New York Times: SEC Accuses Former Sunbeam Official of Fraud. Albert J. Dunlap took over as the CEO at Sunbeam Corporation, which it was performing poorly. The corporation manufactured electric appliances ranging from electric blankets to blenders. He was to steer it back to profitability. He engaged in a vigorous restructuring program. He sent home a large number of workers and closed plants true to his nickname Chainsaw Al. The SEC took legal action against the CEO, his top executives and the external auditing partner on the ground that they engaged in financial statement fraud.
It was revealed that the purported improvement in the corporation’s performance was actually untrue. The top management had engaged in financial fraud to create an impression that that they had actually managed to turn around the corporation. Under the stewardship of Dunlap and his CFO, R Kersh, they applied various accounting tricks to achieve their objective. They created cookie jar reserves to increase the loss in 1996 when Dunlap was appointed and boost the profit in 1997 after he had initiated his restructuring program.
They also used aggressive sales techniques to boost sales such as channel stuffing and then recognized the revenue immaturely. They failed to disclose all the information required in the corporation’s financial statements and issued press statements supporting these statements. The stocks rallied to new highs as the corporation seemed to recover from its poor performance and investor interest grew. At its peak, the corporation bought three other companies in partly cash and partly stock deals. The fraud was finally detected when reports appeared in the media questioning the accuracy of the Sunbeam’s financial statements.
The share price plummeted and an internal investigation carried out. Dunlap was fired two years after his appointment. The company then filed for bankruptcy under the new management. It was unable to recover from the damage inflicted by the fraud and the restructuring program. The fraud had a huge implication shareholder’s wealth. The company also restated the statements with significant differences noted between the two sets of statements. The SEC suit seeks a cease and desist order for Dunlap, Kersh and other top officials and the auditing partner, Phillip Harlow, in an attempt to stem rising number of fraud cases.
It had managed to enter in o a similar settlement with Sunbeam Corporation earlier Qualities: The quality of financing statements determines its usefulness in regards to decision making. It is the usefulness of such statements that makes gathering and processing of financial information included in a corporation’s statements worthwhile. The characteristics of such information that make it useful are set out in a framework known as the hierarchy of accounting qualities. The hierarchy firsts determines the capability of the users to digest such financial information.
It looks at the abilities of the users that would make such accounting information useful to them. Different users have different needs and financial information produced should serve the various uses of different user groups. Sunbeam financial statements that were financially incorrect were relied upon in decision making different users much to their detriment. Many potential investors bought shares in to the corporation in anticipation of the stock appreciating over time. They based the decisions on bloated results for the financial year 1997.
Similarly, results released for the company’s first half of 1998 fiscal year were doctored to reflect a growth in income and revenue. Others who relied on the false statements were the owners of the three companies that merged with Sunbeam in 1998 among them Perelman, the proprietor of Coleman, who exchanged his stocks for sunbeam’s shares and cash. The cash was raised through issuance of a bond and the lenders also relied on the false statements. Accounting qualities are grouped in to primary and secondary qualities. Also read Sunbeam corporation case study
Under primary qualities, relevance and reliability of financial information are crucial characteristics of financial data while making decisions. For information to be relevant it must be useful in decision making in that in its absence the user will make a different judgment. It makes a difference in conclusions due to its predictive value and it must also be well timed. If information is not present at the time decision-making it is thus irrelevant. Relevant information must also assist the user to verify the projections he had earlier made.
They highly misrepresented facts to achieve the set out targets. The investors used the false information in the statements to make predictions and also to later confirm their predictions. In buying into the company, they believed that the financial statement provided relevant information for their investing decisions on future value of their investments. They however were not due lack of full disclosure of some information. For financial information to be reliable, it must give a true picture of the entity’s financial position it is meant to represent.
Three features determine reliability of such information namely: verifiability, faithfulness and neutrality. Information is verifiable if different analyzers arrive at almost similar findings while using a single technique. Faithful information concurs with the true account of events. Neutrality of financial information on the other hand means that its preparation was devoid of any bias to achieve a predetermined outcome. The financial statements provided by sunbeam management violated the reliability criteria in that they did not give the true picture of financial position of the corporation.
A different accounting group would come up with more conservative results than were presented by the management. The management prepared the financial statements with forecasts and investors expectations in mind. Secondary qualities of comparability and consistency act to reinforce the primary qualities. Comparability means that the information can correctly aid the user in differentiating the financial performance of the entity across enterprises and over accounting periods. The reporting method must therefore be similar between the sets of statements being compared.
On the other hand, consistency requires that accounting principles be retained over accounting periods and if new ones are adopted, it must be for a widely acknowledge improvement which must be disclosed. The financial statements provided by the Sunbeam management did violated the comparability and consistency accounting qualities. The results were not comparable across enterprises and over time due to the inclusion of cookie jar reserves and undisclosed risk accompanying the recognized revenue.
The corporation was also not consistent in its application of accounting principles. The management introduction of such sales and profit boosting methods such as cookie jar reserves and channel stuffing was not consistent with the accounting procedures applied prior to that. Procedures had been changed to give an impression of reviving the corporation. The above qualities are subject to materiality in that they only apply where an item makes a significant difference to the user in decision-making. The inclusion of the item must also have greater benefits over cost.
The cost of providing the financial information must be worthy it. These two constraints cannot be determined in isolation of management motives. The Sunbeam management failed to fully disclose the nature of their sales and profits in their financial statements. It went on to recognize profit from provisional sales transactions where the corporation retained ownership and the customer could revoke the deal whenever he wished to. The external auditor noted the discrepancy but was brought around to the management way of thinking.
They labeled the transactions as immaterial but while looked at individually they could be immaterial. On the aggregate, the effect was that a third of the profit reported was incorrect. The transactions were therefore material and all information should have been provided. The cost of providing the information was over ridden by the benefits the users would derive from it. The financial statements released were materially false since the inflated figures did influence investors and lenders in their decision-making. They relied on inaccurate profit calculations.
Basic Principles. One of the basic principles of accounting is the full disclosure principle, which stipulates that financial statements must include any important information that a user would require to make a decision. Any information an investor or a lender needs in making his investing or lending decision must be available in the statements either within the financial statements, among the notes accompanying the statements or provided elsewhere in the report. The Sunbeam management violated this principle by withholding information on the nature of sales transactions.
The corporation should have made full disclosure of doubtful trade receivables. They should also have made relevant provisions for sales returns which were likely under the overly aggressive sales drives undertaken by the company. It also failed to disclose discounts. The right accounting practice would have been to recognize the revenue in later accounting periods when the management reasonably believed that the revenue could actually be collectible. They should have acted more conservatively in recognizing such revenue. Another principle is the revenue recognition principle.
Under accrual method of accounting, it stipulates that revenue be recognized when realized or is realizable and when earned regardless of when cash payments are made. Cash accounting basis stipulates that revenue be recognized when paid up. corporations must use the accrual basis accounting. Revenue is realized when the commodities are paid for or exchanged put under trade receivables. The revenues is realizable where a supplier gets assets that could be easily transformed into cash or trade receivables while it is earned when a supplier has delivered goods or performed a service that warrants payment.
The supplier must also believe convincingly that the buyer will meet his obligations. The Sunbeam management violated this principle by early recognition of contingency sales revenue. The management recognized profit from sales that the distributors had not assumed ownership or the accompanying risks. The goods were sold months before they would be demanded and had a high chance of being returned. The sales were also beyond the capacity of most of the customers. The management could reasonably project that the sales returns would be high but went ahead to recognize such revenue.
Thirdly, is the matching principle, which stipulates that expenses be charged when the corresponding revenue is recognized. Such expenses help generate revenue in one period and should not be charged in another accounting period. Sunbeam management did not change discounts allowed against the revenue they helped generate for the financial years 1997 and 1998. The management also charged the expenses incurred in the manager’s restructuring program in 1997, against revenue generated in 1996 which in effect increased the loss incurred in 1996 and boosted the profit reported in 1997.
Failure to match the expenses to the revenue created the false impression that the corporation had made a turnaround in performance. The elements and definitions The elements of a balance sheet include assets, liabilities, and equity and changes in owners’ investments while those of an income statement include revenue, income from other source, expenses and gains or losses. Under assets, the accounts receivables were bloated because some transactions included were not supposed to be under that account. The accounts receivables account includes credit sales with a realistic chance of being paid up.
The sunbeam management included under this account some contingent sales that clearly would be returned by the retailers in a bid to boost sales revenue recognized in 1997 and 1998. The Sunbeam management also understated the inventory item under assets. Inventories show amount of stock currently held by a corporation for trade purposes. The corporation held stock for retailers and distributors that was beyond their selling capacity and would be eventually returned. This stock was treated as sold yet it would eventually remain unsold and part of inventory. The management did this in a bid to boost the sales figure.
The Sunbeam management also created reserves that were unwarranted. The cookie jar reserves were understated earning in 1996. The management introduced them so that they would be used to boost the earnings in the subsequent accounting period. The reserves in effect would be used to give an impression of a huge turn around in the corporation’s performance. In the income statement prepared by the sunbeam management, the revenue item included sales revenue that was not realized or realizable. This revenue resulted from sales that would most likely fail to go through and the goods returned.
The dubious sales were conducted through channel stuffing, a technique that forces goods through the distribution channel beyond its capacity. The corporation achieved this by issuing huge discounts and guaranteeing distributors profit for holding goods in excess of retailers capacity. As for the expenses, those incurred in 1996 were greatly overstated as they included expenses incurred in 1997. Expenses that were incurred during the restructuring program conducted by the new management in 1997 were charged of in 1996. The effect of this was to boost income in 1997 while worsening the performance in 1996.
The Sunbeam management also failed to record trade discounts and guarantees offered to retailers and distributors as expenses completely ignoring them. The expense element was therefore understated in this respect. The effect was to give an impression of greater profitability of the corporation. Valuation terminology When Sunbeam Corporation acquired Coleman, First Alert and Mr. Coffee, the other management of these companies relied on financial data available on sunbeam to agree on the merger. Ronald Perelman, exchange his part of shares in Coleman for shares in Sunbeam just about the time Sunbeam started collapsing.
By studying the unqualified financial statements provided by the management, he expected the share price to rise further. His valuation of Sunbeam was based on false results and their sign stock price. When the stock appreciation burst, he lost a lot of funds. Finally when Sunbeam filed for bankruptcy, his investment was reduced to nothing. Reference: Norris, Floyd 2001. SEC accuses former sunbeam official of fraud. New York Times, May 16, 2001. Retrieved on 12/03/07 from http://query. nytimes. com/gst/fullpage. html? res=9B0CE0DE123AF935A25756C0A9679C8B63&sec=&spon=&pagewanted=1