D. Diamond Foods, Inc.

In February 2017, the Wall Street Journal reported that Diamond

Foods, Inc. fired its CEO and CFO, and would restate financial results for two years. The
restatement was required after the company found that it had wrongly accounted for
crop payments to walnut growers. The investigation focused primarily on whether
payments to growers in September 2016 of approximately $60 million and payments to
growers in August 2015 of approximately $20 million were accounted for in the correct
periods. Shareholders suing the company alleged the payments may have been used to
shift costs from a prior fiscal year into a subsequent fiscal year. In a February 2017 filing
with the SEC, the audit committee stated that Diamond had one or more material
weaknesses in its internal control over financial reporting. In January 2019, the SEC
charged Diamond Foods and two former executives for their roles in the accounting
scheme to falsify walnut costs in order to boost earnings and meet estimates by stock

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analysts. Diamond Foods agreed to pay $5 million to settle the SEC’s charges.

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a. Does the restatement suggest that the company’s internal controls contained a

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material weakness? Explain your rationale.
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It is not impossible for an entity to restate its financial statements. In fact, a standard is
set to guide an entity for its restatement procedures so that these financial statements are fairly
presented. Restatements may occur because of error or a change in accounting estimate or
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policy. Therefore, restatement is not a conclusive presumption that the entity’s internal controls
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are weak or ineffective. However, the scenario above suggests the contrary. The fact of the
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matter is that the reason for the entity’s restatement of its financial statements for two years is
because it was found that there was material fraud on the reporting, and when there is material
fraud, it can be assumed that there is a material level of ineffectiveness on the entity’s internal
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controls.
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b. In September 2011, the company filed its annual report with the SEC for its fiscal year
ended July 31, 2011. As part of that filing, the company maintained that it had effective
internal controls over financial reporting as of its year-end date. Do you believe that
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management’s report on internal control over financial reporting was accurate?

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The management’s report on the entity’s internal controls as effective was inaccurate.
Although the scenario above was about the years 2015 and 2016, because the weakness in
internal control concerns the entity’s control environment, it can suggest that the entity has long
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had ineffective internal controls, especially because the management was at fault.

c. In February 2012, the audit committee indicated that the company had ineffective
internal controls. What types of material weaknesses do you think might exist at

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 Diamond?

One of the qualities of an effective internal control system is the firm’s emphasis on an
environment that fosters integrity and honesty from the top management down to its operations.
While the management is responsible to produce financial statements that are fairly presented,
they are also equally responsible to encompass a culture of uprightness and honesty among its
members. In the scenario given, iIt was found that there was a scheme to falsify costs to
inaccurately report its earnings that are falsely favorable among analysts.It was also found that
the entity’s CFO and CEO were the ones responsible. Given the kind of authority the guilty
party has, this may be a case of undue influence that the authoritative party may have on its
employees. They may have forced employees to falsify the financial statements and to intently
account costs incorrectly.

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