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Zzzz Best

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Submitted By tracychiu
Words 3056
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Case 4-6
ZZZZ Best*

The story of ZZZZ Best is one of greed and audaciousness. It is the story of a 15-year old boy from Reseda, California who was driven to be successful regardless of the costs. His name is Barry Minkow. Minkow had high hopes to make it big – to be a millionaire very early in life. He started a carpet cleaning business in the garage of his home. Minkow realized early on that he was not going to become a millionaire cleaning other people’s carpets. He had bigger plans than that. Minkow was going to make it big in the insurance restoration business. In other words, ZZZZ Best would contract to do carpet and drapery cleaning jobs after a fire or flood. Since the damage from the fire or flood probably would be covered by insurance, the customer would be eager to have the work done. The only problem with Minkow’s insurance restoration idea was that it was all a fiction. There were no insurance restoration jobs, at least for ZZZZ Best. In the process of creating the fraud, Minkow was able to dupe the auditors, Ernst & Whinney into thinking the insurance restoration business was real. In fact, over 80 percent of his revenue was allegedly from this work. The auditors never caught on until it was too late.
How Barry Became a Fraudster Minkow wrote a book, Clean Sweep: A Story of Compromise, Corruption, Collapse, and Comeback** that provides some insights into the mind of a 15-year old kid
__________________
* The facts are derived from a video by the ACFE, Cooking the Books: What Every Accountant Should Know about Fraud.
**Barry Minkow, Clean Sweep: A Story of Compromise, Corruption, Collapse, and Comeback (Nashville, TN: Thomas Nelson, 1995). who was called a “wonder boy” on Wall Street until the bubble burst. He was trying to find a way to drum up customers for his fledgling carpet cleaning business. One day, while he was alone in the garage-office, Minkow called Channel 4 in Los Angeles. He disguised his voice to sound not like a teenager and told a producer that he had just had his carpets cleaned by the 16-year owner of ZZZZ Best and was very impressed that a high school junior was running his own business. He sold the producer on the idea that it would be good for society to hear the success story about a high school junior running his own business. The producer bought it lock, stock and carpet cleaner. Minkow gave the producer the phone number of ZZZZ Best and waited. It took less than five minutes for the call to come in. Minkow answered the phone and when the producer asked to speak with Mr. Barry Minkow, Minkow said: “Who may I say is calling?” Within days a film crew was in his garage shooting ZZZZ Best at work. The story aired that night and it was followed by more calls from radio stations and other television shows wanting to do interviews. People called demanding that Barry Minkow personally clean their carpets. As his income increased in the spring of 1983, Minkow found it increasingly difficult to run the company without a checking account. He managed to find a banker that was so moved by his story that the banker would agree to allow someone under-aged to open a checking account. Minkow used the money to buy cleaning supplies and other necessities. Even though his business was growing, Minkow ran into trouble paying back loans and interest when due. Minkow developed a plan of action. He was tired of worrying about not having enough money. He went to his garage – where all his great ideas first began – and he looked at his bank account statement which showed that he had more money than he thought he had based on his own records. Minkow soon realized it was because some checks he had written had not been cashed by customers so it didn’t yet shown up on the bank statement. Voila! Minkow started to kite checks between two or more banks. He would write a check on one ZZZZ Best account and deposit it into another. Since it might take a few days for the check written on bank number one to clear that banks’ records, at least back then when checks weren’t always processed in real time, Minkow could pay some bills out of the second account and the first bank would not know – at least for a few days – that Minkow had written a check on his account when, in reality, he had a negative balance. The bank didn’t know it because some of the checks that Minkow had written before the visit to bank number two had not cleared his account in bank number one. It wasn’t long thereafter that Minkow realized he could kite checks big-time. Not only that, he could make the transfer of funds at the end of a month or a year and show a higher balance than really existed in bank number one and carry it on to the balance sheet. Since Minkow did not count the check written on his account in bank one as an outstanding check, he was able to double-count.
Time to Expand the Fraud Over time, Minkow moved on to bigger and bigger frauds like having his trusted cohorts confirm to banks and other interested parties that ZZZZ Best was doing insurance restoration jobs. Minkow used the phony jobs and phony revenue to convince bankers to make loans to ZZZZ Best. He had cash remittance forms made up from non-existent customers with whatever sales amount he wanted to appear on the document. He even had a co-conspirator write on the bogus remittance form, “job well done.” Minkow could then show a lot more revenue that he was really making. Minkow’s phony financial statements enabled him to borrow more and more money and expand the number of carpet cleaning outlets. However, Minkow’s personal tastes had become increasingly more expensive including purchasing a Ferrari with the borrowed funds and putting a down payment on a 5,000-square foot home. So, the question was: How do you solve a perpetual cash flow problem? You go public! That’s right, Minkow made a public offering of stock in ZZZZ Best. Of course he owned a majority of the stock to maintain control of the company.
Minkow had made it to the big leagues. He was on Wall Street. He had investment bankers, CPAs and attorneys all working for him -- the 15-year old kid from Reseda who had turned a mom and pop operation into a publicly-owned corporation.
Barry Goes Public Minkow’s first audit was for the twelve months ended April 30, 1986. A sole practitioner performed the audit. (There are eerie similarities in the Madoff fraud with its small practitioner firm – Frichling & Horowita – conducting the audit of a multi-billion dollar operation and that of the sole practitioner audit of ZZZZ Best). Minkow had established two phony front companies that allegedly placed insurance restoration jobs for ZZZZ Best. He had one of his cohorts make out invoices for services and respond to questions about the company. There was enough paperwork to fool the auditor into thinking the jobs were real and the revenue was supportable. However, the auditor never visited any of the insurance restoration sites. If he had done so, there would have been no question in his mind that ZZZZ Best was a big fraud. Pressured to get a big-time CPA firm to do his audit as he moved into the big leagues, Minkow hired Ernst &Whinney to perform the April 30, 1987 fiscal year-end audit. Minkow continued to be one step ahead of the auditors. That is until the Ernst & Whinney auditors insisted on going to see an insurance restoration site. They wanted to confirm that all the business – all the revenues --- that Minkow had said was coming in to ZZZZ Best, was real.
The engagement partner drove to an area in Sacramento, California where Minkow did a lot of work – supposedly. He looked for a building that seemed to be a restoration job. Why he did that isn’t clear but he identified a building that seemed to be the kind that would be a restoration job in process.
Earlier in the week, Minkow sent one of his cohorts to find a large building in Sacramento that appeared to be a restoration site. As luck would have it, Minkow’s associate picked out the same site as had the partner later on. Minkow’s cohorts found the leasing agent for the building. They convinced the agent to give them the keys so that they could show the building to some potential tenants over the weekend. Minkow’s helpers went up to the site before the arrival of the partner and placed placards on the walls that indicated ZZZZ Best was the contractor for the building restoration. In fact, the building was not fully constructed at the time but it looked as if some restoration work would have been going on at the site. Minkow was able to pull it off in part due to luck and in part because the Ernst and Whinney auditors did not want to lose the ZZZZ Best account. It had become a large revenue producer for the firm and Minkow seemed destined for greater and greater achievements. Minkow was smart and he used the leverage of the auditors not wanting to lose the ZZZZ Best account as a way to complain whenever they became too curious about the insurance restoration jobs. He would even threaten to take his business away from Ernst and Whinney and give it to other auditors. Minkow also took a precaution with the site visit. He had the auditors sign a confidentiality agreement that they would not make any follow-up calls to any contractors, insurance companies, the building owner, or other individuals involved in the restoration work. This prevented the auditors from corroborating the insurance restoration contracts with independent third parties.
The Fraud Starts to Unravel It was a Los Angeles housewife that started the problems for ZZZZ Best that would eventually lead to the demise of the company. Since Minkow was a well known figure and flamboyant character, the Los Angeles Times did an expose about the carpet cleaning business. The Los Angeles housewife read the story about Minkow and recalled that ZZZZ Best had overcharged her for services in the early years by increasing the amount of the credit card charge for carpet cleaning services.
Minkow had gambled that most people don’t check their monthly statements so he could get away with the petty fraud. However, the housewife did notice the overcharge, complained to Minkow, and eventually he returned the overpayment. She couldn’t understand why Minkow would have had to resort to such low levels back then if he was as successful as the L.A. Times article made him out to be. So, she called the reporter to find out more and that ultimately led to the investigation of ZZZZ Best and future stories that weren’t so flattering.
Since Minkow continued to spend lavishly on himself and his possessions, he always seemed to need more and more money. It got so bad over time that he was to close to defaulting on loans and had to make up stories to keep the creditors at bay, and he couldn’t pay his suppliers. The complaints kept coming in and eventually the house of cards that was ZZZZ Best came crashing down.
During the time that the fraud was unraveling, Ernst and Whinney decided to resign from the ZZZZ best audit. The firm never did issue an audit report. It had started to doubt the veracity of Minkow and the reality of business at ZZZZ Best.
The procedure to follow when a change of auditor occurs is for the company to file an 8-K form with the SEC and the audit firms prepares an exhibit commenting on the accuracy of the disclosures in the 8-K. The exhibit is attached to the form that is sent to the SEC within 30 days of the change. Ernst & Whinney waited the full 30-day period and the SEC released the information to the public 45 days after the change had occurred. Meanwhile, ZZZZ Best had filed for bankruptcy. During the period of time that had elapsed, Minkow had borrowed more than $1 million dollars and the lenders never were repaid. The Bankruptcy laws protected Minkow and ZZZZ Best from having to make those payments.
Legal Liability Issues The ZZZZ Best fraud was one of the largest of its time. ZZZZ Best reportedly settled a shareholder class action lawsuit for $35 million. Ernst & Whinney was sued by a bank that had made a multimillion-dollar loan based on the financial statements for the three-month period ending July 31, 1986. The bank claimed that it had relied on the review report issued by Ernst & Whinney in granting the loan to ZZZZ Best. However, the firm had indicated in its review report that it was not issuing an opinion on the ZZZZ Best financial statements. The judge ruled that the bank was not justified in relying on the review report since Ernst & Whinney had expressly disclaimed issuing any opinion on the statements. Barry Minkow was charged with engaging in a $100 million fraud scheme. He was sentenced to a term of 25 years. Minkow was paroled after serving eight years in jail. During his time in prison, Minkow became involved in Christian ministry, which continued after his probationary release from prison in April 1995. Today he is senior pastor of the Community Bible Church in San Diego, California, having renounced his felonious acts. Minkow is recognized as an expert on fraud, and speaks on the subject to university students and the business community in an effort to prevent fraud.

Questions 1. Do you believe that auditors should be held liable for failing to discover fraud in situations such as ZZZZ Best where top management goes to great lengths to fool the auditors? Why or why not?
Auditors should be held liable for failing to discover material fraud. There were many red flags that the auditors could have observed and been tipped off to the fraud. The amount and type of restoration work by ZZZZ Best defiled common sense. The auditors could have done a reasonableness test by determining the amount of square footage under restoration in the area; the newspapers coverage of the occurrences; and how much market share ZZZZ Best of the work. Also all the water damages on the restoration contracts were on top floors but not any damages on the lower floors. The auditors should have been liable for signing a confidentiality agreement that was a limitation of scope.

2. The AICPA Code obligates CPAs to follow specific standards of conduct in conducting audits. Answer the following questions with respect to those standards and the related ethical expectations. (a) Why is it important to exercise sensitive moral judgments when conducting an audit? Did Ernst & Whinney meet its obligations in this regard? If not, describe why it failed to meet its obligations.
Ernst & Whinney had an obligation to be independent, objective and with due care. Objectivity requires that an auditor should be skeptical and obtain independent evidence to verify information from the client. Ernst & Whinney failed to meet this obligation when they did not require corroboration of the insurance restoration contracts from independent third parties. When Ernst & Whinney resigned from the audit engagement, they had a professional obligation to disclose the reason for the withdrawal.

(b) What are the criteria for audit independence? Comment on the independence of Ernst & Whinney in conducting its audit of ZZZZ Best.
Independence means protecting the integrity of the audit, maintaining objectivity and avoiding any subordination of judgment. Ernst & Whinney were eager to keep the ZZZZ Best account; Minkow used the leverage of threatening to take his business away to keep Ernst & Whinney from being too curious about the restoration jobs. Ernst & Whinney bought into Minkow’s hype and celebrity status and lost their skepticism.

(b) Auditors are expected to exercise due care in the performance of professional services. Explain the purpose of the due care standard. Based on the facts of the case, do you think Ernst & Whinney met their due care obligations? Why or why not?
Due care requires that an auditor discharges professional responsibilities with competence and diligence. It imposes the obligation to perform professional services to the best of the auditor’s ability with concern for the best interest of the public. The sole proprietor-auditor and Ernst & Whinney did not gather enough evidence on the restoration contracts, nor viewed the evidence gathered with skepticism.

3. These are selected numbers from the financial statements of ZZZZ Best for fiscal years 1985 and 1986: 1985 1986
Sales $1,240,524 $4,845,347
Cost of goods sold 576,694 2,050,779
Accounts receivable 0 693,773
Cash 30,321 87,014
Current liabilities 2,930 1,768,435
Notes payable-current 0 780,507 What calculations or financial analyses would you make with these numbers that might help you assess whether the financial relationships are “reasonable?” Given the facts of the case, what inquiries might you make of management based on your analysis?
Between 1985 and 1986 there is a 390% increase in Revenue and 350% increase in Cost of goods sold. The auditors should question the increase in accounts receivable, which was 33% of sales and represents four months on an annualized basis. The auditors should question where the cash is from the collection of sales (Sales of $4,845 less A/R of $693 less Cost of goods sold of $2,050). The company should have approximately $2 million to pay down liabilities or invest in assets. With the cash flow with borrowings of current liabilities and notes payable, the company had approximately $6.5 million before paying cost of goods sold or approximately $4.5 to pay down liabilities or invest in the company, yet cash only increased $50,000 for the year. Where was the cash used?

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...CASE 1.9 ZZZZ Best Company, \nc. On May 19,1987, a short article in The Wall Street Journal reported that ZZZZ Best Company, Inc., of Reseda, California, had signed a contract for a $13.8 million insurance restoration project. This project was just the most recent of a series of large restoration jobs obtained by ZZZZ Best (pronounced "zee best"). Located in the San Fernando Valley of southern California, ZZZZ Best had begun operations in the fall of 1982 as a small, door-ta-door carpet cleaning operation. Under the direction of Barry Minkow, the extroverted 16-year-old who founded the company and initially operated it out of his parents' garage, ZZZZ Best experienced explosive growth in both revenues and profits during the first several years of its existence. In the three-year period from 1984 to 1987, the company's net income surged from less than $200,000 to more than $5 million on revenues of $50 million. When 72ZZ Best went public in 1986,Minkow and several of his close associates became multimillionaires overnight. By the late spring of 1987,the market value of Minkow's stock in the company exceeded $100 million, while the total market value of 72ZZ Best surpassed $200 million. The youngest chief executive officer in the nation enjoyed the "good life;which included an elegant home in an exclusive suburb of Los Angeles and a fire-engine red Ferrari. Minkow's charm and entrepreneurial genius made him a sought-after commodity on the television talk show circuit and......

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Zzzz Best Company

...Transcript of ZZZZ Best Company, Inc ZZZZ Best Company, Inc Case 1.9 Audit Review VS Full Audit Review • The accountant is not aware of any misstatements or material modifications that need to be made • Limited assurance • Auditor has no opinion on the financial statements, just looks them over Barry Minkow- 16 years old 1982 Carpet cleaning business turned insurance restoration Tom Padgett and Interstate Appraisal Services Ernst & Whinney- elaborate scheme to convince them History 1. Client imposed audit limitations 2. Limitations of audit evidence 3. Importance of auditor communication when one resigns & 8K filing Key Issues Audit- • Auditor obtains a high level of assurance • Auditor can express an opinion about the accuracy and level of assurance • Auditor tests internal controls and tests for misstatements and obtains and understanding of the entities internal control and fraud risk Matt Sepiol Samantha Claysen Limitations of Audit Evidence AU 326- Audit Evidence Auditors Used Confirmation, Documentation, and Analytical Procedures AU 326.08- Information from outside sources is better than from internal sources Confirmations were made by Tom Padgett who was involved in the scheme. Interstate Appraisal Services and Assured Property Management provided the Documentation Was Involved in Fraud Collusion amongst outside Parties Gives Evidence Limitations The client receiving payment doesn't prove the existence of those contracts. No......

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Zzzz Best Company

...ZZZZ Best company Inc. Summary “ZZZZ Best company” was founded by 16-year old Barry Minkow. The core activity of company was carpet cleaning. As he began doing business, Minkow soon realized that carpet cleaning was a difficult way to earn money because customers always complained and vendors demanded payments. Soon Minkow started seeking for financing but realized that bank were not willing to lend him money due to his age and low profitability of his business. That’s why he came up with the idea of forgeries and thefts from his insurance company. Later on, making friends he asked the insurance claim adjuster - Tom Padgett to confirm from time to time that Minkow’s company received occasional insurance restoration contracts on remodeling works on properties damaged by fire, storms and other catastrophes. Soon he realized that there was no need in development of carpet business because the main “income” was obtained by restoration operations. Then, Minkow decided to go public and for that purpose he hired independent auditor – George Greenspan. By that time Minkow had established fake insurance company and Padgett had got the top position in it to confirm fraudulent restoration contracts, so Greenspan didn’t notice any problems with those sites. By the end of the year he was dismissed and Minkow retained “Ernst & Whinney” to enhance creditability of his operations on restoration contracts. “Ernst & Whinney” agreed to provide 4 types of services to “ZZZZ best......

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Zzzz Best Company

...mengeluarkan opini audit atas laporan keuangan Best ZZZZ tetapi mengeluarkan laporan review terhadap laporan kuartalan perusahaan untuk tiga bulan yang berakhir 31 Juli 1986. Bagaimana tinjauan berbeda dari audit, terutama dalam hal tingkat jaminan tersirat oleh laporan auditor? Jawab : Riview dilakukan untuk mendapatkan dasar memadai untuk memberikan jaminan terbatas yang laporan keuangan klien telah disusun sesuai dengan prinsip akuntansi yang berlaku umum. Audit independen dirancang untuk memberikan dasar memadai untuk menyatakan pendapat tentang apakah atau tidak laporan keuangan klien ini telah disusun sesuai dengan prinsip akuntansi yang berlaku umum. Ada juga perbedaan besar antara review dan audit dalam hal lingkup pekerjaan yang dilakukan. Ketika review ini dilakukan, teknik pengumpulan bukti utama adalah prosedur analitis dan pertanyaan dari personil klien. Padahal, dalam audit, berbagai macam teknik pengumpulan bukti yang tersedia kepada auditor kemungkinan akan digunakan. Riview tidak menilai risiko pengendalian, tes catatan akuntansi dan tanggapan terhadap pertanyaan dengan mendapatkan memvalidasi bukti melalui inspeksi, pengamatan atau prosedur audit lain. Hal ini dapat menunjukkan hal-hal yang signifikan dari laporan keuangan tetapi tidak memberikan jaminan keakuratan. Karena riview umumnya tidak seperti audit, bukti yang dikumpulkan dari riview lebih sedikit dibandingkan dengan audit. Masalah dengan kasus Best ZZZZ adalah bahwa review auditor tidak cukup......

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