ACC618 Case Study Diamond Foods Accounting for Nuts

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ACC618: Professional Ethics for the Accountant (FSJ2302A)

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8th February, 2023

Case Study: Diamond Foods: Accounting for Nuts

Incentives/Pressures – I believe the large bonuses awarded to top executives when their targets were reached encouraged the fraud in this case. As an added incentive, everyone working for the company would feel the weight of the corporation’s high expectations for performance. The more the pressure, the greater the possibility of deception. Our company’s motto was “Bigger is Better.” To put it another way, this is an example of excessive pressure being placed on workers. It seemed like they were determined to reach a certain financial goal at whatever cost.

Opportunity – The corporation could perpetrate fraud because of the special payment mechanisms used in the walnut industry. Payments to Mendes and Neil were expected to be sent in installments, thus they were delayed until a later accounting period. Their extensive work in the company’s accounting department paved the way for this chance. The two of them were able to reach such a high level of accounting responsibility, yet the company’s safeguards failed to detect any wrongdoing. Management’s lack of emphasis on ethical behavior also contributed to an atmosphere in which employees might more easily commit the deception.

Rationalization – Diamond Foods justified this behavior on the grounds that hard financial targets had to be met regardless of the cost. The message from upper management appeared to be that everyone should throw themselves into their work to achieve these targets. This type of conduct was tolerated because of the company’s culture. Plus, I believe CEOs often received sizable incentives that they came to rely on. Even missing one payment was unacceptable to the upper management. Last but not least, I believe that because accounting duties were distributed so widely, no one employee felt personally responsible for any wrongdoing. I believe that most employees were unaware of the company’s rules and accounting treatments because they were never made public. They rationalized the deceit because they were ill­equipped to see it for what it was.

Diamond Foods did break the law, that much is true. Accounting fraud occurs when transactions are recorded as having occurred in a different year than they actually did. Due to the serious nature of GAAP violations, Diamond Foods should be punished for their absence of compliance. The key would be demonstrating their deliberate intent.

The corporation has also engaged in conduct that violates Section 302 of the SarbanesOxley Act. If upper management knowingly approves a financial report that has a serious concern related to fraud, they might face up to ten years in prison and a fine of up to one million dollars. Diamond Foods' CFO and CEO knew about the deception, making this a textbook case of corporate misconduct.

Diamond Foods did not fully comply with the AICPA’s rule named “Compliance with standards,” which is part of the organization’s code of professional conduct. By following this guideline, accountants will ensure that all material risks are mitigated to an appropriate degree. There is room for fraud or error in the system that keeps track of when and how much money is paid. A director was questioned by an accountant about a $46,000 cheque he had received but was unsure of how to deposit. Diamond Foods required a protocol for processing these checks to guarantee that they would be allocated to the relevant accounting period.

However, I believe that some sort of safeguards should be put in place even before a process is drawn out to make sure everything is done correctly and professional judgment is not impaired.

To check for gaps or improper use of the budget, I recommend a variety of projection types be available to the organization. If you have a prediction, you’ll know whether or not a $46,000 check is on the way, and what it’s for.

Diamond paid the ultimate pay for the ineffective controls that they had implemented throughout the organization. The company’s financial reporting methods, including the recording of payments to growers and estimates of related expenditures, lacked adequate controls. The Exchange Act’s Section 13(b)(2)(B) makes it illegal to operate without sufficient internal controls. Their lack of documentation of accounting policies was a major flaw in their controls.

The policies and procedures for dealing with various accounting issues are documented in a good control environment. The auditors are then given these guidelines and briefed on them before any auditing is done. In addition, there was no predetermined procedure for determining either the payments to walnut growers or the walnut cost estimates. They had no documented procedures, and they hadn’t even established procedures to document.

The culture of the company centered on maximization of profits and successful completion of set objectives. While this benefits the investors, it does not foster a trustworthy workplace. This might lead to dishonest behavior as employees will resort to any means necessary to achieve management’s goals. The company’s management is accountable for setting an ethical standard that permeates the workplace.

Absolutely, I believe that Deloitte could have done more to prevent this fraud and that they have some of the blame for failing to spot it.

The audit by Deloitte was flawed in multiple ways that would have allowed the fraud to be uncovered by GAAS. When I’ve worked with auditors in the past, they’ve always used the prior year’s data to determine if the current year’s numbers were reasonable. If there are significant differences between the books from one year to the next, I must explain the shift. Each justification is documented and stored for possible use in a later audit. One danger flag that should have been investigated is the dramatic increase from 1.5% net income as a percentage of sales in 2006 to 5% in 2011(merit ,2022. It wouldn’t take much digging to find out that their expansion is the exception rather than the norm for their sector. Deloitte either failed to see the warning signs or actively ignored them.

Further, it appears that Deloitte was unaware of the standard industry practice of including extra charges for walnuts in their estimates. Mendes never gave an explanation because he feared it would reveal his dishonest dealings. First meetings with auditors usually last an hour, during which time we discuss general business operations and the auditing process. In order to ensure accurate financial reporting, auditors must have domain expertise. Deloitte could have done a better job of addressing the issue of walnut pricing if it had taken the time to learn about the sector.

They did not establish procedures reasonably designed to give reasonable certainty that illegal conduct has not had a material influence on the financial statements, as required by Section 10A of the Securities Exchange Act.

When conducting the formal audit of Diamond Foods, Deloitte did in fact break GAAS. They did not meet the fieldwork requirements, which state, “They need to get a sufficient grasp of the entity and its internal controls.” If they had done so, they might have uncovered problems that could have resulted in a substantial misrepresentation (Mintz & Morris, 2014). Diamond Foods' internal controls would have been judged to be inadequate, and the company would have been required to take extra steps to ensure that its financials complied with GAAP.

To add insult to injury, I don’t think they exercised enough professional skepticism during the audit. This would have been helpful when Neil offered them misleading information about how to account for the payments.

In addition, I believe a fraud risk assessment conducted in advance of the audit procedures would have been beneficial. In order to get a better grasp on any problems that may occur, AU­C 240 suggests that the audit team consult with both the prior auditors and the management. Analyzing financial data also involves making comparisons between financial statements and calculating ratios. If they had looked at this first, they would have seen warning signs before even talking to the company. When compared to the industry average, these ratios might help identify departments with a higher potential for fraud within the organization. Massive year­over­year gains in profit margins would have stood out like a sore thumb.

References

Mintz, S. M., & Morris, R. E. (2014). Ethical obligations and decision making in accounting: Text and cases (3rd ed.). Retrieved from https://www.vitalsource.com

Mert, I. (2022). Theoretical Approaches of Value and Valuation. In Assessment of Accounting Evaluation Practices: A Research­Based Review of Turkey and Romania (pp. 11­60).

Cham: Springer International Publishing.