HealthSouth: A Wagon To

TZU-YU

LIN,

PING-CHIEN

CHEN,

FANG-YI

YANG

Introduction
HealthSouth is a large Alabama-based healthcare corporation in
the United States. It provides several service including diagnostic,
surgery and

especially rehabilitation, and also runs over 90

rehabilitation hospitals, over 20 home health care agencies, more

than 1,800 facilities and 6 long- term care institutions throughout
the United States and abroad. However, the mismanagement
caused the grand scale fall of this billion dollar corporate.
Aaron Beam, the CFO and co-founder of HealthSouth, witnessed
the rise and fall of the epic public corporation. It gives an insight to
the personality of Richard Scrushy, CEO of HealthSouth, and also
provides a very direct view from the top insider of one of the largest
tragedy in American financial history.

The book starts with how

Aaron Beam met Richard Scrushy, how they established the public
company and how it ends in a notorious way. It details for the first
time Aaron met the young Richard Scrushy, a inspiring respiratory
therapist who seemed to be brilliant and had the talent to bring
those around him toward success. Richard and Aaron were
colleagues in a regional hospital division in Life Mark Corporation
before they fund HealthSouth.

Richard told Aaron that he saw a

great opportunity of a latest kind of rehabilitation health care

company. So they started to raise venture capital in the market. By
1995, HealthSouth expanded rapidly in all the fifty states and had
over 40,000 employees.
After the fantastic start of the company, Richard Scrushy kept
estimating on the existing business unrealistically high. To meet the
expectation, he started to command its officers, including Aaron, to
perform fraud. Aaron did it against his moral judgment and it
strained him ever since. According to his statement, Aaron said he

and all other executives let Richard to bully and instruct them into
the scheme. I should have had the courage to stand up and say no,
we cannot cross the line. Said Aaron Beam. He decided to make an
early retirement the next year and thought he could walk away from
the deception. HealthSouth was a large white-collar crime, and as
part of the fraud, Aaron went to jail for that.
The fraudulent scheme started from a small number and
snowballed to an incredible amount of 2.5 billion dollars during 1999
to 2003. By the third quarter of 2002, HealthSouth inflated its assets
by eight hundred million, according to enforcement chief of SEC.
Richard Scrushy began to manipulate accounting fraud soon after
HealthSouth went public in 1986. During the time, the stock price
kept rising, and Scrushy was constantly telling the analysts from
Wall Street that. It got more difficult to meet the revenue Scrushy
promised investors. Senior accountants of the company will have a
meeting about how to make up the numbers Richard expected. Also,
they made several aggressive accounting, capitalizing to meet the
acceptable standard and false entries to the balance sheet and
revenue

account

to

avoid

the

suspicion

from

the

external

accountants. Finally, one of its internal officer advised CEO to stop it.
But Scrushy refused and told the officer not until I sold my stock.
Scrushy obtained 9.2 million for compensation and estimated to
have pocketed about 6.5 million bonus from artificial gains.
How?
After knowing the context of the whole scandal, lets look deeper
into the underlying accounting schemes. There were two major
schemes at play: Contractual Adjustments, and Overstatement of
Assets.
Contractual Adjustments

Fraudulent contractual adjustments comprised more than 80% of

HealthSouths misstatements. A contractual adjustment is a part of
a patient's bill that a doctor or hospital must write-off because of
billing agreements with the insurance company. It is a contrarevenue account subject to estimation, which implies that its
difficult for auditors to confirm or verify its existence or value. This is
where management discretion and deceptive gimmicks came into
play. HealthSouth deliberately underestimated the contractual
adjustment to inflate revenue, and at the same time overstated its
fixed assets to make it balance.
Overstatement of Assets
Management would compare the companys true earnings to
earnings expected by Wall Street analysts, and decide how much
adjustments would be necessary to fill the gap.
A production line by the name of AP Summary was falsified for
the purpose of inflating fixed asset amount. Knowing that the
auditors set the materiality for transactions at $5,000, company
employees would only make adjusting entries with dollar amounts
between $500 and $4,999 rather than one lump sum that might
attract

attention

from

regulatory

authorities.

Besides,

each

adjustment amounts were deliberately made different so as to lower

suspiciousness. Consider the nearly $5 Billion overstatement in
HealthSouths revenue.
Assuming that the average journal entry was $2,500 to fend off
auditor detection, it would have required at least two million journal
entries to cover the fraud. This volume of work indicated severe
collusion and lack of proper internal control within the company.
In HealthSouth case, we believe that there are several deficiencies
in the internal control. Here is some suggestion for HealthSouth.
Management override

The most serious problem is management override.

Weston Smith had joined Scrushy in 1987 and in 2001 became
CFO, manipulating ledgers to scheme auditors and keeping sold
assets on the balance sheets, among other tricks.
The CFO himself should have monitored and ensured the
implementation of internal control. However, he overrode the
internal control and manipulated the financial reports.
To solve this problem, the board of director should set a hotline
which will guarantee confidentiality of whistleblowers. Besides board
of director should give ethic training to the managements and
employees to create a control environment of integrity.

Segregation of Duties
From the beginning, we were putting things on the balance sheet
that probably should have stayed on the profit and loss statement.
HealthSouth should design and implement internal control for
segregation of duty and the access to asset database. The board of
director mist be responsible to review and monitor their internal
control frequently.
HealthSouth should separate approval of transaction from cash
handing and bookkeeping. These three functions must be separated
under sound internal control.