Case 7-3 Managing Earnings and Putting Ethical

Leadership to the Test

Jeremy Strong, CPA was recently hired as the new CFO of Imageware Consolidated (IC) a small
publicly owned company. This is Jeremy’s first job outside of public accounting, leaving
Deloitte after ten years, where he rose in the ranks to senior audit and assurance manager. IC is a
rapidly growing and trend setting company in the sportswear industry. They are being compared
to an early-stage Nike or Under Armour and Jeremy is excited by the prospect of working for a
company that appears to have tremendous growth potential.
During Jeremy’s recruitment, he was told by the CEO, that the old CFO was forced to retire for
health reasons. The CEO stated that IC really needed someone who would hit the ground
running. Specifically, the CEO said that IC needed someone to step into this role who had a firm
grasp of SEC reporting requirements and was comfortable speaking with all the various
stakeholder groups including industry analysts who were following the company closely.
One of Jeremy’s first tasks was to prepare for an earnings-call where he would be introduced as
the new CFO. He had just one week to prepare for that call. Jeremy spent that first week in
meetings with IC’s Controller, Samantha (Sam) Bee, CPA and other executives who provided
him with reams and reams of financial and operational data to help bring him up to speed and
prepare him for the call.
In one discussion with Sam, Jeremy was told that the company has been able to meet or exceed
the analysts’ consensus EPS estimates every quarter since going public two and a half years ago.
She explained that the company relies heavily on a continuous flow of financial data (actual and
forecasted) from the financial reporting group that she oversees. Sam explained that their
expertise in forecasting provides the company with an early warning system of sorts that has
enabled the sales and marketing department to make very sound operational decisions quarter
after quarter, resulting in their ability to meet or beat analysts’ expectations. She was clearly
proud of the work she was doing. The hairs on the back of Jeremy’s neck rose a little as he
listened to what Sam was telling him.
In response, Jeremy asked Sam to explain what she meant by operational decisions. Sam stated
that while there has been a steady increase in demand for their products year over year, there are
seasonal swings and other trends that can impact monthly and quarterly sales demand in the
sportswear industry. She explained that the sales and marketing department have the authority to
use a variety of techniques to entice IC’s customers to purchase their products (earlier then they
would have otherwise) including things like rebates, discounts, free products, and even extended
payment terms.
Jeremy then asked Sam whether these practices had been disclosed publicly. Without realizing it
he held his breath as we waited for her response.
Questions:
1. Explain how the sales and marketing incentives used by IC represent earnings
management. In your response explain why Jeremy asked about disclosure of
these practices.
These incentives are a common form of earnings management discussed in both Chapter
6 and this chapter as operational earnings management designed to pull revenue forward.
In this particular case, we see these incentives are being used to help smooth earnings
from quarter to quarter and to meet analyst quarterly consensus estimates. This technique
may be pushing (delaying) bad news to some future quarter(s) as it is presumed that at
some point these incentives will no longer be enough to offset the shortfall in revenue.
In the case of Marvell discussed in Chapter 6, the SEC found that they used this
technique to fraudulently represent the financial condition of the company because they
failed to disclose their use and that in the case of Marvell, they were used to cover up the
fact that revenue was decreasing over time and it was unlikely they could continue to
meet future earnings estimates.
In the case of Maga-Chip discussed in this chapter, they used pull-in sales practices
offering distributors undisclosed concessions through side agreements to incentivize them
to order products earlier than wanted or needed in order to hit revenue targets.
Jeremy asked about disclosures surrounding the use of the incentives at IC, as the
response might indicate whether the company was involved in fraudulent financial
reporting or not. Either way, their use represents a clear indication that earnings are being
managed at IC and Jeremy needs to be concerned as to what their use might indicate in
regard to the ethical culture of the organization.
These types of incentives can be used to manipulate the reported financial results in
violation of GAAP, so they are considered a red flag. While there may be valid reasons
that a company needs to use these techniques (short term need for cash), their use needs
to be disclosed along with a valid assessment of the impact of their use to future periods
may be. Jeremy as the new CFO will be putting his credibility and reputation at risk on
the upcoming earnings call.
2. The case states that the hair on the back of Jeremy’s neck rose during a
discussion with IC’s Controller when he learned about the first of several red
flags outlined in the case. Identify and discuss at least three actual and two
potential red flags.
Jeremy having just left a position as a senior audit and assurance manager at Deloitte,
would have a keenly developed sense of professional skepticism. Expect your students to
identify at least two of the three actual red flags we identify next. The three actual red
flags include: A focus on consensus earnings, the use of revenue pull-in earnings sales
incentives, and the meeting or beating of consensus earnings estimates for multiple
quarters in a row.
Focus on consensus earnings – Managing attainment of consensus earnings is effectively
placing importance on the maintenance, or management, of the market value of a
company’s common stock. While maintaining or increasing a company’s stock price is
not a bad thing, it does not directly provide the company with any benefit.
The focus on stock price like this is an example of making decisions which result in short
term benefits of some kind (increase stock price today), which potentially have long-term
negative ramifications (stock price drop later, or even leading to other forms of stock
manipulation in the future) – the slippery slope. The importance placed on consensus
earnings is considered a red flag as it provides an incentive and potentially a justification
to make unethical decisions in order to achieve the consensus numbers.
Use of Revenue pull-in sales incentives – These types of incentives can be used to
manipulate the reported financial results in violation of GAAP, so they are considered a
red flag. While their may be valid reasons that a company needs to use these techniques
(short term need for cash), their use needs to be disclosed along with a valid assessment
of the impact of their use to future periods may be.
Meeting of Consecutive Quarter Consensus Earnings – This is considered a red-flag that
earnings management techniques may be in use (especially if they are just met, or
exceeded by a small amount). The techniques used to manage earnings can run the
gambit from valid, legal and ethical operational decisions to illegal and unethical
accounting decisions which clearly violate GAAP. An accountants’ professional
skepticism should increase the more consecutive quarters of attainment that are reported.
The reason for this is that it is that there are many reasons that a company will fall short
of meeting earnings estimates from time to time. In fact, it is probable that they will fall
short from time to time, so a company that simply meets or exceeds estimates every
quarter should be viewed with heightened skepticism.
The existence of the red flags discussed above, suggest that there may be other red flags
that Jeremy needs to be on the lookout for. Two potential red flags in this case include
that there may be other forms of earnings management going on that the controller may
or may not be aware of, and the ethical culture within the organization may be weak.
Jeremy needs to engage in more conversations with Sam and the other executives to get
comfortable with exactly what is going on at the company.
Other EM techniques in use: The existing of the three red flags discussed previously
suggest that there may be others in use. The adage of where there is smoke, there is fire
comes to mind. Similar to an audit where additional procedures need to be performed
when exceptions are found through samples analyzed, the existence of multiple red flags,
is an indication that other red flags may also exist. Jeremy needs to investigate the
quarterly close and financial creation process paying particular attention to any manual
adjustments (journal entries) that are made.
Ethical Culture: The red flags identified in the case suggest that the ethical culture might
not be strong in this organization. Jeremy will need to keep this in mind as he continues
to learn about the company that he has gone to work for. His professional skepticism will
help him as he moves forward.

As discussed in Chapter 7, a distinguishing characteristic of many of the accounting

frauds discussed in this book is that short-term factors were allowed to compromise long-
term ethical decision making in the interest of creating the illusion that earnings were
strong and sustainable. CFOs and CEOs acted based on non-ethical values, such as
enhancing share prices and creating personal wealth. Those on the front line “held their
nose” and carried out unethical orders that led to managed earnings. “Leaders” such as
Jeff Skilling at Enron, Bernie Ebbers at WorldCom, and Dennis Kozlowski at Tyco
created hands-off environments that sent the message “all is well” while the companies
were collapsing around them. Jeremy needs to make sure that IC’s ethical culture is one
that will provide him the opportunity to maintain his obligations to honesty, integrity,
objectivity and professional skepticism.

3. What additional questions should Jeremy ask to help assess the ethical culture
within the organization?

Jeremy needs to continue to have conversations with the executives in the

organization with a focus toward learning about the importance that is placed
surrounding meeting the consensus earnings estimates. He should be asking the same
or similar questions of multiple people separately as a way of verifying what he is
told. His questions should include questions like:
a. What importance is placed on meeting the consensus earnings numbers over
other things?
b. How does meeting the consensus earnings numbers impact (if at all) other
decisions that the company has made in the past?
c. What actions would you want to take if it did not appear that the company
could meet consensus earnings even with the use of the sales incentives?
d. By what amount have the consensus earnings been met/exceeded each
quarter?
e. Have any other things beyond the incentives been done in order to meet the
numbers?
f. Why did the old CFO leave the organization?
Jeremy should arrange a meeting with the external auditors and get their
perspective on the use of these incentives. He should also ask about how their
interactions with IC management have been in the past and he should discuss their
view of IC’s internal controls over financial reporting (ICFR). He can also ask
them for their assessment of the ethical tone at the top of the organization. These
are questions that as a new CFO coming from public accounting can ask without
raising any concerns in doing so.
Case 7-8 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,
causing investors billions of dollars in losses. The defendants in the action included Sunbeam’s
former CEO and chair Albert J. Dunlap, former principal financial officer Russell A. Kersh,
former controller Robert J. Gluck, former vice presidents Donald R. Uzzi and Lee B. Griffith,
and Arthur Andersen LLP partner Phillip Harlow.

The SEC complaint described several questionable management decisions and fraudulent actions
that led to the manipulation of financial statement amounts in the company’s 1996 year-end
results, quarterly and year-end 1997 results, and the first quarter of 1998. The fraud was enabled
by weak or nonexistent internal controls, inadequate or nonexistent board of directors and audit
committee oversight, and the failure of the Andersen auditor to follow GAAS. The following is
an excerpt from the SEC’s AAER 1393, issued on May 15, 2001:

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
improper restructuring reserves and other “cookie-jar” reserves as part of a year-end 1996
restructuring, which were reversed into income the following year. Also, in 1997, Sunbeam’s
management engaged in guaranteed sales, improper “bill-and-hold” sales, and other fraudulent
practices. At year-end 1997, at least $62 million of Sunbeam’s reported income of $189 million
came from accounting fraud. The undisclosed or inadequately disclosed acceleration of sales
through “channel-stuffing” also materially distorted the Company’s reported results of operations
and contributed to the inaccurate picture of a successful turnaround.

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
directors investigated the fraud and fired Dunlap and the CFO. An extensive restatement of
earnings from the fourth quarter of 1996 through the first quarter of 1998 eliminated half of the
reported 1997 profits. On February 6, 2001, Sunbeam filed for Chapter 11 bankruptcy protection
in U.S. Bankruptcy Court.

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
materially distorted the Company’s reported results of operations for fiscal year 1996 and would
materially distort its reported results of operations in all quarters of fiscal year 1997, as these
improper reserves were drawn into income.

The most substantial contribution to Sunbeam’s improper reserves came from $18.7 million in
1996 restructuring costs that management knew or was reckless in not knowing were not in
conformity with generally accepted accounting principles. Sunbeam also created a $12 million
litigation reserve against its potential liability for an environmental remediation. However, this
reserve amount was not established in conformity with GAAP and improperly overstated
Sunbeam’s probable liability in that matter by at least $6 million.

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.
These bill-and-hold transactions led to recording $35 million in revenue too soon. However, the
auditors (Andersen) reviewed the documents and reversed $29 million.

In 1997, the company failed to disclose that Sunbeam’s 1997 revenue growth was partly
achieved at the expense of future results. The company had offered discounts and other
inducements to customers to sell merchandise immediately that otherwise would have been sold
in later periods, a practice referred to as “channel stuffing.” The resulting revenue shift
threatened to suppress Sunbeam’s future results of operations.
Sunbeam either didn’t realize or totally ignored the fact that, by stuffing the channels with
product to make one year look better, the company had to continue to find outlets for their
product in advance of when it was desired by customers. In other words, it created a balloon
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.

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
earnings for the first year, based on the belief that increases in future earnings through the
release of the reserves or other techniques make it appear that the CEO has turned the
company around, as evidenced by turning losses into profits. Some companies might take
it to an extreme and pile on losses by creating reserves in a loss year, believing that it
doesn’t matter whether you show a $1.2 million loss for the year or a $1.8 million loss
($0.6 million reserve). This is known as “big-bath accounting.”
2. Reserve amounts reduced after initial overstatement. Fluctuations in the reserve amount
should have raised a red flag because they evidenced earnings management as initially
recorded reserves were restored into net income.
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 collectability of receivables, as indicated by the significantly
larger percentage increase in receivables compared to revenues.
 EXHIBIT 2

Sunbeam Corporation’s Operational Performance

Operational Performance

9 months 9/97 ($ in 9 months 9/96 ($ in %

millions) millions) Change

Revenue $830.1 $715.4 16%

Gross profit 231.1 123.1 86%

Operating revenue 132.6 4.0 3,215%

Receivables 309.1 194.6 59%

Inventory 290.9 330.2 12%

Cash flow from (60.8) (18.8) N/A

operations

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
the differential in these amounts at Sunbeam seems to defy logic. Financial analysts tend
to rely on the cash figure because of the inherent unreliability of the estimates and
judgments that go into determining accrual earnings.

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
sign an “agreement to agree” to buy the parts for $11 million, with a clause letting EPI walk
away in January 1998. In fact, the parts were never sold, but the profit was posted anyway.

Along came Phillip E. Harlow, the Arthur Andersen managing partner in charge of the Sunbeam
audit. He concluded the profit was not allowed under GAAP. Sunbeam agreed to cut it by $3
million but would go no further. Harlow could have said that if such a spurious profit were
included, he would not sign off on the audit. But he took a different tack. He decided that the
remaining profit was not material. Since the audit opinion says the financial statements “present
fairly, in all material respects” the company financial position, he could sign off on them. The
part that was not presented fairly was not material. And so, it did not matter.

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
and considered Sunbeam’s reported levels of inventory for certain items to be unusual for the
time of year. For example, he noted massive increases in the sales of electric blankets in the third
quarter of 1997, although they usually sell well in the fourth quarter. He also observed that sales
of grills were high in the fourth quarter, which is an unusual time of year for grills to be sold and
noted that accounts receivable were high. On April 3, 1998, just hours before Sunbeam
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
repeated and that Sunbeam would post increased earnings in the second quarter. It didn’t work.
The press continued to report on Sunbeams’ bill-and-hold strategy and the accounting practices
that Dunlap had allegedly used to artificially inflate revenues and profits.

Dunlap called an unscheduled board meeting to address the reported charges on June 9, 1998.
Harlow assured the board that the company’s 1997 numbers were in compliance with accounting
standards and firmly stood by the firm’s audit of Sunbeam’s financial statements. As the meeting
progressed the board directly asked Sunbeam if the company would make its projected second
quarter earnings. His response that sales were soft concerned the board. A comprehensive review
was ordered and eventually Dunlap was fired after the directors said they had “lost confidence”
in his leadership. Sunbeam employees reportedly cheered the move openly when it was
announced.

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
stated that Andersen had conducted an audit in accordance with generally accepted auditing
standards, and that the company’s financial statements fairly represented Sunbeam’s results and
were prepared in accordance with generally accepted accounting principles. In 2002, the SEC
resolved a legal action against Andersen when a federal judge approved a $141 million
settlement in the case. Andersen agreed to pay $110 million to resolve the claims without
admitting fault or liability. In the end, losses to Sunbeam shareholders amounted to about $4.4
billion, with job losses of about 1,700.

Questions
 1. Explain the accounting techniques used by Sunbeam to manage its earnings.

Here were the three most common financial shenanigans used by Sunbeam to manage earnings
and an explanation why the company chose those methods.

Cookie-jar reserves. Setting up cookie-jar reserves enabled Sunbeam to smooth out earnings
over time and make it look like the company was meeting or exceeding financial analysts’
earnings projections.

Channel stuffing. This technique was used by Sunbeam when recorded sales were insufficient to
meet projections so the company had to develop incentives for customers to buy product sooner
than they would have liked but made sense for them to do so because of concessions on the price
or other terms in the affected transactions.

Bill-and-hold sales. In some cases, the customers did not want to take ownership of the product
at the time Sunbeam needed it in order to accelerate the recording of revenue. Sunbeam still
recorded revenue even though it maintained control over the product in its own distribution
facility.

2. 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.
Andersen should have known of Dunlap’s reputation on Wall Street and his promise of a fast
turnaround at Sunbeam. Shareholders may have loved Dunlap, but employees despised him. A
fearful culture at Sunbeam grew as employees feared pink slips and intimidation from top
management. Dunlap created a culture in which employees would do anything to meet the
number goals Dunlap established for the company. Andersen should have used COSO’s
Integrated Framework to evaluate the control environment including the management
philosophy and operating style under Dunlap. Andersen should have been more skeptical and on
guard for unusual accounting treatments or transactions.
Andersen failed in its risk assessment as the red flags were all around including the compromised
ethical culture and games Dunlap was playing with reporting earnings. Sunbeam used a variety
of techniques and financially structured transactions, such as that with EPI Printers, to make
things look better than they really were.

3. 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.

Understanding financial relationships is essential in planning and evaluating the results of

analytical procedures, and generally requires knowledge of the client and the industry or
industries in which the client operates. An understanding of the purposes of analytical procedures
and the limitations of those procedures is also important. Accordingly, the identification of the
relationships and types of data used, as well as conclusions reached when recorded amounts are
compared to expectations, requires judgment by the auditor.

Analytical procedures are used for the following purposes:

• To assist the auditor in planning the nature, timing, and extent of other auditing
procedures
• As a substantive test to obtain evidential matter about particular assertions related to
account balances or classes of transactions
• As an overall review of the financial information in the final review stage of the audit

Analytical procedures should be applied to some extent for the purposes referred to above for all
audits of financial statements made in accordance with generally accepted auditing standards. In
addition, in some cases, analytical procedures can be more effective or efficient than tests of
details for achieving particular substantive testing objectives.

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

1
[Link]
 • Anticipated results—for example, budgets, or forecasts including extrapolations from
interim or annual data
• Relationships among elements of financial information within the period
• Information regarding the industry in which the client operates—for example, gross
margin information
• Relationships of financial information with relevant nonfinancial information

In the case of Sunbeam even a cursory review of analytical procedures would have raised red
flags as it is counter-intuitive that a company’s operating revenues would increase by 3,215%
over a 12-month period while receivables increased 59% during the same period. Moreover, an
almost doubling of gross profit is highly unlikely even under the best circumstances. Andersen
seems to have ignored these realities and, as such, violated their ethical obligation for exercising
due care, being skeptical about Sunbeam’s methods and results, and in gathering sufficient
competent information to verify management’s representations.

4. What role did leadership play in the accounting fraud at Sunbeam?

Dunlap’s leadership style contributed to the toxic environment at Sunbeam where managing
earnings was the mantra, regardless of the validity of methods used to accomplish the goal. It
was the motivation for the financial shenanigans and played a role in bad decision-making by
Dunlap. For example, by turning to channel stuffing time and again, Dunlap was basically
borrowing from the future to make the current periods’ earnings look better than they really
were. Moreover, the techniques used eventually died out because customers stopped agreeing to
more lenient terms in order to buy product sooner than they needed in order to keep Dunlap
happy. They already had bought more than they could possibly use in a period.

As stated in the case, Dunlap was fired after the directors said they had “lost confidence” in his
leadership. Sunbeam employees reportedly cheered the move openly when it was announced.
The pressure that was constantly placed on employees to meet the numbers created a toxic
environment and corrupted the culture of the organization. It’s no wonder the employees cheered
when they found out Dunlap had been fired.

Dunlap had an overly-aggressive style that sent a signal that employees were expected to be
loyal to the boss and a team player. The employees were fearful of incurring the wrath of Dunlap
because of his reputation as “Chainsaw Al.” A fear-driven culture is the opposite of what ethical
leadership should be, whereby subordinates want to follow the leader because they are trusted
and the employees have confidence that the leader acts in their own best interests.