Phar-Mor Fraud

Topics: Risk, Auditing, Internal control Pages: 6 (1830 words) Published: July 8, 2013
Phar-Mor, Inc was a thriving discount grocery store in the late 1980’s. Phar-Mor was moving product quickly but profit margins were not significant enough to pay the bills. By the early 1990’s, Phar-Mor declared bankruptcy due to fraudulent financial reporting and misappropriation of assets, making it one of the largest frauds in U.S. history. Below, we will use auditing standard AU 316.85 Appendix A in conjunction with the video “How to Steal $500 million” to analyze how incentives/pressures, opportunities, and attitudes/rationalizations allowed for fraud to start and continue at Phar-Mor.

Annual reoccurring losses due to small margins put pressure on the CFO and controller to divide the overall loss incurred by Phar-Mor upon each of the individual stores, making the dollar amount of loss per store appear much less material than the millions actually incurred. Phar-Mor’s threat of facing bankruptcy was an incentive for the president, CFO, accounting manager and controller to find ways to “cook the books”, such as overstating the price of inventory.

Each character involved had significant incentive and felt a lot of pressure to allow the fraud to continue. At one part in the documentary, the controller for Phar-Mor even stated that he, “feared physical harm,” should he not go along with the fraud.

It was the president, who was the one who initially decided not to post the losses, but told his CFO and controller to hide the company’s losses in a separate subledger while continuing to tell the CEO and board members that the company was in good financial standing. The president felt significant pressure as the business model was his, and the simple notion of pride can sometimes propel people to do the wrong thing. Appendix A.2 of AU 316 lists several factors that incentivize and pressure employees into committing fraud. It states that if “Financial stability or profitability is threatened by economic, industry, or entity operating conditions,” one may be more inclined to perpetrate fraud. Obviously, all those involved realized that Phar-Mor would not be able to remain in business should they report the losses. In an industry as highly competitive as the discount grocery/retail business, declining margins are a death sentence.

Appendix A.2 also states that if “Excessive pressure exists for management to meet the requirements or expectations of third parties,” there will be more incentive to purposely misstate transactions/reports. In the case with Phar-Mor, management not only felt pressure from an upcoming IPO (which will be analyzed in the subsequent paragraph), but also from vendors who sold products at Phar-Mor. If the vendors knew that Phar-Mor was experiencing losses too big to recoup, they would pull their line from Phar-Mor locations and that would spell the end to Phar-Mor.

Another incentive/pressure described in Appendix A.2 states that the company may be committing fraud if “Information available indicates that management or the board of directors’ personal financial situation is threatened by the entity’s financial performance.” In the midst of the substantial misstatements that were being done by Phar-Mor management, the company was preparing an IPO, from which upper-management, namely the president and CEO, were set to make millions. This was a strong incentive to allow the fraud to continue.

Most associated with the fraud never meant to start it, but they never did anything to stop it until they were about to get caught. Once they started following orders from the president, they were under increased pressure to continue covering up the fraud or risk being harmed, financially or physically. Personal financial obligations of those involved in the fraud allowed for them to justify the misappropriation of assets.

When the CFO informed the president that Phar-Mor was in the red, Phar-Mor’s president knew of ways to fraudulently...
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