ZZZZ Best Case

Introduction:

          Barry Minkow founded a carpet-cleaning company named ZZZZ Best in his sophomore year of high school.  ZZZZ Best appeared to be an instant success.    However, it was actually a front to attract investments for a massive Ponzi scheme.  Business pressures and unpaid bills caused a young entrepreneur to perpetrate one of the largest accounting frauds.  

 

Fraud Methods Used:

           With the help of friend, Tam Padgett, Barry Minkow turned ZZZZ Best Carpet Cleaning Company to ZZZZ Best Building Restoration Shell-Company.  Minkow and his employees never performed any building restorations.  Instead, they created a fictitious plan to fool auditor’s inspections. 
           Minkow used numerous methods to perpetrate this fraud.  These included accounts receivable fraud, check kiting, loan fraud, bribery, fictitious record keeping, broken trusts, phony loan files, check registers and general journals.   

 

Red Flags:

1. Insurance restoration contracts were unrealistically large.
2. Restoration contracts failed to identify whether the insurance companies or the locations of the jobs were being insured.
3. Contracts did not contain details and specifications of the work to be done.
4. All contracts were with the same party.
5. Payments were paid directly to ZZZZ Best.
6. Inadequate internal controls.
7. Revenue was recorded but there was no cash.

 

Fraud Triangle:

              Pressure, opportunity, and rationalization make up the fraud triangle.  When these three factors are present concurrently a person is more likely to commit fraud.  In the ZZZZ Best case, these three components were present. 

• Pressure:  Parents used Minkow as an example of how working hard pays off.  This led children to look up to Minkow as their role model.  Also, talk shows such as Oprah started requesting Minkow’s appearance on their show.  This added pressure to run a successful, profitable business was very overwhelming to Minkow.
• Opportunity:  Unexpected attention gave Minkow the opportunity to create a positive image for himself in the press.  He used this to his advantage by gaining trust in the community so people would not be suspicious of the fraud or question ZZZZ Best’s financial stability.
• Rationalization:  Minkow was able to rationalize his crimes by believing it was up to him to rescue his failing business. 

 

Independence Violated in The Case:

              The internal control independence was compromised by the auditing team, which caused the fraudulent activity to take place.  Barry Minkow manipulated the auditors by redirecting their attention away from the restoration contracts and drawing their attention to the legitimate side of the business.  Minkow did this by forming relationships with the auditors’ spouses, which enabled him to blackmail the auditors to grant positive audits.  Under a legitimate audit, auditors would have easily found the errors contained in the financial statements. 

 

Auditors’ actions that could have made a difference:

               I believe the Ernst & Whinney audit team had the capability to detect the ZZZZ Best’s fraud much sooner.  There were numerous red flags that stood out on the financials and insurance restoration contracts, which should have led to a fast and easy detection.  Instead, the auditing team gave into Minkow’s manipulation and walked away from the audit without reporting anything.  A competent auditing team would have informed officials of any suspected fraud.
               A competent auditing team would have examined ZZZZ Best’s internal controls as well as their past and current accounting practices.   Assessing internal controls plays a vital role in the avoidance of fraud.  Having strong internal controls allows for less of a chance of fraudulent activities.  In ZZZZ Best’s case, the internal control of Independence was manipulated.  When analyzing ZZZZ Best’s financials, the auditors should have compared the changes in numbers from year to year.  Simply looking at the numbers and conducting a ratio analysis would have pointed out numerous discrepancies that were present.  A ratio analysis would have revealed that the current ratio, debt to equity, and return on equity ratios made no sense.  The current ratio showed ZZZZ Best was recording revenue but had no cash.  During 1985 to 1986, ZZZZ Best’s debt to equity ratio increased by 8600% and the return on equity dropped by more than 75%.  This fraud was very easy to discover; however, the auditors failed to open their eyes and had no desire to see the fraud.

 

*** To learn more about the ZZZZ Best fraud and to view letters between Barry Minkow and Ernst & Whinney the reader can view this website:  http://www.rohanchambers.com/Courses/Auditing/ZZZZ%20Best%20Company.htm 

 

Work Cited

1. Knapp, Michael. "ZZZZ Best Company." ZZZZ Best Company. N.p., n.d. Web. 09 Nov. 2013