financial accounting

HealthSouth Summary

Pressures:

1. Need to expand and grow very quickly.

2. Need to increase valuation before going public and after going public to increase profits from stock options.

3. Need to meet analyst expectations to again maintain high stock prices and increase value of stock options.

4. CEO Richard Scrushy’s ego and greed which prevented him from reporting losses.

5. The CEO was narcissistic, extremely self-centered and opportunistic as mentioned by Aaron Beam in the video, everything was always about “him”, this added to the pressure created in the company to constantly report high profits.

6. Vanity spending by CEO at the company’s expense further increased pressure on earnings. E.g. football ticket purchases from Troy University, church donations etc.

Opportunities:

1. Concentration of power and lack of appropriate internal controls which enabled the CEO to blatantly change accounting numbers. This also enabled the top management to collude and hide the fraud.

2. Lack of proper oversight over the CEO and CFO’s actions by the Board of Directors. The BOD comprised of individuals who were either friends and family or who could be easily controlled by Richard Scrushy.

3. Absence of audit Committee and appropriate Internal Audit Function.

4. The CEO carefully hired relatively young individuals or individuals who could be easily controlled to management positions. This was done so that they could be easily manipulated and they would be less likely to blow the whistle on the fraud.

5. The banker at Drexel & Burnam helped to initiate the fraud rather than advising against it.

Rationalization

1. Employees bought into the cult of Richard Scrushy and believed that things would eventually turn for the better.

2. The CFO and other employees believed that HealthSouth was a sound business and wanted to give time to the CEO to turn things around. They feared that blowing the whistle too soon would not only adversely impact the 50,000 employees but also other stakeholders.

How was the fraud hidden?

1. Start-up costs which should have been expensed immediately were capitalized and written off over 4-5 years

2. In the healthcare industry there is a significant difference between revenues billed to insurance providers and revenues actually realized from insurance providers. The healthcare providers factor in this difference and appropriately make provisions for the uncollectible portion and report net revenues. HealthSouth was making very low provisions for the uncollectible revenues to inflate their earnings and net profits.

3. Fictitious revenue entries across several general ledger accounts were created against inventory and accounts receivables to inflate earnings and net profits.

Applicable Fraud Framework:

1. Fraud Triangle

2. MICE. The company had a good business model and would have succeeded if the CEO had not been greedy and corrupt. The pressures were self-created.

(Please introspect on how these frameworks are applicable to this fraud)