Accounting Fraud 101

Published Sep 10, 2004

One of the most famous accounting frauds ever perpetrated in the US is the Salad Oil Caper, which, surprisingly enough, has nothing to do with small, green berries. The story behind the caper is this: back in the ’60s, an Italian American-owned firm in Chicago looked to the then-well respected accountancy of Arthur Andersen to value and underwrite bonds that would be issued, backed by the 1.8 billion pounds of salad oil posessed by this firm. The Andersen auditors dropped by the storage facilities to confirm that the firm did, in fact, have said 1.8 billion pounds of salad oil. These auditors, in crisp white shirts and pressed suits, didn’t want to get covered with salad oil, so they just climbed a ladder to the top of the giant vats of salad oil, opened a hatch, stuck their fingers in, and determined that yes, Virginia, there was salad oil in there. The gigantic bond issue was approved and underwritten, and the bonds (certified to be particularly low-risk) were extensively purchased by widows and orphans. Whereupon it was discovered that the gigantic vats of salad oil were actually filled with water, on top of which the oil floated; and, as the Andersen auditor had traveled from one vat to the next, a complicated system of pipes had pumped a relatively small amount of oil from one vat to the next. The bonds were worthless, people were pushed into penury, and the world learned a lesson about asset valuation!

Another famous accounting fraud was carried out by a hard disk drive maker in the lat ’80s. The entire industry had fallen on hard times and one manufacturer after another was losing money. One company was taken over by the VC firm that had financed it and a new, whip-cracking boss was put in charge. This boss became famous for having big all-hands meetings at which individuals were singled out, asked about their sales performance relative to their targets, and, if they fell short, fired on the spot. This created a climate of fear, so the CFO hatched a devious plan. Sales staff had put up good numbers, but production was lagging; already-made sales would be lost because the hard drives to fulfill those sales hadn’t been made yet. But if the sales were lost, then people, probably including the CFO, would be fired! Shipments absoloutely had to be made to the purcharsers in the current year. The solution: the CFO drove to the hardware store, bought a pallet of bricks (the red kind, that you use to make buildings — about the same size and weight as a hard drive, at the time), and brought them down to shipping. Into each hard drive box went a bridk and a certificate that entitled the bearer to redeem the brick for a hard drive, when one was available. The brick-filled boxes were shipped, and the revenue from sales duly booked. The company made its target, and nobody was fired, of course until all the customers noticed that they had bricks and not hard drives and then people went to prison.

It’s all true. Every word. I swear.

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