Sunbeam_Case

Sunbeam Case I’ve learned that there are three conditions that are likely to be present when fraud occurs. These three conditions are also known as the “fraud triangle”, and it consists of incentives/pressures, opportunities, and attitudes/rationalization. As I read through the Sunbeam case, I noticed that the most prevalent condition that’s apparent throughout the case is the incentive/pressures condition. There were multiple instances where management and other employees were pressured into fraudulent financial reporting. They were provided with strong incentives that made them more susceptible to committing fraud. Albert J. Dunlap was appointed to becoming CEO and Chairman of the Sunbeam Company in April of 2006. Very soon after taking his new position with the company he invested $3 million of his own money into the Sunbeam stock shares. This is a major risk factor of the incentives condition because he had a very dominant position on the executive board and this meant that his personal net worth, with respects to his investment, were dependent on the performance of the company. He even stated himself, “If I make a lot of money here [at Sunbeam]—which I certainly intend to do—then the shareholders will make a lot… I’m lockstep with the shareholders.”1 This statement was a clear shout to the public that he wanted to make a profitable outcome of his investment and that in fact, he was determined to make a return off of his investment. In Dunlap’s restructuring process, he hired a new Chief Financial Officer and he replaced the vast majority of top management. The new CFO was Russell Kersh, who jointly entered into a profitable 3-year employment agreement with Dunlap, anticipated strong financial incentives from raising the company’s stock price. The new replacements of the top management were also assured strong financial incentives for improving the share price of the company. These incentives placed more than enough pressure on these high board members into possible misstatements in the financial reporting so that the Sunbeam Company would appear profitable. Throughout the case, there are a few factors that would contribute to an increase in inherent risk. One of these factors is the nature of the client’s business. There were previous issues within the electrical appliance manufacturing industry. Because of the industry conditions, the company was encouraged to find alternative ways to survive as a business. They were driven to finding new ways to increase their competitive advantage, so the company resulted to introducing new product lines, making more acquisitions, and investing in larger production capacities. Even after these changes the company was still unsuccessful with sales and earning results. Dunlap’s restructuring involved things such as decreasing the amount of product lines, selling and consolidating the many of the facilities, and eliminating the majority of the company’s product list. The inherent risk should definitely increase with all of the new inventory, property, plant, and equipment; these may be more difficult to account for and valuate. In addition to that, since products are always undergoing some form of improvement or technological advancement in this industry, there is greater likelihood of obsolete inventory. The accounting of these accounts would definitely affect the balance sheet and it’s likelihood of misstatements. The second factor I noticed was the related parties factor. The relationship between management and the corporate entity is a major factor that would likely cause an increase in the inherent risk. Dunlap, Kersh, and other top management were all subject to incentives dependent of the success of the company. Dunlap had a significant influence on the management and financial reporting. He basically hired all of the new management under the assumption that the better the company is looking financially, the more money the management earns. Since all of the management was new to their current positions, this created pressure on them to possible misstate financial information for their own benefit of receiving incentives. The transactions between the management and company should be carefully monitored and recorded to avoid misstatements. The third factor that would increase the inherent risk of the Sunbeam case is the initial versus repeat engagement. Since this was Dunlap’s first time chairing an electrical appliance manufacturer, he is greater likelihood of material misstatements because of his experience with this industry during the first year or so. There needs to be an increase in the inherent risk until after the initial engagement. After the auditor gains more knowledge about the new management and their strategies, the inherent risk can be reduced respectively. Dunlap’s number one objective was to increase the price of shares by creating an illusion that the restructuring of the company ran successful. After making the company look good on paper, his ultimate goal was more than likely to sell Sunbeam at an inflated price, increasing his initial investment by millions. During 1996, his first year as CEO of Sunbeam, he had the company overstate its net loss by $20 million, which in turned understated the net income by creating false accounting reserves. These reserves are also known as “cookie jar reserves”, and they are intended on being used during future periods. He did this because he wanted to create a false image of the rapid turnaround. He reported that net loss from 1996 as income during the 1997 fiscal year. “In addition, to further boost income in 1997, and to create the impression that Sunbeam was experiencing significant revenue growth, Dunlap, Kersh, Gluck, Uzzi, and Griffith ("the Sunbeam officers") caused the Company to recognize revenue for sales that did not meet applicable accounting rules. As a result, for fiscal 1997, at least $60 million of Sunbeam's reported (record-setting) $189 million in earnings from continuing operations came from accounting fraud.” 2 This is also known as “channel stuffing”, where the company borrowed revenues from future periods. He did this by offering discounts and specials to customers to buy seasonal products that weren’t intended on being sold until later periods. In 1998, he understated the net income by $10 million (substantially less than the $71 million “gain” in 1997), during this period to shift the supposed earnings to the previous period of 1997. All of the revenue shifts threatened Sunbeams going concern for the future. “These actions inflated the price of Sunbeam shares to a high of $52 per share in March 1998. If the Company had been sold at an inflated share price, Dunlap and Kersh could have reaped tens of millions of dollars from the sale of their Sunbeam securities.” 2 Works Cited 1 Joann S. Lublin and Martha Brannigan, “Sunbeam Names Albert Dunlap as Chief, Betting He Can Pull Off a Turnaround.” Wall Street Journal, July 19, 1999, B2 2 http://www.sec.gov/news/press/2001-49.txt Norris, Floyd. S.E.C. Accuses Former Sunbeam Official of Fraud. May 16, 2001 http://query.nytimes.com/gst/fullpage.html'res=9B0CE0DE123AF935A25756C0A9679C8B63&n=Top%2fReference%2fTimes%20Topics%2fPeople%2fD%2fDunlap%2c%20Albert%20J%2e#