Case 7-7
Sunbeam Corporation
One of the earliest frauds during the late 1990s and early 2000s was at Sunbeam. The SEC alleged in its
charges against Sunbeam that top management engaged in a scheme to fraudulently misrepresent
Sunbeam’s operating results in connection with a purported “turnaround” of the company. When
Sunbeam’s turnaround was exposed as a sham, the stock price plummeted, causing investors billions of
dollars in losses. The defendants in the action included Sunbeam’s former CEO and chair Albert J. Dunlap;
former principal financial officer Russell A. Kersh; former controller Robert J. Gluck; former vice
presidents Donald R. Uzzi, and Lee B. Griffith; and Arthur Andersen LLP partner Phillip Harlow.
The SEC complaint described several questionable management decisions and fraudulent actions that led
to the manipulation of financial statement amounts in the company’s 1996 year-end results, quarterly and
year-end 1997 results, and the first quarter of 1998. The fraud was enabled by weak or nonexistent internal
controls, inadequate or nonexistent board of directors and audit committee oversight, and the failure of the
Andersen auditor to follow GAAS. The following is an excerpt from the SEC’s AAER. 1393 issued on May
15, 2001:
“From the last quarter of 1996 until June 1998, Sunbeam Corporation’s senior management
created the illusion of a successful restructuring of Sunbeam in order to inflate its stock
price and thus improve its value as an acquisition target. To this end, management
employed numerous improper earnings management techniques to falsify the Company’s
results and conceal its deteriorating financial condition. Specifically, senior management
created $35 million in improper restructuring reserves and other “cookie jar” reserves as
part of a year-end 1996 restructuring, which were reversed into income the following year.
Also in 1997, Sunbeam’s management engaged in guaranteed sales, improper “bill and
hold” sales, and other fraudulent practices. At year-end 1997, at least $62 million of
Sunbeam’s reported income of $189 million came from accounting fraud. The undisclosed
or inadequately disclosed acceleration of sales through “channel-stuffing” also materially
distorted the Company’s reported results of operations and contributed to the inaccurate
picture of a successful turnaround.”
A brief summary of the case follows.
Chainsaw Al
Al Dunlap, a turnaround specialist who had gained the nickname “Chainsaw Al” for his reputation of
cutting companies to the bone, was hired by Sunbeam’s board in July 1996 to restructure the financially
ailing company. He promised a rapid turnaround, thereby raising expectations in the marketplace. The
fraudulent actions helped raise the market price to a high of $52 in 1997. Following the disclosure of the
fraud in the first quarter of 1998, the price of Sunbeam shares dropped by 25 percent to $34.63. The price
continued to decline as the board of directors investigated the fraud and fired Dunlap and the CFO. An
extensive restatement of earnings from the fourth quarter of 1996 through the first quarter of 1998
eliminated one-half of the reported 1997 profits. On February 6, 2001, Sunbeam filed for Chapter 11
bankruptcy protection under U.S. Bankruptcy Court.
Accounting Issues
Cookie Jar Reserves
The illegal conduct began in late 1996 with the creation of cookie jar reserves that were used to inflate
income in 1997. Sunbeam then engaged in fraudulent revenue transactions that inflated the company’s
record-setting earnings of $189 million by at least $60 million in 1997. The transactions were designed to
create the impression that Sunbeam was experiencing significant revenue growth, thereby further
misleading the investors and financial markets.
Channel Stuffing
Eager to extend the selling season for its gas grills and to boost sales in 1996, CEO Dunlap’s “turnaround
year,” the company tried to convince retailers to buy grills nearly six months before they were needed in
exchange for major discounts. Retailers agreed to purchase merchandise that they would not physically
receive until six months after billing. In the meantime, the goods were shipped to a third-party warehouse
and held there until the customers requested them. These bill and hold transactions led to recording $35
million in revenue too soon. However, the auditors (Andersen) reviewed the documents and reversed $29
million.
In 1997 the company failed to disclose that Sunbeam’s 1997 revenue growth was, in part, achieved at
the expense of future results. The company had offered discounts and other inducements to customers to
sell merchandise immediately that otherwise would have been sold in later periods, a practice referred to as
“channel stuffing.” The resulting revenue shift threatened to suppress Sunbeam’s future results of
operations.
Sunbeam either didn’t realize or totally ignored the fact that by stuffing the channels with product to
make one year look better, the company had to continue to find outlets for their product in advance of when
it was desired by customers. In other words, it created a balloon affect in that the same amount or more
accelerated amount of revenue was needed year after year. Ultimately, Sunbeam (and its customers) just
couldn’t keep up and there was no way to fix the numbers.
Sunbeam’s Shenanigans
Exhibit 1 presents an analysis of Sunbeam’s accounting with respect to Schilit’s financial shenanigans.
Red Flags
Schilit points to red flags that existed at Sunbeam but either went undetected or were ignored by Andersen
including the following:
1. Excessive charges recorded shortly after Dunlap arrived. The theory is that an incoming CEO will
create cookie jar reserves by overstating expenses even though it reduces earnings for the first year
based on the belief that increases in future earnings through the release of the reserves or other
techniques make it appear that the CEO has turned the company around, as evidenced by turning losses
into profits. Some companies might take it to an extreme and pile on losses by creating reserves in a loss
year believing that it doesn’t matter whether you show a $1.2 million loss for the year or a $1.8 million
loss ($0.6 million reserve). This is known as the “big bath accounting.”
Exhibit 1
Sunbeam Corporation’s Aggressive Accounting Techniques
Technique Example Shenanigan Number
Recorded bogus revenue Bill and hold sales No. 2
Released questionable reserves into
income
Cookie jar reserves No. 5
Inflated special charges Litigation reserve No. 7
2. Reserve amounts reduced after initial overstatement. Fluctuations in the reserve amount should have
raised a red flag because they evidenced earnings management as initially record reserves were restored
into net income.
3. Receivables grew much faster than sales. A simple ratio of the increase in receivables to the increase in
revenues should have provided another warning signal. Schilit provides the following for Sunbeam’s
operational performance in Exhibit 2 that should have created doubts in the minds of the auditors about
the accuracy of reported revenue amounts in relation to the collectibility of receivables as indicated by
the significantly larger percentage increase in receivables when compared to revenues.
Exhibit 2
Sunbeam Corporation’s Operational Performance
Operational Performance
9 months 9/97
($ in millions)
9 months 9/96
($ in millions) % Change
Revenue $830.1 $715.4 16%
Gross profit 231.1 123.1 86%
Operating revenue 132.6 4.0 3215%
Receivables 309.1 194.6 59%
Inventory 290.9 330.2 12%
Cash flow from operations (60.8) (18.8) N/A
4. Accrual earnings increased much faster than cash from operating activities. While Sunbeam made
$189 million in 1997, its cash flow from operating activities was a negative 60.8 million. This is a
$250 million difference that should raise a red flag even under a cursory analytical review about
the quality of recorded receivables. Accrual earnings and cash flow from operating activity
amounts are not expected to be equal but the differential in these amounts at Sunbeam seems to
defy logic. Financial analysts tend to rely on the cash figure because of the inherent unreliability
of the estimates and judgments that go into determining accrual earnings.
Quality of Earnings
No one transaction more than the following illustrates questions about the quality of earnings at Sunbeam.
Sunbeam owned a lot of spare parts that were used to fix its blenders and grills when they broke. Those
parts were stored in the warehouse of a company called EPI Printers, which sent the parts out as needed. To
inflate profits, Sunbeam approached EPI at the end of December to sell it parts for $11 million and book an
$5 million profit. EPI balked stating the parts were only worth $2 million, but Sunbeam found a way
around that. EPI was persuaded to sign an “agreement to agree” to buy the parts for $11 million, with a
clause letting EPI walk away in January 1998. In fact, the parts were never sold but the profit was posted
anyway.
Paine Webber, Inc. analyst Andrew Shore had been following Sunbeam since the day Dunlap
was hired. As an analyst, Shore’s job was to make educated guesses about investing clients’ money in
stocks. Thus, he had been scrutinizing Sunbeam’s financial statements every quarter and considered
Sunbeam’s reported levels of inventory for certain items to be unusual for the time of year. For example,
he noted massive increases in the sales of electric blankets in the third quarter of 1997, although they
usually sell well in the fourth quarter. He also observed that sales of grills were high in the fourth quarter,
which is an unusual time of year for grills to be sold, and noted that accounts receivable were high. On
April 3, 1998, just hours before Sunbeam announced a first-quarter loss of $44.6 million, Shore
downgraded his assessment of the stock. By the end of the day Sunbeam’s stock prices had fallen 25
percent.
Questions
1. Is there a difference between aggressive accounting and earnings management? Would the
motivation for using the techniques described in this case influence whether they should be
labeled as aggressive accounting or earnings management? Incorporate ethical
considerations in your answer.
Aggressive accounting and earnings management are both defined as the practice of incorrectly recognizing
revenue in order to please investors. Aggressive accounting and earnings management seek to falsely
record revenues or expenses to manipulate earnings as a way of meeting analysts’ expectations, inflate
Earnings management can occur through aggressive accounting techniques, such as at Sunbeam, but it also
Both aggressive accounting and earnings management violate the accounting values of objectivity, integrity
and due care that accounting for transactions are specifically done to show a desired result rather than
conform to GAAP. Aggressive accounting violates the rights of investors and creditors to receive accurate
2. How did pressures for financial performance contribute to Sunbeam’s culture, where
quarterly sales were manipulated to influence investors? To what extent do you believe the
Andersen auditors should have considered the resulting culture in planning and executing its
audit?
Sunbeam was in financial distress when it hired Dunlap to turn the company around. Dunlap had already
earned the name of “Chainsaw Al” prior to working at Sunbeam. Dunlap was known as expecting mangers
Andersen should have known of Dunlap’s reputation on Wall Street and his promise of a fast turnaround at
Sunbeam. Shareholders may have loved Dunlap, but employees despised him. A fearful culture at Sunbeam
grew as employees feared pink slips and intimidation from top management. Dunlap created a culture in
3. Chapter 3 addresses issues related to corporate governance and ethical management. Given
the facts of the case, identify deficiencies in ethics and corporate governance failures at
Sunbeam.
Sunbeam was lacking corporate codes of conduct and code of ethics for CEOs and CFOs. The board of
directors was rubber-stamping management’s decisions; the audit committee was ineffective; and internal
controls were being overridden by top management. Control was centralized into one person, Al Dunlap, as
Sunbeam had no effective oversight of Dunlap. A company should never allow one person to make the big
decisions unchecked by what is ethical and in accordance with laws and regulations. This happened at
4. Given the variety of income adjusting techniques described in the case that were used by
Sunbeam to manipulated the numbers, do you think it was proper for the Andersen auditors
to dismiss $2 million of the $5 million income from the sale of the spare parts inventory?
What factors do you think Andersen should have considered in addition to materiality in
making the determination?
Andersen often proposed certain adjustments that management rejected, and then passed on the adjustments
after quantitative materiality analysis. This resulted in Andersen’s audit reports on those financial
statements being inaccurate in that the reports stated incorrectly that Sunbeam’s financial statements
conformed to GAAP and that the Andersen audits were conducted in accordance with GAAS. At year-end
Optional Question
4. Why is it important for auditors to use analytical comparisons such as the ratios in the
Sunbeam case to evaluate possible red flags that may indicate additional auditing is
required?
Analytical procedures involve evaluations of financial statement information by a study of relationships
between financial and nonfinancial date. A basic premise using these procedures is that relationships among
Techniques used in performing analytical procedures range in sophistication from analysis of trends and
ratios to complex regression modeling of many relationships and data from previous years. This may range
Auditing standards require the application of analytical procedures at the planning and overall final review
stages of the audit. The auditors may also use analytical procedures during the audit to test the
reasonableness of accounts; in which case, the procedures provide substantive evidence. Analytical
procedures performed during the planning stage of the audit assess risk and help to determine the nature,