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2.5
Case
Sunbeam: Due
Professional Care
Synopsis
In April 1996 Sunbeam named Albert J. Dunlap as its CEO and chairman.
Formerly with Scott Paper Co., Dunlap was known as a turnaround specialist
and was even nicknamed “Chainsaw Al” because of the cost-cutting measures he typically employed. Almost immediately Dunlap began replacing
nearly all of the upper management team and led the company into an
aggressive corporate restructuring that included the elimination of half of its
12,000 employees and 87 percent of Sunbeam’s products.
Unfortunately, in May 1998 Sunbeam disappointed investors with its
announcement that it had earned a worse-than-expected loss of $44.6 million in the first quarter of 1998.1 CEO and Chairman Dunlap was fired in
June 1998. In October 1998 Sunbeam announced that it would need to
restate its financial statements for 1996, 1997, and 1998.2
Arthur Andersen
Sunbeam’s auditor, Arthur Andersen, came under fire for having issued an
unqualified opinion on the company’s financial statements for both 1996 and 1997.
In January 1999 a class action lawsuit alleging violation of the federal securities
laws was filed in the U.S. District Court for the Southern District of Florida against
Sunbeam, Arthur Andersen, and Sunbeam executives. The suit reached the settlement stage in 2001. As part of the settlement, Andersen agreed to pay $110 million.3
1
Robert Frank and Joann S. Lublin. “Dunlap’s Ax Falls—6,000 Times—at Sunbeam,” The Wall
Street Journal, November 13, 1996, p. B1.
2
GAO-03-138, Appendix XVII “Sunbeam Corporation,” p. 201.
3
Nicole Harris, “Andersen to Pay $110 Million to Settle Sunbeam Accounting-Fraud Lawsuit,” The
Wall Street Journal, May 2, 2001, p. B11.
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Not surprisingly, Phillip Harlow, the engagement partner in charge of the
Sunbeam audit during this period, also found himself under fire on an individual basis for his work on the audits. The Securities and Exchange Commission
(SEC) barred Harlow from serving as a public accountant for three years after it
found that Harlow failed to exercise due professional care in auditing Sunbeam’s financial statements.4
The 1996 Audit
Through the 1996 audit, Andersen partner Phillip Harlow allegedly became
aware of several accounting practices that failed to comply with GAAP. In
particular, he allegedly knew about Sunbeam’s improper restructuring costs,
excessive litigation reserves, and an excessive cooperative advertising figure.
Improper Restructuring Costs
During the 1996 audit, Harlow allegedly identified $18.7 million in items
within Sunbeam’s restructuring reserve that were improperly classified as
restructuring costs because they benefited Sunbeam’s future operations. Harlow
proposed that the company reverse the improper accounting entries, but management rejected his proposed adjustments for these entries. Harlow relented
on his demand after deciding that the items were immaterial for the 1996
financials.5
Excessive Litigation Reserves
Sunbeam also failed to comply with GAAP on a $12 million reserve recorded
for a lawsuit that alleged Sunbeam’s potential obligation to cover a portion of
the cleanup costs for a hazardous waste site. Management did not take appropriate steps to determine whether the amount reflected a probable and reasonable estimate of the loss, as required by GAAP. Had they done so, the reserve
would not have passed either of the criteria. The SEC determined that Harlow
relied on statements from Sunbeam’s general counsel and did not take additional steps to determine whether the litigation reserve level was in accordance
with GAAP.6
The 1997 Audit
The SEC also found that Harlow discovered several items that were not compliant with GAAP during the 1997 audit. These items related to revenue, the
4
Cassell Bryan-Low, “Deals & Deal Makers,” The Wall Street Journal, January 28, 2003, p. C5.
SEC Accounting and Auditing Enforcement Release No. 1393, May 15, 2001.
6
SEC Accounting and Auditing Enforcement Release No. 1706, January 27, 2003.
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Case 2.5 Sunbeam: Due Professional Care 69
restructuring reserves, and inventory, in particular. In several cases he proposed
adjustments that management refused to make. In response to management’s
refusal, Harlow acquiesced, however. By the end of 1997, it appears Harlow
knew that approximately 16 percent of Sunbeam’s reported 1997 income
came from items he found to be not in accordance with GAAP.7 In fact, at
least $62 million of Sunbeam’s reported $189 million of income before tax
failed to comply with GAAP.8 The following examples illustrate two of the
different techniques used by Sunbeam to overstate revenue earned.
Bill and Hold Sales
The SEC wrote in its findings that Harlow “knew or recklessly disregarded
facts, indicating that the fourth-quarter bill and hold transactions did not
satisfy required revenue recognition criteria.”9 Among other things, Sunbeam’s revenues earned through bill and hold sales should not have been
recognized because these sales were not requested by Sunbeam’s customers,
and they served no business purpose other than to accelerate revenue recognition by Sunbeam. Sunbeam offered its customers the right to return any
unsold product. Further, several of Sunbeam’s bill and hold transactions
were also characterized by Sunbeam as offering its customers financial
incentives, such as discounted pricing, to write purchase orders before they
actually needed the goods.10
Sale of Inventory
Sunbeam’s fourth quarter revenue included $11 million from a sale of its
spare parts inventory to EPI Printers, which, prior to this transaction, had
satisfied spare parts and warranty requests for Sunbeam’s customers on an
as-needed basis. As part of the transaction, Sunbeam agreed to pay certain
fees and guaranteed a 5 percent profit for EPI Printers on the resale of the
inventory. The contract with EPI Printers also stipulated that it would terminate in January 1998 if the parties did not agree on the value of the inventory
underlying the contract.
Harlow allegedly knew that revenue recognition on this transaction did
not comply with GAAP due to the profit guarantee and the indeterminate
value of the contract. Thus Harlow proposed an adjustment to reverse the
accounting entries that reflected the revenue and income recognition for
this transaction. Yet Harlow acquiesced in management’s refusal to reverse
the sale.11
7
SEC Accounting and Auditing Enforcement Release No. 1706, January 27, 2003.
SEC Accounting and Auditing Enforcement Release No. 1393, May 15, 2001.
9
SEC Accounting and Auditing Enforcement Release No. 1706, January 27, 2003.
10
SEC Accounting and Auditing Enforcement Release No. 1393, May 15, 2001.
11
SEC Accounting and Auditing Enforcement Release No. 1706, January 27, 2003.
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Case Questions
1. Consider the alleged accounting improprieties related to increased expenses
from the 1996 audit. If you were auditing Sunbeam, what type of evidence
would you like to review to determine whether Sunbeam had recorded the
litigation reserve amount and the cooperative advertising amount in accordance with GAAP?
2. For the excessive litigation reserves and excessive cooperative advertising
amount, identify the journal entry that is likely to have been proposed by
Andersen to correct each of these accounting improprieties. Why would
Sunbeam be interested in recording journal entries that essentially reduced
its income before tax in 1996?
3. As discussed in the case, during both the 1996 and 1997 audits, Phillip
Harlow allegedly discovered a number of different accounting entries
made by Sunbeam that were not compliant with Generally Accepted
Accounting Principles (GAAP). Speculate about how Harlow might have
explained his decision not to require Sunbeam to correct these alleged
misstatements in the audit working papers.
4. Consult Paragraph 69 of PCAOB Auditing Standard No. 5 and Sections 204
and 301 of SARBOX. In the post-Sarbanes audit environment, which of the
issues that arose in 1996 and 1997 would have to be reported to the audit
committee at Sunbeam? Do you believe that communication to the audit
committee would have made a difference in Harlow’s decision not to record
the adjusting journal entries? Why or why not?
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