Although financial statement fraud is a fairly rare event, the misrepresentations in Maxidrive's statements aptly illustrate the importance of fairly presented financial statements to investors and creditors. They also indicate the crucial importance of the public accounting profession in ensuring the integrity of the financial reporting system. The recent Enron and WorldCom debacles have brought the importance of these issues to the attention of the general public.

As noted at the beginning of this chapter, Maxidrive is not a real company but is based on a real company that perpetrated a similar fraud. (The focus companies and contrasting examples in the remaining chapters are real companies.) Maxidrive is loosely based on the infamous fraud at MiniScribe, a real disk drive manufacturer. The size of the real fraud, however, was more than 10 times as great as that in the fictional case, as were the losses incurred and the damages claimed in the lawsuits that followed. (Many of the numbers in Maxidrive's financial statements are simply one-tenth the amounts presented in MiniScribe's fraudulent statements.) The nature of the fraud also was quite similar. At MiniScribe, sales revenue was overstated by transferring nonexistent inventory between two facilities and creating phony documents to make it look as though the inventory was transferred to customers. MiniScribe even packaged bricks as finished products, shipped them to distributors, and counted them as sold. Cost of goods sold was understated by activities such as counting scrap parts and damaged drives as usable inventory. MiniScribe managers even broke into the auditors' locked trunks to change numbers on their audit papers.

As a consequence, MiniScribe reported net income of $31 million, which was subsequently shown to be $9 million. MiniScribe's investors and creditors filed lawsuits claiming more than $1 billion in damages. Actual damages in the hundreds of millions were paid. Both the chairman and the chief financial officer of MiniScribe were convicted of federal securities and wire fraud charges and sentenced to jail. Although most managers and owners act in an honest and responsible fashion, this incident, and the much larger frauds at Enron and WorldCom, are stark reminders of the economic consequences of lack of fair presentation in financial reports. Both companies were forced into bankruptcy when their fraudulent financial reporting practices were brought to light. Penalties against their audit firm, Arthur Andersen, also led to its bankruptcy and dissolution. A sampling of firms that have recently been involved in financial statement misrepresentations follows:

Enron WorldCom Adelphia Global Crossing Computer Associates Tyco HealthSouth McKesson Xerox Rite-Aid Aurora Foods Halliburton

Parmalat Nortel Goodyear Cardinal Health Homestore.com Dynegy Fannie Mae Freddie Mac Qwest Communications Gerber Scientific Stanley Works AIG