Case 7-10 Beazer Homes
Beazer Homes is a home-building company headquartered in Atlanta, Georgia. Its stock is listed
on the New York Stock Exchange. Beazer is required to file Form 10-Q and Form 10-K, as well
as an 8-K form when certain changes occur, such as restating financial statements.
As a homebuilder, Beazer often builds fimodel homes” for prospective homebuyers to tour while
the remainder of a neighborhood and its future homes are under construction. As one of the last
Sale-Leaseback Scheme
Under its sales-leaseback program, Beazer sold its model homes to investors, typically at a
discounted price, thereby permitting it to recognize revenue and income from the sales. Under
the fileaseback” portion of the transaction, Beazer leased back from the investor/buyer the same
model homes, which Beazer could then use to show prospective home buyers.
In December 2005, the chief accounting officer, Michael T. Rand, CPA, entered into a secret
side-agreement with one or more GMAC Model Home Finance personnel under which: (a)
Beazer would fisell” the model homes and recognize revenue and income from such sales; (b) the
Overstated Pretax Income from Sale-Leaseback Transactions
Quarter Ended
# Homes Sold
Overstated Pretax Income
December 31, 2005
90
$8.0 million
March 31, 2006
79
$4.2 million
June 30, 2006
37
$1.6 million
Ethical Obligations and Decision Making in Accounting, 4/e 2
Cookie-Jar Reserves
Prior to 2006, Rand and other Beazer employees engaged in an accounting scheme involving
ficookie–jar accounting.” Specifically, Rand improperly decreased Beazer’s income by artificially
establishing, increasing, and/or maintaining future anticipated expenses or fireserves.” He
Land Inventory Accounting
As part of its home building and sale operations, Beazer purchased parcels of land upon which it
constructed houses to form subdivisions. Beazer recorded the acquired land, along with costs for
the common development of the parcel, such as sewer systems and streets, as an asset on
Beazer’s balance sheet in the land inventory accounts. As subdivisions were built, Beazer
allocated the costs accumulated in the land inventory accounts to individual home lots, which
As additional houses in a subdivision were sold, the land inventory account continued to be
decreased (credited) by amounts representing the land acquisition and development costs
allocated to each individual house. If costs had been allocated properly, then, shortly after the
Overstatement of Land Inventory Costs
Quarter 1
Quarter 3
2001
$1,455,000
$1,322,000
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On January 8, 2002, after the end of the first quarter, Rand e-mailed a target earnings amount to
the relevant financial personnel in numerous Beazer divisions with instructions not to exceed the
target by a certain amount. The distributed target for each division was less than each division’s
previously expected quarterly results. Rand advised the divisions to review their land inventory
accounts in order to increase expenses and reduce earnings. In one particular e-mail, Rand
instructed the Florida division to provide fimore than adequate land allocations in communities
closing out this year” as a means to reduce its earnings.
Manipulation of fiHouse Cost–to–Complete” Reserves
Under its accounting policies, Beazer recorded revenue and profit on the sale of a house after the
close of the sale of that house to a homebuyer. In the journal entries to record the sale, Beazer
typically reserved a portion of its profit earned on the house. This reserve, called a fihouse cost–
to–complete” reserve, was established to cover any unknown expenses that Beazer might incur
Ethical Obligations and Decision Making in Accounting, 4/e 4
on the sold house after the close, such as minor repairs or final cosmetic touch-ups. Although the
amount of this reserve varied by region, it was typically $1,000 to $4,000 per house.
The following table shows the over-expensing of the cost-to-complete expense from 2000 to
2005.
Over-Expensing of the Cost-to-Complete Expense
Year
Quarter 1
Quarter 2
Quarter 3
Quarter 4
2000
N/A
$610,000
$ 5,000
$2,288,000
2001
$1,138,000
$543,000
N/A
N/A
2002
$2,184,000
$813,000
N/A
N/A
2003
$1,380,000
N/A
N/A
2004
$1,057,000
$1,137,000
$2,051,000
2005
N/A
$805,000
$1,427,000
N/A
Reversal of Excess Cost-to-Complete Reserves
Year
Quarter Ended
Amount of Reversal
2006
March 31
$ 183,000
2006
September 30
$2,130,000
2006
December 31
2007
March 31
$1,549,000
Deloitte & Touche
Beazer’s auditor, Deloitte & Touche, specifically advised Rand via e–mail that Beazer’s
appreciation rights in the homes represented a continuing interest that, pursuant to GAAP,
precluded Beazer from recognizing revenue when the homes were sold to GMAC. In an attempt
to circumvent GAAP, and to deceive Deloitte, Rand caused the final, written versions of the sale-
leaseback agreements to omit any reference to Beazer’s continuing profit participation. Rand
then directed, by e-mail, his subordinates to record revenue at the time the model homes were
initially sold to the GMAC investor pools. Rand provided Deloitte with copies of the sale-
settle the claim.
The investors had accused Beazer of managing earnings, recognizing revenue earlier than
allowed under generally accepted accounting principles, improperly accounting for sale-
leaseback transactions, creating ficookie–jar” reserves, and not recording land and goodwill
impairment charges at the proper time.
The investors accused Deloitte of turning fia blind eye” to the myriad of fired flags” that should
have alerted the firm to potential GAAP violations. These warning signs included the fiexcessive
pressure” employees were under to meet their higher–ups’ sales goals, tight competition in
Restatements of Financial Statements
Due to Beazer’s material noncompliance with the financial reporting requirements of the federal
securities laws, Beazer was required to issue accounting restatements. On May 12, 2008, Beazer
filed accounting restatements for the fiscal year 2006. In various reports filed that day, Beazer
restated its financial statements for fiscal 2006 and each of the first three quarters of fiscal 2006.
Beazer admitted to the improper accounting with the following statement:
In the filings, Beazer further acknowledged material weaknesses in its internal control over
financial reporting including in its control environment and the design of accounting policy,
procedures, and controls—fispecifically related to the application of GAAP in accounting for
certain estimates involving significant management judgments.”
According to a separate filing by the SEC against Ian McCarthy, former CEO of Beazer Homes,
during the 12-month period following Beazer’s filing of its inaccurate financial statements in
2006, and before any restatement or correcting disclosure by Beazer, McCarthy received bonuses
and incentive- and equity-based compensation and profits from his sale of Beazer stock. In fiscal
year 2006, McCarthy received a bonus of $7.1 million, of which he received $5,706,949 in cash.
During fiscal year 2006 and the first quarter of fiscal 2007, McCarthy also realized total profits
Ethical Obligations and Decision Making in Accounting, 4/e 7
McCarthy had not reimbursed Beazer for the bonuses and incentive- and equity-based
compensation and profits from his sale of Beazer stock received from Beazer during the relevant
statutory periods, as required under the Sarbanes-Oxley Act and its clawback provision.
A statement released by the U.S. Attorney’s Office quotes John A. Strong, the special agent in
charge for the Charlotte Division of the FBI:
Questions
1. What role did organizational ethics play in the Beazer Homes fraud? Is this
something the auditors of Deloitte should have been more conscious of? Explain.
Beazer Homes had a very aggressive management starting with chief accounting officer, Michael
Rand, and down throughout the organization. Rand and others created a culture of deceit and
carried out a variety of unethical actions with respect to its accounting and financial reporting. It
financially structured the lease transactions to record sales revenue even though the transaction
did not meet accounting criteria to do so. It even convinced GMAC to alter the contract with
Beazer to omit the latter’s continuing interest in home properties under the sale-leaseback
agreements. Beazer fooled Deloitte into thinking the transactions met the criteria for sales
recording even though the lease-back provision was ironclad.
Ethical Obligations and Decision Making in Accounting, 4/e 8
2. Evaluate Beazer’s accounting for cost–to-complete reserves from a GAAP
perspective. Was the initial accounting for the reserve in conformity with GAAP?
What was the company trying to achieve with its accounting?
Beazer recorded revenue and profit on the sale of a house after the close of the sale of that house
to a homebuyer. In the journal entries to record the sale, Beazer typically reserved a portion of its
profit earned on the house. This reserve, called a fihouse cost–to–complete” reserve, was
established to cover any unknown expenses that Beazer might incur on the sold house after the
close, such as minor repairs or final cosmetic touch-ups. Beazer’s policy was to reverse any
3. Categorize the accounting devices used by Beazer into one the financial shenanigan
groupings. Include a discussion of how earnings were managed in each case.
Sale-Leaseback Transactions
This is shenanigan #1 – recording revenue too soon. Beazer recorded sales revenue on the
transactions even though it leased-back the assets in those transactions and were set to receive a
share of any profits from the subsequent sale of the model homes. This gave the company
Reserves for Future Anticipated Expenses
This is shenanigan #4 – shifting current expenses to a later date. Rand set up land development
and house reserves to artificially reduce earnings in earlier periods and then shift them to later
periods when the company was in danger of not meeting financial analysts’ earnings
Ethical Obligations and Decision Making in Accounting, 4/e 9
Land Inventory Accounting
The land inventory account included the estimated costs for the common development of the
parcel, such as sewer systems and streets, as an asset on Beazer’s balance sheet and then charged
these amounts as a cost of sale when the homes were sold. There is nothing inherently wrong
about the practice but the estimates were made in a way to manage earnings. They were initially
overstated as indicated in the case and then used as another cookie-jar reserve to record higher
earnings by reducing the reserves as desired. Rand even e-mailed a target earnings amount to the
House Cost-to Complete Reserves
Beazer recorded revenue and profit on the sale of a house after the close of the sale of that house
to a homebuyer. In the journal entries to record the sale, Beazer typically reserved a portion of its
profit earned on the house. This reserve, called a fihouse cost-to–complete” reserve, was
established to cover any unknown expenses that Beazer might incur on the sold house after the
close, such as minor repairs or final cosmetic touch-ups.
4. Assume you were hired to analyze the information in this case and write a two- to
three-page report on your findings. Discuss each element of the fraud and why
Beazer, Rand, and/or Deloitte violated ethical and professional standards.
The purpose of this assignment to give students a chance to demonstrate their written
communication skills. Much of the information has already been discussed above. The added
factor that should be included in any report is to evaluate the professional and ethical obligations
of Deloitte & Touche in its audits of Beazer.
Ethical Obligations and Decision Making in Accounting, 4/e 10
As reported in the case, a class-action lawsuit filed against Deloitte was settled on May 7, 2009.
The agreement said that the audit firm should have considered the homebuilder’s fimake the
numbers” culture to be a red flag as the housing market tanked. Deloitte agreed to pay investors
of Beazer Homes nearly $1 million to settle the claim.
The investors accused Deloitte of turning fia blind eye” to the myriad of fired flags” that should
have alerted the firm to potential GAAP violations. These warning signs included the fiexcessive
pressure” employees were under to meet their higher-ups’ sales goals, tight competition in
Beazer’s market, and weak internal controls. Accusing the auditor of fisevere recklessness,” the
shareholders alleged, for example, that Deloitte should have noticed that Beazer was likely
overdue in recording impairments on its land assets, as the real estate market began to decline,
among the other alleged accounting violations.