Fraud case Studies Case 2 - Pleasant Pasta
Overview
Pleasant Pasta (the Company) was the largest dry pasta producer inNorth America. As a manufacturer and marketer of pasta
products, Pleasant competed for market share with many othercompanies in a low-growth industry. Despite the competitive
nature and maturity of the pasta market, Pleasant’s management teamwas determined to become a high-growth company.
After successfully executing an initial public offering (IPO),Pleasant’s management team developed a short-term strategywhich
would allow the Company to achieve the rapid growth promised to itsnew investors. Specifically, Pleasant decided to focus
on marketing its products under generic brand names owned byseveral leading grocery chains. While the strategy did allow
the Company to initially achieve the sales and earnings growthmanagement desired, it became clear that Pleasant could not
continue to rapidly grow its business solely through genericchannels of distribution. Aware of this, management devised along
term performance plan that outlined aggressive top and bottom linenumbers for fiscal years 2002, 2003, and 2004. The strategic
initiative referred to as “Extraordinary Performance” unambiguouslylaid out management’s primary objective for the next three
years: grow revenue, grow earnings, and grow earnings per share(EPS) at all costs.
Achieve the “Extraordinary” targets
Shortly after the start of fiscal year 2002, it became obvious thatPleasant Pasta was having difficulty meeting the aggressive
“Extraordinary” targets set by management. Due primarily to theincreasing popularity of low-carbohydrate diets like theAtkins
diet, consumer demand for pasta had dropped, rather dramatically.Plummeting demand coupled with a historically low industry
growth rate created a difficult environment for the Company tooperate in. Dissatisfied with performance, the CEO assembled
a task force to focus on “closing the gap” between the“Extraordinary” targets and actual results. In these meetings,the
CEO boldly stressed that their task would only be accomplished whenreported results met analysts’ expectations. As a direct
consequence, task force members were committed to the fullexecution of strategic profit initiatives to enable theCompany
to meet its “Extraordinary” targets. Without a doubt, the tone atthe top set by the CEO in these meetings had an impact on
task force members because most considered the use of improperaccounting practices to be part of the plan to achieve the
“Extraordinary” initiatives.
Close the Gap
To start, the task force focused on the “trade promotion” expenseaccount to help close the gap between actual and targeted
profit. For example, the Company had recently acquired severalother large pasta brands. A routine aspect of promoting such
brands involved product discounts, promotions, advertising, andvolume rebates that together made up “trade promotion”
expenses. Based on a detailed financial analysis, it was clear thatthese types of expenses were consistently greater than the
amount “accrued” for in the budget, which reduced actual profits.To remedy this, the task force decided that Pleasant Pastawas
justified in including a portion of promotional expenses into thebrand acquisition costs, thereby capitalizing a portion of thecosts
that had previously been expensed. These unsupported journalentries reduced the trade promotion expenses by greater than
50%, boosting the Company’s actual profits.
The second phase of the task force’s strategic profit initiativefocused on reducing manufacturing expenses. Since its IPO,the
Company had grown at a tremendous rate and taken on a number ofsignificant capital projects to expand production lines.
Under GAAP, the Company should have separated out internal laborcosts from ordinary operating expenses, capitalizing only the
labor related to the capital projects. However, the task forcedetermined that it would be best to reduce operating expensesby
capitalizing all budgeted internal labor and manufacturingoverruns. To further contain rising expenses, the task forcerefused to
write off “obsolete” assets, which had the effect of reducingreported depreciation expense.
As the pasta market continued to shrink, the task force realizedthat its efforts to suppress the Company’s expenses weresimply
not enough. Determined to meet the CEO’s objectives, the task forcebegan to concentrate on ways to increase Pasta’s reported
sales revenue. Reduced demand for pasta had driven many customerorders well below the contractually agreed upon minimum
purchase volume. As such, numerous customers were contractuallyrequired to pay the Company a higher price on purchases © 2014KPMGLLP, a Delaware limited liability partnership and the U.S. memberfirm of the KPMG network of
independent member firms affiliated with KPMG InternationalCooperative (“KPMG International”), a Swiss entity. All
rights reserved. Printed in the U.S.A. The KPMG name, logo and“cutting through complexity” are registered trademarks
or trademarks of KPMG International. NDPPS 309511 Case 2 PleasantPasta until contractual volume numbers were met. Under GAAP, thepremiums paid on each order should have been recognized as
revenue immediately. However, at the direction of the task force,the Company not only recognized the revenue associated with
the actual price increases, but also their projected priceincreases in order to boost reported earnings. Further, the taskforce
authorized significant promotional discounts that resulted inseveral material sales in the final days of each period. Unwillingto fall
short of the “Extraordinary” targets, the task force evenimproperly recognized revenue before shipping the product in manyend
of year transactions.
Overall, the task force’s efforts to improperly reduce costs andinflate revenues resulted in an overstatement of EPS by 23%in
2002, 41% in 2003, and 59% in 2004. Additionally, over thefraudulent years, Pleasant Pasta’s pretax income wasimproperly
inflated by greater than 66%, which helped to fuel a significantstock price increase for the company.
Fraud Discovery
In 2008, Pleasant Pasta publicly admitted that the Company’s 2002,2003, and 2004 consolidated financial statements were
materially misstated due to fraud. In its admission and subsequentrestatement, the Company attributed the fraud to an
inadequate system of internal controls as well as management’sfailure to maintain an appropriate tone at the top. Thediscovery
was made through a combination of an internal whistle-blower,significant management turnover, and ultimately an SEC
investigation.
i would like a summry for the case .
