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Healthcare IT fraud: deficiencies in internal controls

Search on several U.S. health care publicly-traded companies and choose a health care organization that has been accused of committing health care fraud. (You may use HealthSouth Corp. Accounting Fraud or choose other case.)

- Determine whether deficiencies existed in the IT environment, and suggest ways to improve audit trails, data integrity, and policies and procedures in order to reduce the risk of fraudulent activity.

- Review the audit report issued by the external auditing firm from the company's Website for the year it was accused of fraud. Then, determine whether the external auditors were negligent in preparing the audit report for the company. Formulate an opinion regarding which Internal Control was deficient or what GAAP was violated. Defend your position.

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The health care fraud I selected is the Ligand Pharmaceuticals fraud concerning sales returns. The fraudulent reporting was about sales of drugs that could be returned within the expiration data. In 2003, the estimate for sales returns was significantly understated in order to report higher revenues.

Ligand used sales return patterns from other products to estimate "sell through" rates for new drugs even though they had limited historical experience to use. Further, in the first quarter of 2004, it was clear that the 2003 year end estimate was very wrong and they remained silent. In May 2005, Ligand's management announced that they would be restating the 2003 and first three quarters of 2004 financial statements to fix errors that are mostly from improperly recognizing revenue on product shipment to distributors.

This fraud could have been avoided if the system tracked the product including the expiration date so that they knew the "exposure" for items sold to distributors that may be returned. Once the expiration date passed, they could have been safe in recording revenue without a concern about restatement. Because they did not have this data, the auditors did not have any evidence to use to show the extend of the exposure.

Another IT system that would have helped is to have a system when the distributors reported either sold or unsold items by quarter so that unsold items within the expiration period could be easily estimated for the purposes of financial reporting.

One policy that would have been helpful would be to require all sales that are "at risk" to be estimated as a potential sales return, or at least to record all until a good two year history was established.

The auditor report for 2003 is below. Sarbanes Oxley was not yet effective so the report on the controls was not included in the 2003 Form 10K.

It has been determined ...

Solution Summary

Your discussion is 377 words plus two references and the audit report for Ligand Pharmaceuticals. The fraud is discussed as well as three ideas for improving IT to avoid the fraud and comments about auditor negligence.