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,
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
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
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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.
Sunbeam took a total restructuring charge of $337.6 million at year-end 1996. However,
management padded this charge with at least $35 million in improper restructuring and other
reserves and accruals, excessive write-downs, and prematurely recognized expenses that
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 receive physically 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.
effect, 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.
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Sunbeam’s Shenanigans
Exhibit 1 presents an analysis of Sunbeam’s accounting with respect to Schilit’s financial
shenanigans.
EXHIBIT 1
Sunbeam Corporation’s Aggressive Accounting Techniques
Technique
Example
Shenanigan Number
Recorded bogus revenue
Bill-and-hold sales
2
Released questionable reserves into income
Cookie-jar reserves
5
Inflated special charges
Litigation reserve
7
Red Flags
Schilit points to several 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
($0.6 million reserve). This is known as “big–bath accounting.”
2. Reserve amounts reduced after initial overstatement. Fluctuations in the reserve amount
3. Receivables grew much faster than sales. A simple ratio of the increase in receivables to
the increase in revenues should have provided another warning signal. Schilit provides
the following for Sunbeam’s operational performance in Exhibit 2 that should have
created doubts in the minds of the auditors about the accuracy of reported revenue
amounts in relation to the collectibility of receivables, as indicated by the significantly
larger percentage increase in receivables compared to revenues.
EXHIBIT 2
Sunbeam Corporation’s Operational Performance
9 months 9/97 ($ in
millions)
9 months 9/96 ($ in
millions)
%
Change
Revenue
$830.1
$715.4
16%
Gross profit
86%
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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
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
1997, to sell it parts for $11 million (and book a $5 million profit). EPI balked, stating that the
parts were worth only $2 million, but Sunbeam found a way around that. EPI was persuaded to
Dunlap tries to Quiet the Markets . . . and the Board
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
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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.
Dunlap continued to run Sunbeam as if nothing had happened. On May 11, 1998, he tried to
reassure 200 major investors and Wall Street analysts that the first quarter loss would not be
Settlement with Andersen
Harlow authorized unqualified audit opinions on Sunbeam’s 1996 and 1997 financial statements
although he was aware of many of the company’s accounting improprieties and disclosure
failures. These opinions were false and misleading in that, among other things, they incorrectly
Questions
1. 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” because he had a reputation of cutting organizations
to the bone to protect the profitable operations. Dunlap was known as demanding that employees
meet budgeted amounts or face the consequences of being demoted or fire. He created a culture
of fear and poisoned the well by demanding results all the while sacrificing proper accounting
and financial reporting.
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2. 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? How does making such calculations enable auditors to meet
their ethical obligations?
AU Section 329A of PCAOB standards provides useful guidance on the purpose and application
of analytical procedures.
1
Analytical procedures are an important part of the audit process and consist of evaluations of
financial information made by a study of plausible relationships among both financial and
nonfinancial data. Analytical procedures range from simple comparisons to the use of complex
models involving many relationships and elements of data. A basic premise underlying the
application of analytical procedures is that plausible relationships among data may reasonably be
expected to exist and continue in the absence of known conditions to the contrary. Particular
conditions that can cause variations in these relationships include, for example, specific unusual
transactions or events, accounting changes, business changes, random fluctuations, or
misstatements.
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Analytical procedures involve comparisons of recorded amounts, or ratios developed from
recorded amounts, to expectations developed by the auditor. The auditor develops such
expectations by identifying and using plausible relationships that are reasonably expected to exist
based on the auditor’s understanding of the client and of the industry in which the client operates.
Following are examples of sources of information for developing expectations:
• Financial information for comparable prior period(s) giving consideration to known
changes
• Anticipated results—for example, budgets, or forecasts including extrapolations from
interim or annual data
3. Assume you were the technical advisory partner for Andersen on the Sunbeam
engagement and reported directly to Harlow. You have just reviewed all the
workpapers on the audit including materiality judgments. You are concerned about
what you have just seen. Further assume that you consider yourself to be a
pragmatist, one who is concerned with your own material welfare, but also with
moral ideals. Develop a plan of action for voicing your values to ensure you are
heard by Harlow and others in the firm. Consider the following in developing the
plan to do the right thing:
o What do you need to say to Harlow?
Harlow used the concept of materiality to conclude that Sunbeam’s adjustments to its recorded
earnings could be kept at a minimum. As the technical advisory partner I would need to convince
him that the needed adjustments are material as is clearly evident by the comparative numbers. I
o What are the likely objections or pushback?
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Harlow is likely to look for rationalizations to support his position such as we need to go along
with the client at least this one time or Dunlap has the company on the right track and we need to
o What would you say next? To whom, and in what sequence?
If Harlow isn’t receptive to my arguments that counter his reasons and rationalizations, then the
next step is to bring the matter to top management. That may cause Harlow to give in to my
position and insist that Sunbeam correct its accounting.
CPA firms should have hot lines as do most corporations today. If one existed at Andersen, then
the technical review partner could use it as an alternative to blowing the whistle by going to firm
management. Some might consider it the less ethical way to go as a technical partner should