making it difficult for auditors to establish trends in the accounts (Corporate Narc, n. d, Par 2-5).
The result was that the PP&E account had been inflated by $1Billion while the total assets were inflated by $1.5 Billion.
The entire fraud was well planned and executed taking adequate care to cover up all the loopholes. The normal audits conducted by Ernst & Young over years had failed to capture the fraud.
Engaging forensic audits enabled the discovery of the fraud. The statements issued regarding the effect of the changes in Medicare were not just that for the forensic auditors. They meant that the company was attempting to over emphasis the effects to justify drops in share prices. The forensic auditors identified the unjustified increase in assets because they understood the need to ensure the balance sheet was balanced. It is with these understanding that the forensic accountants were able to unravel the plot. They were also keen on the contractual agreement accounts as they are prone to manipulation. In forensic auditing motive is very crucial (Freeman, 2008, Par 5).
Forensic accounting therefore looks at the financial transaction with suspicion especially in cases where the environment is enticing towards lies. It looks at the transaction in the context of the applicable accounting system and more importantly, the legal framework allowing suitability of to establish valuation. Despite the fact that Richard was acquitted, his successor pleaded guilty to the fraud case in the understanding that the forensic audit was able to unravel the truth and more importantly the evidence collected and prepared by forensic experts was admissible in the courts. Other officers were also jailed for different periods depending on their roles in perpetrating the fraud. A critical lesson learnt from the case was that users of financial statements must be very diligent in examining all components of the financial statements and their relationships to each other. This should have been the catch for the firm.
Therefore the practice of forensic accounting is crucial in unraveling high profile fraud that has been ingeniously concealed to escape the normal auditor’s eye. An understanding of the legal aspects of transactions is important just like the business environment is. At the same time, auditors should strive to dig deeper into statements in a bid to reduce such cases. Ernst and Young, the auditing company was not thorough with the audits.
Reference List
Corporate Narc, (n. d). Richard Scrushy HealthSouth Corporation Scandal. Web.
Department of Justice (2003). Healthsouth Founder And Former CEO Richard Scrushy Charged In $2.7 Billion Accounting Fraud Conspiracy. Web.
Forensic Accounting, (n. d). Forensic Accounting Demystified. Web.
Freeman, S., (2008). How Forensic Accounting Works.
HowStuffWorks.com. Web.
HealthSouth press release, ( 2003). Web.
Larry, C., (2003). What Is Forensic Accounting? Journal of Forensic Accounting. Web.
Leonard, G., Peter, M., & Lorraine, M., (2009). Anatomy of a Financial Fraud. A
Forensic Examination of HealthSouth. 2009. Web.