The Phantom of the Audit

You have probably never heard of Livent Inc., or if you have your memory of what transpired within the company may have faded over the past 15 years. Yes, one of Canada’s most disgraceful accounting scandals is “celebrating” its 15th anniversary this year. Livent has also recently been in the news since the Ontario Securities Commission (the stock exchange regulator for Livent) has finally decided to actually regulate. I don’t want to be too harsh on the OSC, but really—it took 15 years to decide that the perpetrators should be banned from being involved with publicly traded companies?

Let’s rewind to 1998, when the *&^% hit the fan. Livent had been on a roll; it was producing great theatre performances in Toronto, including the Phantom of the Opera, and had been reporting fantastic financial results. Ex-Disney executive Michael Ovitz purchased Livent in 1998 and then realized that it was a financial house of cards. Note: all documents referenced below are publicly available through

First, let’s take a look at the original December 31, 1997 balance sheet:


Source: Livent Consolidated Balance Sheet, as at December 31, 1997,

Things to note:

  • A small negative deficit ($27M)
  • Accounts payable and accruals ($29 M) that are less than the cash available ($10M) and the accounts receivable ($32M)
  • A preproduction cost asset, representing money already paid to develop future performances, $67M

Now, here is the restated balance sheet after examining some dodgy accounting practices:



Look at the December 31, 1997 column and compare that to the original figures:

  • The deficit is no longer small. It is $124M, approximately $100M larger than originally reported. Total equity now represents just 1% of total assets. This means that 99% of Livent’s assets really belong to debt holders
  • Accounts receivable has gone down by $13M and accounts payable has gone up by almost $20M
  • Preproduction cost assets have decreased by $8M

With virtually all frauds, one key culprit is revenue recognition. Revenue would seem to be an easy thing to account for, but it can become complex pretty easily, depending on revenue timing and amounts. A simple example of this is Livent’s treatment of certain sponsorship revenue. Like many arts organizations, Livent earned a portion of its revenue through sponsorship dollars—companies paid for the right to have their logos and signage in theatre lobbies, on the stages, or in playbills. This is very similar to the corporate logos you see at hockey rinks. Assume that a business paid Livent $500 000 to have its logo on the playbill for the Phantom of the Opera. The company probably paid months in advance to secure its sponsorship right. When should Livent record that payment as revenue? (a) When it received the cash; (b) when the show started its 3 year run; or (c) it should be spread evenly over the show’s three year run. If you answered (a), you may want to review revenue recognition criteria ASAP, before you meet Livent executives in jail (IAS 18). If you answered (c), congratulations! You’re well on your way to becoming an excellent accountant. Or, you just used common sense. It’s interesting how accounting, when done right, involves a lot of common sense.

Another frequent form of accounting fraud is to record expenses as assets. How does this work? Well, there is a fine line between an asset and an expense. To keep it relatively simple, assets are expenses that have a benefit in the future. That’s why we capitalize property and buildings—they will provide benefit for years to come. Conversely, expenses do not have any future benefit—their benefit has been entirely used up in the current period. A business can (fraudulently) increase its net income by recording expenses as assets. Did you notice that decrease in Livent’s preproduction costs? Yep, this is exactly what was going on. Livent was capitalizing (recording as an asset) production costs that were never going to generate any future value.

A third area where Livent got caught with its hand in the cookie jar was less common: it didn’t even record some of its expenses. When Livent received a bill near its year end, it didn’t pay the bill immediately (that’s fine, it’s good cash flow management). A proper accounting system would set that bill up as an expense and as an account payable before year end. By not doing this, Livent artificially increased its net income (since it didn’t record the expense) and artificially decreased its liabilities (since it didn’t record the accounts payable). This is wrong on both accounts. Now, why is this not a common area of fraud? Because its pretty darn easy to find. All an auditor has to do is look through a stack of unpaid bills and subsequent bill payments and note the date on the bill. Prior to year end? It should be recorded. Just after year end? Let’s do a little more investigation. So Livent was a case of really sloppy auditing. No surprise that the three key auditors have all had their knuckles rapped pretty hard.

In conclusion, I know this case is REALLY old but it is worth revisiting since it highlights very basic accounting principles that all accounting students should be able to understand. One final thought—if you’re involved as an accountant with a business, avoid this kind of crap at all costs. It’s not worth the damage to your reputation.

Here is the official description of the accounting restatements that I discussed above (November 18, 1998 letter):


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