CASE 3.7
FOAMEX INTERNATIONAL, INC.
Synopsis
In the years leading up to World War II, German scientist Otto Bayer discovered a new
chemical compound that would become known as polyurethane. Polyurethane foam was developed
in the early 1950s when water was accidentally added to the production process for polyurethane.
This polyurethane derivative would eventually be used in a wide range of consumer products. By
the turn of the century, the largest producer of polyurethane foam was Foamex International, Inc., a
former division of Firestone Tire and Rubber Company that had become an independent public
company.
Foamex became the largest producer of polyurethane foam due to an ambitious acquisition
program initiated by company executives in the late 1980s. By 2001, Foamex owned more than 50
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180 Case 3.7 Foamex International, Inc.
Foamex International, Inc.—Key Facts
1. Polyurethane foam, a derivative of polyurethane, is used in the manufacture of a wide range of
consumer products.
3. Because Foamex allowed the companies it acquired to retain their accounting systems, the
4. Foamex’s failure to develop a coherent, integrated corporate accounting system complicated the
annual audits of the SEC registrant.
6. Foamex did not resolve the internal control problems identified by PwC; in 2001, PwC resigned
and Foamex retained Deloitte & Touche as its new audit firm.
8. In March 2004, shortly after Deloitte issued a negative report on Foamex’s internal controls to
9. The following year, Foamex became the first public company sanctioned by the SEC solely for
10. The SEC developed a detailed plan for Foamex to follow to strengthen its internal controls that
was consistent with the Section 404 internal control initiatives mandated by the Sarbanes-Oxley Act
of 2002.
Instructional Objectives
Case 3.7 Foamex International, Inc.
181
1. To compare and contrast the internal control-related responsibilities of client executives, audit
committees, and independent auditors.
Suggestions for Use
This case focuses almost exclusively on internal control issues. Similar to practically every case
in this textbook, there are other issues or important facts pertinent to the case’s “story line” that I did
not document within the case. For example, Foamex has faced repeated going-concern issues over
its recent history and, in fact, has had multiple bankruptcy filings. I did not address those issues—
and related issues—because they tend to detract from the central internal control issues raised in this
Suggested Solutions to Case Questions
1. The final responsibility for the reliability or integrity of a company’s internal controls rests with
2. Auditors of public companies:
When the bulk of the key events of this case transpired, the PCAOB did not exist—of course,
the PCAOB was created as a result of the passage of the Sarbanes-Oxley Act of 2002 and did not
become operational until 2003. The current internal control standard of the PCAOB, which is the
enforceable standard for audits of public companies, is AS No. 5, “An Audit of Internal Control Over
182 Case 3.7 Foamex International, Inc.
Internal control deficiency: “A deficiency in internal control over financial reporting exists when
the design or operation of a control does not allow management or employees, in the normal course
of performing their assigned functions, to prevent or detect misstatements on a timely basis.”
Significant deficiency in internal control: “A significant deficiency is a deficiency, or a
combination of deficiencies, in internal control over financial reporting that is less severe than a
Paragraph 3 of AS No. 5 notes that “The auditor’s objective in an audit of internal control over
financial reporting is to express an opinion on the effectiveness of the company’s internal control
over financial reporting” This paragraph goes on to indicate that “a company’s internal control
cannot be considered effective if one or more material weaknesses exist.” As a result of this latter
premise, “the auditor must plan and perform the audit to obtain reasonable assurance about whether
material weaknesses exist as of the date specified in management’s assessment [of internal control].”
“The auditor must communicate, in writing, to management and the audit committee all material
weaknesses identified during the audit.”
“If the auditor concludes that the oversight of the company’s external financial reporting and
internal control over financial reporting by the company’s audit committee is ineffective, the
auditor must communicate that conclusion in writing to the board of directors.”
“The auditor also should consider whether there are any deficiencies, or combinations of
Case 3.7 Foamex International, Inc.
Auditors of private companies:
The current internal control standards of the Auditing Standards Board, which are the
enforceable standards for audits of nonpublic companies, include SAS No. 109, “Understanding the
“The auditor should use professional judgment to determine the extent of the understanding
required of the entity and its environment, including its internal control. The auditor’s primary
consideration is whether the understanding that has been obtained is sufficient to assess risks of
material misstatement of the financial statements and to design and perform further audit
procedures.”
Notice that the focus in an auditor’s evaluation of internal controls for a nonpublic company is
obtaining a level of understanding that allows him or her to assess the risk of material misstatement
3. In the U.S., public companies, just like other organizations, can dismiss their auditors essentially
at will. Of course, a company that frequently changes its auditors may be accused of “auditor
shopping,” which may cost the company credibility in the eyes of investors, creditors, and other
parties.
Generally, auditors can also resign at will from audit engagements as long as the resignation
184 Case 3.7 Foamex International, Inc.
The SEC’s Regulation S-K, Item 304, documents the specific disclosures that have to be made
when there is a change of auditors by an SEC registrant. These disclosures are required in a Form 8-
K filing. Item 304 is several pages long but the principal features of the auditor change disclosure
rules are fairly simple and are summarized next:
—The 8-K must indicate whether the auditor “resigned,” “declined to stand for re–election,” or “was
dismissed” and “the date thereof.”
To review the complete text of the auditor change disclosure rules, refer to the following
4. This question raises a public policy issue regularly debated in the U.S. within many business
and nonbusiness contexts. By most standards, the SEC is a very small federal agency. With the