Livent Produces An Accounting Theatrical Story Based out of Toronto, Livent was a company that produced live theatrical entertainment, such as Ragtime, The Phantom of the Opera, Show Boat, Sunset Boulevard and Fosse. It owned and operated theaters in Toronto, Vancouver, Chicago and New York in the 1990s. On May 1993, Livent became a public company in Canada, in May 1995 it began trading on the NASDAQ national stock market and on the Toronto Stock Exchange. (SEC January 13, 1999) An accounting fraud perpetrated by CEO Garth Drabinski, President Myron Gootlieb, and Tony Fiorino, CA, the Theater Controller, led to Livent declaring bankruptcy in the USA and Canada on November 18 and 19, 1998, respectively. (SEC 1999a) In August 1998, a new management team at Livent discovered the vague, false and misleading financial statements and disclosures from former senior management. KPMG Peat Marwick conducted an independent investigation of the fraud. In November 1998, KPMG reported that Livent had submitted at least 17 false filings with the SEC which materially overstated income and operating cash flows throughout the relevant period. As a result of the scheme, Livent’s restatements reported in a cumulative adverse effect on net income in excess of $98 million in Canadian dollars. (SEC 1999b) The fraud included: a multi-million dollar kick-back scheme designed to misappropriate funds for management’s own use; the improper shifting of preproduction costs, such as advertising for Ragtime, to fixed assets, such as the construction of theaters in Chicago and New York; and the improper recording of revenue for transactions that contained side agreements purposefully concealed from Livent’s independent auditors. (SEC 1999a) Livent’s accounting staff used four basic forms of manipulation. First, the staff transferred preproduction costs for shows to fixed asset accounts such as the construction of theaters, in order to delay the amortization of those costs. Theater Controller Fiorino created dummy accounts for the amounts that were improperly transferred to fixed assets Second, the accounting staff, at the end of each quarter, simply removed certain expenses and the related liabilities from the general ledger. These items were literally erased from the company’s books. Third, the accounting staff transferred costs from one show currently running to another show that had not yet been opened or that had a longer amortization period, again in order to delay the amortization of those costs. Finally, senior management entered into various “revenue-producing” contracts containing purposefully concealed side agreements that, in effect, required Livent to pay back to the ticket buyers the amount originally advanced. From September 30, 1997 to December 31, 1997, the first vendor purchased tickets totaling $381,015 (US) from the box office at the Schubert Theater in Los Angeles. These purchases were made using the vendor’s personal credit card or the vendor issued checks from one of his companies. Livent then reimbursed the vendor or his companies based on false invoices the vendor submitted for construction services to Livent. These transactions should have been booked as loans payable rather than as revenue. (SEC 1999a) Livent’s former senior officers directed that various improper adjustments be made to Livent’s books, records, and accounts in order to manage income for each quarter to achieve a predetermined level. (SEC 1999b) Senior management instructed the accounting staff to regularly process the adjustments to the books, records and accounts in such a way as to conceal their existence from the auditors and then prepared financial statements incorporating the adjustments. Adjusting journal entries would have left a trail of “red flags” for the auditors, something Livent’s senior management did not want to create. Consequently, starting in at least 1994, the manager of Livent’s information services department wrote a program that would enable the accounting staff to override the accounting system without a paper or transaction trail. That manager then wrote programs to enable the accounting staff to execute changes on a batch, or volume, basis. This process had the effect of falsifying the books, records and accounts of the company so completely that the adjustments appeared as original transactions, and no trace of the actual original entries remained in the company’s general ledger. (SEC 1999a) As a result of the scheme, Livent’s financial statements for fiscal years 1991 and 1992, prior to Livent becoming a US public company, were materially false and misleading in that Livent overstated pre-tax earnings, or understated pre-tax losses, in each of those years. For fiscal 1991, Livent reported a pre-tax loss of $1.2 million. In fact, Livent’s loss in that year was approximately $4.6 million. For fiscal 1992, Livent reported pre-tax earnings of $2.9 million. In fact, the company’s true earnings were approximately $100,000. (SEC 1999a) As a further result of the scheme, Livent reported inflated pre-tax earnings, or understated pre-tax losses, for each of its fiscal years as a US public company, 1995 through 1997. For fiscal 1995, Livent reported pre-tax earnings of $18.2 million. In fact, the company’s true earnings were approximately $15 million. For fiscal 1996, Livent reported pre-tax earnings of $14.2 million. In fact, the company incurred a loss of more than $20 million in that year. For fiscal 1997, Livent reported a pre-tax loss of $62.1 million. In fact, the company’s true loss in fiscal 1997 was at least $83.6 million. (SEC 1999a) Discussion Questions ■ How did each one of the four accounting fraud schemes impact Livant’s financial statements? ■ What audit procedures might be used to discover these misstatements?