Every time an auditor walks into a warehouse to count inventory, they're following a procedure that didn't exist before December 1938. That's when the McKesson & Robbins scandal—one of the most spectacular frauds in American business history—forced the accounting profession to fundamentally change how audits are conducted.
The fraud was staggering in scope: $87 million in fictitious assets (equivalent to over $1.8 billion today), including $19 million in non-existent inventory and $68 million in fabricated accounts receivable. But the real shock wasn't the size of the fraud—it was how easily it fooled one of the most respected audit firms of the era.
This is the story of Philip Musica, the con artist who built a pharmaceutical empire on lies, and how his downfall created the inventory observation procedures that auditors still follow today under PCAOB AS 2510 and AU-C 501.
"The auditors never asked to see the inventory. They never asked to see the customers. They just took our word for it."
— Philip Musica (F. Donald Coster), in SEC testimony, 1939
Timeline of the McKesson & Robbins Scandal
Philip Musica Born
Born in Naples, Italy. Family immigrates to New York in 1890.
First Fraud Conviction
Musica convicted of bribing customs officials. Serves three years in prison.
Takes Over McKesson & Robbins
Using the alias "F. Donald Coster," Musica acquires control of the 93-year-old pharmaceutical company.
Fraud Peaks
Fictitious assets reach $87 million. Company reports record profits.
Fraud Discovered
Treasurer Julian Thompson questions crude drug inventory. Investigation begins. Musica commits suicide December 16.
SAP No. 1 Issued
American Institute of Accountants issues Statement on Auditing Procedure No. 1, requiring physical inventory observation.
PCAOB AS 2510 Adopted
Modern inventory observation standard codifies procedures that originated from McKesson & Robbins.
The Man Behind the Fraud
Philip Musica was born in Naples, Italy, in 1884. His family immigrated to New York in 1890, where his father opened a small barbershop. By age 16, Philip had taken over the family's hair import business and was already demonstrating the cunning that would define his career.
In 1909, Musica orchestrated his first major fraud: he bribed customs officials to undervalue imported goods, saving hundreds of thousands in duties. When caught in 1913, he cooperated with prosecutors, testified against corrupt officials, and served only three years in prison—a pattern of manipulation and reinvention that would repeat throughout his life.
After his release, Musica changed his name to "Frank Costa" and entered the bootlegging business during Prohibition. He made millions selling illegal alcohol, then used those proceeds to purchase legitimate businesses. In 1926, he assumed the identity of "F. Donald Coster," complete with a fabricated medical degree from Heidelberg University, and acquired McKesson & Robbins, a respected 93-year-old pharmaceutical company.
The Coster Persona
As F. Donald Coster, Musica created an elaborate backstory:
- Claimed to have earned a medical degree from Heidelberg University in Germany
- Said he had worked as a physician before entering business
- Presented himself as a pharmaceutical expert and innovator
- Cultivated relationships with New York's business and social elite
- Served on corporate boards and charitable organizations
The persona was so convincing that no one questioned his credentials for 12 years.
The Scheme
Musica's fraud at McKesson & Robbins was elegant in its simplicity. He created a fictitious crude drug division that supposedly purchased raw materials from Canada, processed them, and sold them to customers around the world. The entire operation existed only on paper.
How the Fraud Worked:
Fictitious Suppliers
Musica created fake Canadian suppliers who supposedly sold crude drugs to McKesson. His brothers operated these shell companies.
Phantom Inventory
The company recorded millions in inventory that never existed. Warehouses listed in financial statements were empty or non-existent.
Fake Customers
Musica created fictitious customers who supposedly purchased the processed drugs. These "customers" generated millions in fake accounts receivable.
Circular Cash Flow
Money from the legitimate pharmaceutical business was cycled through the fake crude drug division to create the appearance of sales and collections.
Auditor Deception
When auditors requested confirmations, Musica's brothers (using fake identities) responded confirming the fictitious transactions.
By 1937, the crude drug division represented nearly 20% of McKesson's total assets. The company's stock was trading on the New York Stock Exchange, and Musica was celebrated as a pharmaceutical industry leader. The fraud had grown so large that it required constant attention to maintain—Musica and his brothers spent their days creating fake invoices, shipping documents, and correspondence to support the illusion.
"We created an entire business that existed only in ledgers and file cabinets. The auditors never questioned it because the paperwork was perfect."
— George Musica (George Vernard), Philip's brother, in SEC testimony
Discovery
The fraud began to unravel in October 1938 when Julian Thompson, McKesson's treasurer, questioned why the crude drug division held such large inventory balances. Thompson was concerned about the company's liquidity and wanted to convert some inventory to cash. When he pressed for details about the inventory's location and marketability, Musica became evasive.
Thompson took his concerns to the board of directors, who authorized an investigation. When investigators attempted to visit the warehouses supposedly holding millions in crude drugs, they found them empty or non-existent. Attempts to contact suppliers and customers revealed that the companies didn't exist or had no relationship with McKesson.
On December 5, 1938, the board confronted Musica with the evidence. He initially denied wrongdoing but quickly realized the game was over. On December 16, 1938, as federal investigators closed in, Philip Musica locked himself in his bathroom and shot himself in the head. He left no note.
The Auditor's Failure
Price Waterhouse & Co., one of the most prestigious accounting firms of the era, had audited McKesson & Robbins for years without detecting the fraud. The SEC investigation revealed shocking gaps in audit procedures:
- No physical inventory observation: Auditors never visited warehouses or observed inventory counts
- Reliance on management representations: Auditors accepted management's inventory listings without independent verification
- Inadequate confirmation procedures: Confirmations were sent to addresses controlled by Musica's brothers
- No investigation of unusual transactions: The crude drug division's consistently high margins and rapid growth went unquestioned
- Limited analytical procedures: Auditors didn't compare crude drug operations to industry norms or investigate anomalies
The Aftermath
The McKesson & Robbins scandal sent shockwaves through the business and accounting communities. The SEC launched a comprehensive investigation, and the American Institute of Accountants (predecessor to the AICPA) formed a special committee to examine audit procedures.
In 1939, the Institute issued Statement on Auditing Procedure No. 1, which fundamentally changed how audits are conducted. For the first time, auditors were required to:
SAP No. 1 Requirements (1939)
- Observe physical inventory counts: Auditors must be present during inventory counts and perform test counts
- Confirm accounts receivable: Direct confirmation with customers, not through management
- Obtain independent evidence: Auditors must seek evidence from sources outside the client organization
- Exercise professional skepticism: Question management representations and investigate unusual transactions
These requirements, revolutionary at the time, became the foundation of modern auditing standards. Today's PCAOB AS 2510 and AU-C 501 are direct descendants of SAP No. 1, refined over decades but still rooted in the lessons learned from McKesson & Robbins.
The Standards McKesson Created Still Govern Auditing Today
See our complete guide to PCAOB AS 2510 inventory observation requirements.
Read the AS 2510 GuideLegacy
The McKesson & Robbins scandal's impact on the accounting profession cannot be overstated. It transformed auditing from a primarily clerical function—verifying mathematical accuracy and compliance with accounting principles—into an investigative process designed to detect fraud and provide reasonable assurance about financial statement accuracy.
Before McKesson & Robbins
- Auditors relied on management representations
- No requirement to observe inventory
- Limited independent verification
- Focus on clerical accuracy, not fraud detection
- Confirmations sent through management
After McKesson & Robbins
- Mandatory physical inventory observation
- Direct confirmation with third parties
- Independent evidence gathering
- Professional skepticism required
- Analytical procedures and risk assessment
"The McKesson & Robbins case marked the beginning of modern auditing. It forced the profession to recognize that auditors must be detectives, not just accountants."
— SEC Commissioner Robert E. Healy, 1940
Modern Relevance
Eighty-six years after the McKesson & Robbins scandal, inventory observation remains one of the most critical—and most frequently deficient—audit procedures. The PCAOB's 2024 inspection findings show that inventory deficiencies appeared in 68% of inspected audits, suggesting that the lessons of McKesson & Robbins are still being learned.
Why Inventory Fraud Still Happens
Despite modern standards and technology, inventory fraud remains common because:
- Inventory is easy to manipulate: Physical goods can be moved, hidden, or misrepresented
- Valuation is subjective: Obsolescence, net realizable value, and lower-of-cost-or-market require judgment
- Complex supply chains: Multi-location inventory, third-party logistics, and just-in-time systems create opportunities for fraud
- Pressure to meet targets: Management faces constant pressure to meet earnings expectations
- Inadequate internal controls: Many companies lack robust inventory controls and cycle count programs
The procedures created in response to McKesson & Robbins—physical observation, independent confirmation, professional skepticism—remain the best defense against inventory fraud. But as the PCAOB findings show, these procedures must be executed rigorously and with adequate resources.
Frequently Asked Questions
How much money did Philip Musica steal from McKesson & Robbins?
The fraud involved $87 million in fictitious assets ($19 million in inventory and $68 million in accounts receivable), equivalent to over $1.8 billion today. However, Musica didn't directly steal this money—he used it to inflate the company's apparent value and maintain his lifestyle. The actual cash stolen was much less, but the fraud destroyed shareholder value and damaged the company's reputation.
Why didn't the auditors detect the fraud?
Before McKesson & Robbins, auditing standards didn't require physical inventory observation or independent confirmation of accounts receivable. Auditors relied on management representations and internal documents, which Musica fabricated. The fraud revealed fundamental gaps in audit procedures that were subsequently addressed by SAP No. 1 in 1939.
What happened to McKesson & Robbins after the fraud?
The company survived the scandal, reorganized, and eventually became McKesson Corporation, one of the largest pharmaceutical distributors in the world today. The legitimate pharmaceutical business was sound—only the fictitious crude drug division was fraudulent. The company's recovery demonstrated that the underlying business had real value despite the fraud.
How did Philip Musica maintain the fraud for 12 years?
Musica was meticulous in creating supporting documentation—fake invoices, shipping documents, correspondence, and confirmations. His brothers operated the shell companies and responded to auditor inquiries. The crude drug division was kept separate from the legitimate pharmaceutical business, limiting the number of people who could detect the fraud. Additionally, the company's legitimate operations were profitable, which helped mask the fictitious division's anomalies.
Could a McKesson & Robbins-type fraud happen today?
While modern auditing standards make such a fraud more difficult, it's not impossible. The procedures created in response to McKesson & Robbins—physical observation, independent confirmation, analytical procedures—are designed to detect such schemes. However, as recent PCAOB inspection findings show, these procedures must be executed properly. Sophisticated fraudsters can still exploit gaps in audit procedures, particularly in complex, multi-location operations.
What is the connection between McKesson & Robbins and PCAOB AS 2510?
PCAOB AS 2510, adopted in 2003, is the modern codification of inventory observation procedures that originated with SAP No. 1 in 1939. The requirements in AS 2510—physical observation, test counts, evaluation of client procedures, alternative procedures when observation is impracticable—are direct descendants of the procedures created in response to McKesson & Robbins. The standard represents 86 years of refinement of the lessons learned from that fraud.
86 Years Later, CPCON Helps Auditors Fulfill the Mandate McKesson & Robbins Created
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