Case Study: Luckin Coffee Accounting Scandal

Luckin Coffee is a Chinese coffeehouse chain that was founded in 2017 and quickly became a formidable competitor to Starbucks in China. In April 2019, Luckin Coffee made its debut on the Nasdaq stock exchange and raised $561 million in an initial public offering (IPO). However, in April 2020, the company was hit by a major scandal that led to the downfall of its top executives and significant losses for its investors.

The scandal began when an anonymous report was published on January 31, 2020, alleging that Luckin Coffee had fabricated its financial results. The report claimed that Luckin Coffee had overstated its revenue by at least RMB 2.2 billion ($310 million) in 2019, and that the company's chief operating officer, Jian Liu, had fabricated the numbers. The report also accused the company of inflating its expenses and engaging in other fraudulent activities.

Luckin Coffee had been reporting "transfers" of coffee and other products between its stores as sales, even though no money had actually been exchanged. These "transfers" accounted for a significant portion of the company's reported sales. Additionally, the company had been reporting sales for products that had not yet been delivered or paid for.

Luckin Coffee initially denied the allegations and launched an internal investigation. However, on April 2, 2020, the company announced that its internal investigation had uncovered evidence of significant financial misconduct. The investigation found that Jian Liu and several other employees had fabricated sales transactions, created false invoices, and misappropriated company funds.

The company disclosed that its 2019 net revenue had been inflated by RMB 2.12 billion ($300 million), and its net loss had been understated by RMB 1.96 billion ($280 million). Luckin Coffee also announced that Jian Liu and several other employees had been suspended or terminated, and that the company would take legal action against them.

As a result of the scandal, Luckin Coffee's stock price plummeted, and the company was delisted from the Nasdaq stock exchange in June 2020. The scandal also led to regulatory investigations by Chinese authorities and the US Securities and Exchange Commission (SEC). In July 2020, the SEC fined Luckin Coffee $180 million for accounting fraud, and several executives, including Jian Liu, were arrested by Chinese authorities.

The falsification of sales figures also had an impact on Luckin Coffee's expenses. The company had been reporting high marketing expenses to support its supposed sales growth. However, it was revealed that much of this spending was not genuine and had been fabricated to support the false sales figures. The company had also been inflating other expenses, such as rental costs and interest expenses, to make it appear that it was a rapidly growing business.

In conclusion, the Luckin Coffee scandal was a major example of a managerial accounting fraud. The company had falsified sales figures and expenses to make it appear that it was a rapidly growing business, which led to a surge in its stock price. However, once the fraud was discovered, the company's reputation was damaged, and it faced significant financial and legal consequences.

Question 1 (CLO1,3):

How did Luckin Coffee's fraudulent accounting practices affect the company's internal decision-making processes and management control systems? What could have been done differently to prevent or detect these practices earlier through the use of managerial accounting tools and techniques?

Based on the case study, critically evaluate and justify your arguments with relevant examples. (25 Marks)

Question 2 (CLO1,3):

How can managerial accounting be used to ensure the accuracy and reliability of financial reporting in a fast-paced and highly competitive industry such as the coffee industry? What specific tools and techniques could Luckin Coffee have implemented to enhance its managerial accounting practices and avoid fraudulent activities?

Based on the case study, critically evaluate and justify your arguments with relevant examples. (25 Marks)