Marschdorf Forensics


The Emperor’s New Clothes

After a large publicly traded manufacturer of turnkey cement factories filed for creditor protection, the situation had manipulated financial statements written all over it. Unfinished projects inventories had to be written down by the equivalent of 400 million dollars from one day to the next. Sizable unfinished projects were located in the Middle East, some in South-East Asia.

Projects requiring several years of manufacturing are typically accounted for by what is called the “percentage of completion” method. This method of accounting allows a manufacturer to recognize profits and record the value of unfinished projects by estimating a degree of completion and record the unfinished projects with this percentage of the total sales value. Such estimates are complex and typically require the use of engineering experts in order to ascertain the project status. The auditors had issued unqualified opinions for the financial year-end prior to the revelation of the necessity for write-downs. The auditors had entirely relied on estimates provided by the external project engineers tasked with managing the construction without performing their own independent reviews. After all, the project engineers were external to the manufacturers.

Who were these engineers? They were located in the Middle East and were managing and overseeing the manufacturing processes – or so it seemed. When an independent review was conducted, because of unpaid invoices and an anonymous tip, it was found that 2 out of three cement plants in the Middle East, which had all be recorded at a near-to-completion had not even been started. A child could have seen that.

It turned out that the engineering firm was a subsidiary of a group of companies involved in the bidding processes for these projects. Another member of this group had provided an inflated bid, which had led to the now troubled manufacturer to win on his proposal. In a typical winner-pays-looser arrangement, the engineering firm received the lucrative subcontract of project management. In fact, the subcontract was so lucrative that the engineering firm had used portions of its proceeds to pay bribes to the ultimate decision maker on the project, a politically exposed person. Some funds also found their ways back to the bank accounts of senior management of the turnkey manufacturer.

Procurement fraud and corruption, however, did not explain the suddenness of the revelation that write-downs were required, at least not all of it. The turnkey manufacturer had undergone several years of losses on other unrelated projects, which needed to be covered. So they decided to record costs relating to those other projects as costs related to the Middle-East projects and some others in South-East Asia, thus appearing to be profitable on the previous projects. In the end, there were close to 20 individuals involved in the cover-up, from engineering, construction, accounting and controlling departments. One of them had blown the whistle, which had led to the review of the unfinished projects inventories.