CASE 5.3
THE NORTH FACE, INC.
Synopsis
In the winter months, you will often find college students wearing parkas, pullovers, or long-
sleeved t-shirts that sport the North Face label. Over the past four decades, North Face has
established itself as a leading supplier of apparel for “run-of-the-mill” outdoors “types.” The
company also markets a wide range of apparel and sporting gear for more adventurous souls
including mountain climbers, whitewater daredevils, ski bums, and the like.
Despite North Face’s prominence in the two markets that it serves, the company has had an “up
and down” history. Various gaffes made by the many management teams that North Face has had
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The North Face, Inc.—Key Facts
Case 5.3 The North Face, Inc. 225
2. A new team of executives that took over control of North Face in the mid-1990s failed to meet
aggressive revenue and earnings goals they had established for the company.
4. In December 1997, North Face’s CFO negotiated a large fraudulent barter transaction to “pump
up” the company’s revenues and profits for both that year and the following year.
6. Deloitte served as North Face’s independent auditor during the time frame that the company’s
operating results were being misrepresented.
7. During the 1997 North Face audit, the Deloitte audit engagement partner documented in the
9. The individual who became the North Face audit engagement partner in early 1998 allowed the
company to improperly account for that portion of the large barter transaction recorded in January
1998.
10. This second partner then instructed his subordinates to make undocumented changes in the 1997
11. The SEC sanctioned the two North Face executives who had masterminded the fraud and the
12. In May 2000, North Face’s turbulent history as a public company ended when it was purchased
226 Case 5.3 The North Face, Inc.
1. To demonstrate the need to document each important decision made during an audit engagement
2. To demonstrate the need for auditors to thoroughly investigate questionable or suspicious
Suggestions for Use
The importance of maintaining the integrity of audit workpapers and other audit-related
documentation is the key theme of this case. Consider having your students discuss the following
hypothetical situation: What would they do if a senior audit partner instructed them to alter opinions
expressed in a set of prior year audit workpapers and told them not to document the fact that those
alterations had been made?
1. The professional standards urge auditors to be cautious when they are considering “uncorrected
misstatements” in a client’s financial statements. AU Section 312 discusses such items at length.
Following is an excerpt from that discussion.
If the auditor concludes that the effects of uncorrected misstatements, individually or in the
aggregate, do not cause the financial statements to be materially misstated, they could still be
Case 5.3 The North Face, Inc. 227
2. To the greatest extent possible, auditors should not provide clients with access to the critical
parameters or facets of audit engagements, including materiality limits. Similar to what transpired in
this case, unethical client personnel can use that information to subvert the intent of individual audit
3. Statement of Financial Accounting Concepts No. 5, “Recognition and Measurement in Financial
Statements of Business Enterprises” (pre-codification) established a two-part revenue recognition
rule for accountants to follow in deciding when to record revenues. Before revenue is recognized
(recorded) in an entity’s accounting records, it should be both realized and earned, according to the
following excerpt from SFAC No. 5.
228 Case 5.3 The North Face, Inc.
4. Note: The PCAOB has established the documentation requirements for the audits of publicly
owned companies in PCAOB Auditing Standard No. 3, “Audit Documentation.” The documentation
requirements that pertain to audits of other organizations can be found in Statement on Auditing
Standards No. 103, “Audit Documentation,” that became effective for audits of financial statements
for periods ending on or after December 15, 2006.
SAS No. 103:
This standard has been integrated into AU Section 339. Paragraph .03 of AU 339 provides the
following general guidance to independent auditors.
Paragraph .32 of AU 339 notes that the “auditor should adopt reasonable procedures to retain and
access audit documentation for a period of time sufficient to meet the needs of his or her practice and
to satisfy any applicable legal or regulatory requirements for records retention.” This paragraph goes
on to note that the retention period for audit documentation “should not be shorter than five years
from the report release date.”
PCAOB No. 3:
This standard defines audit documentation as “the written record of the basis for the auditor’s
conclusions that provides the support for the auditor’s representations, whether those representations
Application to this case:
Case 5.3 The North Face, Inc. 229
The objectives of obtaining audit documentation (workpapers) identified by the ASB and the
5. AU Section 316.07 identifies the three conditions that are generally present when an accounting
fraud occurs. One of those conditions is the “incentive” of management or other employees to
commit fraudulent acts. Clearly, major strategic blunders by client management can create an
environment in which client executives and their key subordinates have a strong incentive to distort