Sunbeam Corporation's fraudulent accounting for its financial years 1996, 1997 and early 1998. The essay also reviews the historic audit failure that occurred, and discusses factors that contributed to the scandal and ways in which it might have been prevented.
Sunbeam, the consumer brand name that was to become well-known among generations of Americans, had its beginnings in 1893 when founders John K. Stewart and Thomas J. Clark began manufacturing and selling a commercial horse clipping machine in Chicago. In 1897 the company was incorporated as the Chicago Flexible Shaft Company. When the company began manufacturing an electric iron named "The Princess," its first electric appliance, the product's introduction marked the beginning of the Electrical Appliance Division of today's Jarden Corporation (Jarden, 2011).
In the early years, the company's products, ranging from toasters to irons to mixers, were so successful that the company changed its name to the Sunbeam Corporation in 1946. In 1980 Sunbeam acquired the Oster Company, which produced consumer items including barber and beauty care items. Allegheny International purchased Sunbeam in 1981 at a time when Sunbeam had sales of well over one billion dollars and was already the best known brand of small electrical appliances in the country (Funding Universe, n.d.).
Allegheny International fell victim to a series of management problems, culminating in the company filing for reorganization under Chapter 11 in 1988. The court approved reorganization resulted in Japonica Partners' purchase of the Sunbeam-Oster Company. Within two years the company yielded a billion dollars in sales revenues, enabling it to make the list of Fortune 500 companies. By the mid-1990s the company's revenues grew to $5.5 billion in global sales of consumer products with manufacturing facilities around the world (Funding Universe, n.d.).
However, by July 1996, the company's shares were trading at a low of $12.50 and revenues had declined drastically. To turn the company around Sunbeam's board of directors brought in Albert J. Dunlap, known in the business press as "Chainsaw Al" and "Rambo in Pinstripes." Within seven months of joining Sunbeam, Dunlap divested divisions, cutting the number of factories from 26 to 8 and warehouses from 61 to 18. He also eliminated 6,000 positions, half the company's workforce. Dunlap also installed his hand-picked team of executives, including executive VP and Principal Financial Officer Russell Kersh who had been Dunlap's right-hand man for 14 years. In 1996 Sunbeam reported $26 million in savings from the cuts, with only a marginal decline in revenues, from $1 billion to $982 million (Sadka, 2010).
Sunbeam revenues increased dramatically in 1997, with sales increasing 22% over 1996. Earnings per share increased $1.41, compared with a $2.37 loss in 1996. In its 1997 Annual Report, the company attributed cost savings to its restructuring, while crediting its revenue growth to the following:
A global sales increase for all five product categories
The introduction of new products in the appliance category, including re-designed blenders, mixers, and toasters, in addition to increased distribution with national retailers
Most significantly, an increase in sales of the company's most popular product, outdoor cooking grills which had previously reported three straight years of declines
The annual report credited the stepped-up grill sales to "increased merchandising and advertising programs," and an entirely new line of grills and accessories for the 1998 season. These products began to ship in the fourth quarter of 1997 under the company's new early buy marketing program that included significant discounts along with credit extending due dates into the second quarter of 1998. Sunbeam claimed that the early buy program leveled out the seasonal dips and peaks. Meanwhile, Sunbeam competitors and market analysts wondered how the company could survive such aggressive selling with such low prices and flexible payment terms (Sadka, 2010).
Investors anticipated further exceptional positive results at the end of the company's first quarter in 1998, sending the stock price climbing to a high of $52 in March. Investors also anticipated that the company would seek a buyer; instead Sunbeam acquired three companies: Coleman, (camping products), First Alert (home safety and security), and Signature Brands (maker of Mr. Coffee coffeemakers), which acquisitions transformed Sunbeam into a $2.6 billion company (Sadka, 2010). Some analysts began to suspect that these acquisitions were intended to disguise losses through the use of write-offs.
With this buildup Wall Street was shocked by Sunbeam's announcement on April 3, 1998 that the company would report a loss, coming in at 5% less than previous year's revenues of $253 million, resulting in a loss. Initially Sunbeam blamed the loss on costs incurred with the three company acquisition; it blamed the revenue deficiency on lower-than-expected orders for barbecue grills, the very same product which it had credited with producing exceptional results for 1997. Dunlap then made a show of firing his executive VP of consumer products, Don Uzzi, along with other top executives. Sunbeam followed that up with an announcement that it would cut 40% of its workforce or 6,400 jobs as well as close 8 of its 24 plants.
Nonetheless the cuts did nothing to counter the news of a first-quarter loss of $44.6 million with a drop in sales of 3.6%, as well as lowered expectations for the remainder of the year. Sunbeam's domestic sales, which made up 75% of the company's revenue, were down 15%, clearly as result of the barbecue grills. Dunlap offered a variety of excuses, blaming a marketing executive for the early buy fiasco, and the weather for discouraging shoppers from grill purchases. Dunlap categorically denied stuffing the channels to pump sales, claiming it was just a failed marketing strategy (Sadka, 2010).
Intentional or not, Sunbeam had indeed employed channel stuffing, a practice wherein a company ships inventory ahead of schedule, in order to fill its distribution channels with way more product that is needed. A company does this by offering promotions that are nearly impossible for the retailer to resist, then booking the shipments as sales. The Securities and Exchange Commission (SEC) allows companies to book sales for the amount of product shipped, less a reasonable estimate for expected returns. At the same time though the SEC prohibits a company from recognizing revenue until the number of returns are known, which requirement may not be met for many months. Sunbeam failed to wait for the returns before recognizing revenue (Sadka, 2010).
Not only did Sunbeam pump its channels with grills, it also employed a "bill and hold" scheme intended to reassure retailers who may have been uncomfortable with holding additional inventory for so long a period of time. Sunbeam let its customers use the company's warehouses to store grills that customers had bought but had not actually paid for yet. Once again, the SEC permits "bill and hold" practices when specific requirements have been met. One such requirement was that the buyer, rather than the seller, must request the arrangement, which was not the case with Sunbeam (Sadka, 2010).
Due to losses and accounting irregularities, furious investors and analysts called for Dunlap's ouster, which happened in July 1998 after only two years at the company's helm. Following its own investigation, the SEC announced in May 2001 that at least $62 million of Sunbeam's reported $189 million in income for the year 1997 did not comply with accounting rules. The SEC charged Dunlap and four former officers, as well as Arthur Andersen partner, Philip Harlow, with knowingly allowing Sunbeam's accounting irregularities. The SEC charged them with fraudulent practices, including channel stuffing and cookie jar accounting, a misleading practice which takes generous reserves set aside from profitable years and uses them in unprofitable years to smooth out earnings. Dunlap initially expressed outrage at the findings, but by 2002 had agreed to pay an insignificant fine of $500,000 as well as accept the SEC's decision to bar him from ever serving again as an officer or director of a publicly traded company. In February 2001 Sunbeam filed for bankruptcy protection (Sadka, 2010).
Nature of Material Misstatement
Sunbeam's manipulation of their financial reporting presented inaccurate financial statement information that was intended to influence the company's value and stock price. Staff Accounting Bulletin (SAB) 99 sets guidelines for use in determining materiality. The bulletin notes that relying exclusively on particular quantitative benchmarks, such as 5% for misstatements, is "inappropriate." Just because a misstatement falls below the 5% threshold does not mean that it can be classified as immaterial (SEC, 1999). In every instance, Sunbeam's accounting practices manipulated financial reports such that misstated amounts far exceeded 5%.
Auditors have traditionally used a rule of thumb which holds that a 5 to 10% impact on a company's financial statements is the threshold for determining if an accounting discrepancy is material. SAB 99 clarifies other qualitative factors which may cause even numerically small misstatements to reach the level of materiality. While it can be argued that the guidelines listed in SAB 99, written after the Sunbeam scandal, should not be applied retroactively to Sunbeam, it was the SEC's position that SAB 99 did not change existing standards (SEC, 1999).…