Accounting Fraud - Sunbeam Corporations Financial Reporting Issue - Case Study Example

EXECUTIVE SUMMARY This report focuses one of the financial frauds which deals with Sunbeam Corporations Financial Reporting Issue. The report focuses on the environmental factors which existed during the time when such a fraud occurs, the report then shifts to how the fraud actually occurred by highlighting the financial data of Sunbeam for the period 1996 to 1998. The report highlights the real reasons for the growth of Sunbeam which was on account of false and misleading financial figures. On close investigation by SEC it was further found that Sunbeam in charge of its CEO, Mr. Dunlap not just materially misstated the financial data but violated various standards and laws issued by GAAP and Securities and Exchange Act respectively which included inflated sales, creating cookie jar reserves, bill and hold transactions, falsified acquisition accounting etc among others. The report then also highlights how the fraud was actually discovered by SEC and legal and regulatory actions taken by the courts for defying various standards and laws. Finally the report is concluded to provide a complete understanding of both theoretical and practical aspects covering the entire topic under discussion. TABLE OF CONTENTS 1.0 Introduction 3 2.0 About Sunbeam Corporations 4 3.0 Environmental factors in which the fraud occurred 4 3.1 General Environment 4 4.0 Occurrence of the fraud 5 4.1 Sunbeam’s financial 1996-1998 6 4.2 Real reasons for growth 7 5.0 Discovery of fraud 8 6.0 Legal and regulatory impact of fraud 10 7.0 Conclusion 10 8.0 Refernces 12 1.0 INTRODUCTION This report focuses on a complete analysis of an incident involving fraud and forensic accounting. The case taken here for the same includes a complete discussion on the Sunbeam Corporation financial reporting issues. The report has been prepared in a sequential and synchronized manner which includes a discussion on the various environmental factors that existed when the fraud took place, a discussion on how the fraud actually occurred and came into the existence along with a discussion of how the fraud was ultimately discovered. The report also covers the various methods, techniques and accounting investigation which has been used to ultimately discover and prove the fraud. Finally the impact of the fraud has been discussed in brief to provide a better understanding of the affects of the same. Lastly the report is concluded to provide both practical and theoretical meaning to ensure a complete summary of the report and provide a deeper meaning of the entire report. 2.0 ABOUT SUNBEAM CORPORATIONS Sunbeam Corporations came into existence in 1897 as the Chicago Flexible Shaft Company and originally dealt in manufacturing mechanical horse clippers. Later the company shifted towards various consumer goods like toaster, mixers, coffeemakers etc. During 1960, Sunbeam Corporations decided to acquire Oster’s which allowed the company to further diversify its products range into home products like hair dyer and other health and beauty related products. Sunbeam Corporations constantly seek towards new innovations in its product range and later included products like electric blankets, mattresses, humidifiers, vaporizers and thermostats (Business, Wire, 1998). It is to be noted with huge product differentiation and large product lines with quality products at affordable prices the company soon became of the leading manufacturers of electric appliances. In 1981 Sunbeam Corporations was finally acquired by Allegheny International and was the most profitable unit for Allegheny International, however the company was eventually forced into bankruptcy due to poor management and frauds which lead Sunbeam Corporations to face a bundle of major financial difficulties under Al Dunlap who was recruited in 1996 as 20% stockholder of the company and engaged in various financial and forensic frauds like massive restructuring to inflate stock prices, inflated sales, recording revenue on contingent sales, accelerating sales from previous quarters into present quarter and involving in bill and hold transactions among various others. 3.0 ENVIRONMENTAL FACTORS IN WHICH THE FRAUD OCCURRED Environmental factors play a major role in boosting up frauds and unfair means which acts as lucrative factors and enable organizations to engage in unfair means to boost up stock prices and inflate sales figure in order to adapt to unethical means. Here is a discussion of the environmental factors which existed at the time when Sunbeam Corporations engaged into major difficulties in reporting its financial statements. 3.1 GENERAL ENVIRONMENT Economic With a long lasting “Bull” market and financial prosperity, the economic environment has been largely in favor of most of the US companies specially firms in home appliances industry. On the other side of the coin many companies were facing financing downturns by increasing productions in recessive markets (DeGeorge, 1995). Home appliances companies relied on a considerable extent on consumer discretionary incomes and with large international operations in multiple countries, sunbeam was largely exposed to fluctuations in foreign and domestic currency exchange rates. Social/Cultural During the 1990’s there was a large demand for time saving small appliances and people were willing to pay premium prices for such products. This certainly provided an opportunity for home appliances companies and Sunbeam Corporation was no exception to the same. However in lure of higher super normal profits quality was exposed to a considerable extent. People acted as investors seeking higher profits from stocks which performed well in the stock markets and has large sales as the same promised higher revenue recognition and higher returns for small investors as well. Political/Legal Political and legal factors did not have any stringent compliance for home appliances companies apart from the normal regulations and responsibilities as was required by others in the industry (Byrnes, 1998). However, it is to be noted that Sunbeam’s manufacturing unit in Venezuela served the Latin-American region well as the company was subjected to usual risks of conducting businesses internationally, which included high import tariffs, trade restrictions and various quotas among others. Technological With technological advancements and changing consumer taste and preferences there was a huge demand for smart home appliances which was nicely catered by Sunbeam Corporations with its huge spending on the Research and Development Department. Sunbeam was thus able to draw huge trust and confidence among the general masses and its products were usually considered superior to other. Sunbeam further gained efficiency through EDI and JIT warehouse management system. Thus we see the general environment possessed both threats and opportunities for Sunbeam Corporation in light of which the company decided upon the following three crucial decisions which laid down a platform for Sunbeam to enter into frauds rather than entering into fair means and ensure higher profits. Sunbeam decided to enter into triple acquisitions to make the company highly leveraged and strapped for higher cash and liquidity (Nocera, 1996). Al Dunlap lacked experience in running the corporation efficiently and much was attracted towards earning shorter profits than focusing on long run objectives (Nocera, 1996) The company’s business was in its maturity phase with low growth and squeezing profits and the company certainly needed a catalyst to boost up its sales and profits (Nocera, 1996) 4.0 OCCURENCE OF THE FRAUD The story of Sunbeam is yet another financial statement fraud. Sunbeam Corporation was languishing when it finally decided to bring Al Chainsaw Dunlap in 1996 which triggered the occurrence of what the world view as one of the largest financial fraud in the history. To understand how the fraud actually took place it is important to have a look at the financials of the company during the period 1996-1998 which has been discussed as under. 4.1 SUNBEAM’S FINANCIALS 1996-1998 Sunbeam decided a restructuring plan and created accounting reserves which increased the Sunbeam’s financial loss for the year 1996. It is to be noted that Securities and Exchange Commission complaint which was filed in 2001, the same was done to build a platform towards fraud as the same was allegedly used to inflate income of the coming year i.e. 1997, thus highlighting a picture of false picture of a rapid turnover which Sunbeam was to experience in the year 1997. 1996 It is a strange fact that Al Dunlap was very vocal in his sayings that he could literally do nothing to save Sunbeam in 1996. He is his powerful stakeholder releases announced that the year 1996 was a loss year for Sunbeam Corporations and the company is looking towards an implementation of a restructuring plan which shall definitely yield favorable results in the very first quarter of 1997 and ensure higher returns and better management of the company for future years with remarkable performances. Dunlap was looking towards 1997 as a turnaround year for Sunbeam Corporations by implementing his designed restructuring plan (Dunlap & Andelman, 1996). 1997 As was promised by Dunlap, 1997 saw a complete turnover for Sunbeam Corporation in terms of its financial reporting. The stock price rose to climbing heights nearly touching $50 per stock. Sales and net income showed a record move in terms of its increasing trend. The stock price was about highest in the industry with an overall increase in sales of over 22% which was much higher than any expectations of any analyst. Dunlap reported that the increase and significant growth was on account of introduction of 35 new US products and 54 new international products. International sales went up by about 34% and Dunlap was pleased to announce the 4th quarter results which showed a 20% operating margin for the last quarter with an overall operating margin of 17% for the year 1997. Dunlap was even more optimistic in his 1998 growth and promised a further growth with its new international expansion and introduction of new products to its existing product line category. 1998 By the end of first quarter of 1998, Sunbeam completed its acquisition of Coleman. However the earning of the company was slightly below the first quarter’s earnings of 1997 and Dunlap announced that with new acquisitions and new synergies the company shall have the best results in the year 1999 and that the year 1998 would be a transition year of implementing new strategies and techniques (Robinson and Munter, 2004). 4.2 REAL REASONS FOR GROWTH It is be noted that while Dunlap announced the reason for the significant turnaround of Sunbeam was due to introduction of new product lines, innovations and global expansion. The real reason for the same was completely different and can be sensed as one of the largest frauds under the complete guidance of Dunlap. Techniques Used It was on 6th August 1998, that Sunbeam announced that the audit committee had determined that Sunbeam needs to restate its financial statements for the year 1997, the first quarter of 1998 and possibly 1996. Finally on October 20, 1998 Sunbeam restated its financial statement for 6 quarters which included last quarter of 1996, four quarters of 1997 and 1st quarter of 1998. The restatement had a huge impact on the financial figures as the company reduced the loss of last quarter of 1996 by $ 20 million which was nearly a 9 percent cut from its previous reported figure, it reduced 1997 net income by $ 71 million which was about 65 percent of its reported earning and increased earnings of 1998 by $ 10 million which lead to a 21 percent recovery of losses from its earlier reported figures. It was determined that the reported figures of 1997 were inflated at the cost of 1996 (Laing, 1997). Further revenue was not recognized as per correct accounting standards and certain costs and allowances were falsely accrued and recorded to inflate the figures. The consolidated financial statements showed signs of improper restructuring, false impairment of assets and other related costs. DOLLARS IN MILLIONS Affected Financial Data Fiscal year 1996 Fiscal year 1997 1st Quarter 1998 Net income/(loss)as reported $(228.3) $109.4 $(44.6) Net income/(loss) as reported $(208.5) $38.3 $(54.1) It is to be noted further than soon after Dunlap took in-charge Sunbeam saw mass firing of its existing employees on account of higher cost structure and vague reasons. One could easily sense on a closer look at the financials an overstatement of loss filings. On examination, it was determined that Sunbeam Corporations created “Cookie-Jar” reserves and inflated huge profits for 1997 by about US$60 million which was equally backed and supplemented by false sales. According to Securities Exchange and Commission, Dunlap and its team mates used various fraudulent techniques which ranged from falsified sales, recognition of sales on contingent items, mismatching sales from last quarter to current quarters and using improper method of “Bill and hold” transactions. Reports show that Sunbeam Corporations was involved in “Channel Stuffing” technique which concentrated on accelerating sales artificially at the closure of the financial year by offering its distributors and dealers special incentive and schemes and ensure higher purchase of goods than the actual requirement (DeGeorge, 1994). This was a unique technique which helped Sunbeam to dramatically boost up the share prices with a guaranteed promise of significant future growth and attracted more investors towards the company. Effect on Share price Sunbeam stocks were listed and traded on The New York Stock Exchange, however the same was delisted in 2001, after the massive confirmation of fraudulent practices by Sunbeam Corporations. It was on 4th March 1998 that the stock touched it’s all time record high of $52 per share however the stock than continued to fall to reach $34 per share due to various profit warning signals (Gibson, 2007). Finally with a confirmed reporting of fraudulent practices of Sunbeam by SEC and removal of Dunlap affected the stock largely and it felt by $20 per share to reach at a level of $ 10.375 per share implying huge losses for the investors and complete bankruptcy for Sunbeam Corporations. Daily Stock Prices for Sunbeam, December 1, 1997–December 31, 1998 5.0 DISCOVERY OF THE FRAUD Statement of Auditing Standard 99 (SAS.99) requires auditors to focus on two major issues which are Fraudulent financial reporting and Misappropriation of assets Which were both defied by Sunbeam Corporations by indulging in inflating sale figures and wrongful impairment of assets. Initially sham profits were discovered by its auditors which were however ignored. It was after the restatement of figures of 1997 which brought SEC to keep an eye over the various transactions and investigate on the results declared by Sunbeam Corporations. On close investigation it was discovered that Sunbeam has violated many sections of Securities Act and Exchange Act which included filing false and materially misleading periodic reports with the commission and disseminated false and fraudulent public statements. Sunbeam was further found violating many accounting standards issued by Generally Accepted Accounting Principles (GAAP). It violated Accounting Standard 5 by, creating a $12 million reserve against its potential liability which was overstated by around $6 million as per GAAP. Sunbeam was involved in making “Cookie Jar” reserves for inflating its figures and involved in huge “bill and hold sales”. The company was found recognizing revenue improperly on purported sales of its parts inventory. It disclosures were materially false and aimed to attract large investors through false inflated profit and growth figures. SEC, found Sunbeam to adapt to additional expedients to forestall an earnings shortfall during the first quarter of 1998 which was not in proper recognition as per the accounting standard of revenue recognition issued by GAAP (Byrne, 1998). There are various methods and standards which strictly abide companies to follow any such method to inflate earnings which was found to be implemented by Sunbeam. It includes creating acquisition accounting which was defied by Sunbeam in its acquisition of Coleman, Signature brands and First Alert, creating “Cookie Jar” liability reserves, Revenue recognition irregularities which Sunbeam implemented by inflating sales of various quarters in different quarters from 1996 to 1998, using materiality concept to record small but intentional misstatements and falsified figures in its financial statements etc (Linden, 1995). Sunbeam was found to be accused of all these standards in lure of higher attractive profits and misleading common investors by creating large materially misstatements in its reported financial figures. It can be rightly said that the actions of Al Dunlap, the CEO of Sunbeam brought the skepticism of fraud in the mind of SEC investigation agency, further Arthur Anderson was the independent auditor of the company and wrote unqualified opinions for Sunbeam although he was allegedly aware about Sunbeam’s accounting fraud, improprieties and disclosure failure. The fraud can be eventually said to be discovered with the very onset of restatement of financials which showed a rapid turnaround in the company’s performance and later on a closer investigation by SEC it was finally discovered that Sunbeam has been violating many GAAP standards and other mandatory disclosures which were either not disclosed or falsely disclosed (Ellis, 1996). 6.0 LEGAL AND REGULATORY IMPACT OF FRAUD On discovery of a huge financial fraud being accelerated and accomplished by Sunbeam Corporations, a consolidated class law suit was filed against Sunbeam and its independent auditor, Arthur Andersen in 1999. The complaint alleged among other things, violation of various sections of Securities Exchange Act and misrepresentation of financial statements by violating various standards issued by GAAP and which were mandatory for the company to follow. The suit reached its final settlement, however Sunbeam was a party to the same due to its previous filing of bankruptcy. The total settlement amount was a huge liability of US$141 million, of which the largest portion was agreed to be paid by its independent auditor Arthur Andersen which amounted to $110 million (Byrne, 1999). Mr. Dunlap had to pay US$15 million while rest amount were paid by firms which had policies covering Sunbeam’s officials. It is to be further noted that various administrative proceedings were also filled against Sunbeam for providing misleading information in its financial figures for the period starting from last quarter of 1996 to first quarter of 1998, improper use of hold and bill transactions, creating false reserves like cookie jar reserves etc. Administrative actions were also filled against David Fannin, former Sunbeam general counsel, for his participation in the drafting of misleading and falsified press releases on company’s operations. As a result of all such action suits, Dunlap and Kersh finally admitted their guilt and paid huge monetary settlements and were finally barred to act as an officer or director of any public company. Sunbeam suffered largely with bankruptcy, delisted shares from major stock exchanges and low stock prices which continued to fall on a continuous basis. Various civil suits were brought up against many officers of Sunbeam along with its independent auditors, some of which are still pending and decisions are yet to be made. It can however be concluded that what once seems to be one of the most dominating companies in the field of appliances industry was shattered to earth and the world witnessed yet another financial fraud which in no fields was smaller to larger frauds like Enron etc. 7.0 CONCLUSION The report has been prepared to highlight all major factors and conditions which existed during the fraud of Sunbeam Corporations. The report first provides an understanding of the general environmental conditions along with how Sunbeam in-charge of its new CEO, Dunlap took to massive firing and violated many standards and laws issued by Securities Exchange Act and GAAP. On close investigation Sunbeam was found to be alleged of creating cookie jar reserves, involved in hold and bill transactions, false acquisition accounting, falsified representation of its financial statements for a period of 6 quarters which ranged from last quarter of 1996 to first quarter of 1998. The report also provides a complete movement of its stock prices and its financial figures as reported earlier and after restricting for the fraud period. Finally the report highlights the various legal and regulatory suits brought against Sunbeam Corporations and its independent auditor along with the decisions and penalties imposed through various legal and civil courts. Thus in a nut shell the report provides a complete understanding of both theoretical and practical aspects and factors which led to one of the largest financial fraud in the history of financial accounting. 8.0REFERNCES Business, Wire, (1998). Sunbeam Corporation Lowers First Quarter Sales and Earnings Expectations; Names Lee Griffith President of Household Products Business. Byrne, A., (1999). Chainsaw: The Notorious Career of Al Dunlap in the Era of Profit-At-Any-Price, Harper Collins, New York. Byrne, A., (1998). How Al Dunlap Self-Destructed. Business Week (Issue 3585), 58-65. Byrnes, N, (1993). Stalking Horse. Financial World 162(21), 28-29. DeGeorge, G. (1994). Why Sunbeam is Shining Brighter. Business Week (Issue 3387), 74. DeGeorge, G. (1996). Al Dunlap Revs His Chainsaw. Business Week (Issue 3503), 37. Dunlap, J. & Andelman, B. (1996). Mean Business: How I Save Bad Companies and Make Good Companies Great, (New York: Simon & Schuster). Ellis, J, (1996). What Sunbeam Isn‟t Saying About Its Savior CEO and its 50% Stock Spurt. Money 25(9), 29-30. Frank, R. and Joann, S. (1996). Dunlap‟s Ax Falls – 6000 Times – at Sunbeam. The Wall Street Journal. Gibson, H., (2007). Financial Reporting and Analysis: Using Financial Accounting Information, 10th edition. (Thomson South-Western Publishers). Laing, R., (1997). “High Noon at Sunbeam: Does Chainsaw Al Have A Truly Revived Operation – or Something Else – In His Sights?” Barron’s Linden, W, (1995). “You Want Somebody to Like You, Get a Dog.” Forbes Nocera, J. (1996). “Confessions of a Corporate Killer.” Fortune 134 (6), 200-204. Robinson, R. and Munter, P. (2004). “Financial Reporting Quality: Red Flags and Accounting Warning Signs.” Commercial Lending Review 19(1), 2-15. Read More