The following paragraphs describe fraudulent accounting committed by the company Rite-Aid in 1999. After reading the paragraphs, list the journal entries you think Rite-Aid would have used to do what is described here. You will have to make an educated guess as to what journal entries the company would use to cover up the fraud.
Rite Aid overstated its FY 1999 net income by charging
the vendors for undisclosed markdowns relating to vendor products. The
vendors did not agree to share in the cost of the price markdowns and, in
fact, were never even told of the markdowns. Instead, Rite Aid misled the
vendors into believing that the deductions taken by Rite Aid in February
1999 were for D&Os. These purported D&Os resulted in an overstatement
of FY 1999 pre-tax income of approximately $30 million. Rite Aid's pre-tax
income was overstated because the credits taken by Rite Aid were
unearned in FY 1999. The amounts were unearned because the vendors
never agreed to the credits prior to the close of FY 1999 and they were lied
to about the nature and calculation of the credits.
Grass and Bergonzi knew, or were reckless in not knowing, about the
undisclosed markdowns. A Rite Aid employee responsible for this area
specifically told Grass and Bergonzi that Rite Aid's failure to charge back the
vendors for the markdowns would negatively impact earnings by $30
million. Although Rite Aid was able to unilaterally record credits totaling $30
million, Rite Aid could not actually obtained that benefit without charging
the underlying amounts back to specific vendors. Grass and Bergonzi also
knew, because they were told, that the relevant markdown information
received by Rite Aid's accounting department from hundreds of stores had
to be resorted by vendor in order to properly charge back the vendors for
the markdowns, but that the volume was so great that the sorting process
was impossible to complete by year-end. Grass was also told that there
were $35 million in unprocessed credits, and Grass knew that some of the
affected vendors no longer did business with Rite Aid (and therefore could
not be charged back). Grass and Bergonzi were told that the eventual
credits claimed would be based on a percentage of purchases from the
vendors rather than the actual dollar value of the markdowns. Thus, Grass
and Bergonzi knew that the credits were arbitrarily determined (and likely
wrong).
Vendor complaints regarding the size of the chargebacks became the
subject of a number of Wall Street Journal articles in March of 1999. Rite
Aid claimed to the newspaper and the vendors that the chargebacks were
appropriate and part of its long-standing business practices. Rite Aid did not
tell the press or the vendors that Rite Aid had misdescribed the amounts
involved as pertaining to D&O product. In response to the Wall Street
Journal's accusation that Rite Aid was inflating its earnings by overstating
the amount of D&Os, Bergonzi was quoted as saying that Rite Aid "did not
inflate earnings in the fourth quarter with these returns allowances and
things like that." On March 31, 1999, in response to a Wall Street Journal
article, Rite Aid issued a press release stating that "[vjendor deductions
and chargebacks have only a minimal impact on our financial results in any
quarter, and credits for damage or unused goods have no impact."
In fact, earnings were significantly inflated because the chargebacks
were for markdowns, not D&Os, and thus went straight to the bottom line.
Grass and Bergonzi knew this, or were reckless in not knowing it.