Inventory Fraud, Essay Example

The inventory fraud at Leslie Fay eventually forced the company to file for Chapter 11 bankruptcy and the company’s stock price dropped by more than 65% on the news. Donald Kenia, Leslie Fay’s controller at the time of the fraud, admitted to overstating inventory and underestimating the cost of making clothes as far back as the last quarter in the year 1991 (Bloomberg Business News). Closing inventory level is used in accounting to determine the cost of goods sold which is why overstating inventory levels enabled Leslie Fay to show higher operating income. In other words, Leslie Fay showed its operations to be more efficient than they actually were.

Later investigation also covered numerous other manipulations of accounting data. The company also omitted markdown allowances to retailers, didn’t record suppliers invoices as costs, and inflated revenues and profits through mismatch between the actual events and the accounting period. When a company omits markdown allowances, it overstates its revenues as well as profits. Similarly, failure to record suppliers invoices mean the company understated its production costs and overstated profits. The company continued to record revenues and profits even after the particular accounting period had ended, thus, overstating its financial performance (Agins).

One of the reasons the inventory fraud occurred at Leslie Fay was that the management’s compensation was tied to the company’s financial performance. Understating costs, particularly, those related to inventory allowed management to show higher profit than what was actually earned by the company. It was estimated that the company overstated its earnings by some $81 million during the period 1990-1992 (Agins, Leslie Fay Cos.’ Profits Restated for Past 3 Years).

References

Agins, Teri. “Leslie Fay Cos.’ Profits Restated for Past 3 Years.” The Wall Street Journal (1993): A3,A4. —. “Report Is Said to Show Pervasive Fraud at Leslie Fay.” The Wall Street Journal (1993): B4.

Bloomberg Business News. Leslie Fay Files For Chapter 11. 6 April 1993. 19 July 2012 <http://articles.chicagotribune.com/1993-04-06/business/9304060343_1_leslie-fay-cos-bankruptcy-protection-filed>.