Department of Accounting & Law

State University of New York at Albany

Acc 461 Auditing

Nicholas J. Mastracchio, Jr. Ph.D. CPA & Jagdish S. Gangolly

Spring, 2003

PAPER ON ETHICS & LEGAL LIABILITY OF ACCOUNTANTS

This written assignment is based on the Securities & Exchange Commission’s Administrative Proceedings against Mr. Philip E. Harlow, CPA, reported as Accounting and Auditing Enforcement Release No. 1706 / January 27, 2003. The Release is appended to this assignment. You also will find it at

REQUIRED:

Based on the information given in the Enforcement Release No. 1706, write an essay not to exceed 5 double-spaced pages. The essay must address the following questions:

  • What were the ethical dilemmas that Mr. Harlow may have faced during the audits in question? How did he deal with them? How would you have dealt with them if you faced a similar situation?
  • What were the liability exposures to the CPA and his firm caused by his actions?

The quality of exposition in terms of grammar as well as coherence of arguments will be considered in grading.

The essay is due at the beginning of the class on March 11, 2003.

UNITED STATES OF AMERICA
Before the
SECURITIES AND EXCHANGE COMMISSION

Securities Exchange Act of 1934Release No. 47261 / January 27, 2003

Accounting and Auditing EnforcementRelease No. 1706 / January 27, 2003

Administrative ProceedingFile No. 3-11020

In the Matter of
PHILLIP E. HARLOW, CPA
Respondent.
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: / ORDER INSTITUTING PUBLIC
ADMINISTRATIVE PROCEEDINGS
PURSUANT TO RULE 102(e) OF THE
COMMISSION'S RULES OF PRACTICE,
MAKING FINDINGS AND IMPOSING
IMPOSING REMEDIAL SANCTIONS

I.

The Securities and Exchange Commission ("Commission") deems it appropriate and in the public interest that public administrative proceedings be, and hereby are, instituted against Phillip E. Harlow, certified public accountant ("Harlow" or "Respondent"), pursuant to Rule 102(e)(1)(ii) of the Commission's Rules of Practice.1

II.

In anticipation of the institution of the administrative proceedings, the Respondent has submitted an Offer of Settlement ("Offer"), which the Commission has determined to accept. Solely for the purposes of this proceeding and any other proceeding brought by or on behalf of the Commission or in which the Commission is a party, and without admitting or denying the Commission's findings contained herein, except that he admits the jurisdiction of the Commission over him and over the subject matter of this proceeding, Respondent consents to the entry of this Order Instituting Public Administrative Proceedings Pursuant to Rule 102(e) of the Commission's Rules of Practice, Making Findings and Imposing Remedial Sanctions (the "Order").

III.

On the basis of this Order and the Respondent's Offer, the Commission makes the following findings:2

A. Summary

Harlow, a former partner at Arthur Andersen, LLP ("Andersen"), Sunbeam Corporation's ("Sunbeam" or "the Company") out-side auditing firm, failed to comply with Generally Accepted Auditing Standards ("GAAS") in auditing Sunbeam's 1996 and 1997 financial statements. Harlow proposed certain adjustments that management rejected, and Harlow passed on the adjustments after quantitative materiality analysis. This resulted in Andersen's audit reports on those financial statements being inaccurate in that the reports stated incorrectly that Sunbeam's financial statements conformed to GAAP and that the Andersen audits were conducted in accordance with GAAS.

B. The Respondent

Phillip E. Harlow, a certified public accountant in the State of Florida, was a partner at Arthur Andersen from 1983 to 2002. From 1994 until the summer of 1998, Harlow was the engagement partner on the Arthur Andersen audits of Sunbeam's financial statements. Harlow has represented that he does not intend to appear or practice before the Commission as an accountant.

C. The Issuer

Sunbeam is a Delaware corporation headquartered in Boca Raton, Florida, that manufactures household appliances and outdoor products. An investigation by Sunbeam in June 1998 resulted in a restatement of Sunbeam's financial statements from the fourth quarter of 1996 through the first quarter of 1998.

D. Sunbeam's False Financial Statements

1. Sunbeam Recorded Reserves That Did Not Comport with GAAP and Recognized 1997 Expenses at Year-end 1996.
Sunbeam recorded total restructuring charges of $337.6 million at year-end 1996. Included in these charges were certain reserves and accruals, and prematurely recognized expenses that were improper under GAAP. These reserves included approximately $18.7 million of items that benefited future activities, and hence were not properly part of the restructuring reserve. Some of these reserves reduced expenses in fiscal 1997. These items included costs of redesigning product packaging, costs of relocating employees and equipment, and certain consulting fees. Under GAAP, these restructuring costs should not have been recorded in 1996 because they benefited Sunbeam's future operations.
In connection with Andersen's audit of Sunbeam's 1996 year-end financial statements, Harlow identified these components of Sunbeam's restruct-uring reserves as not in compliance with GAAP and proposed that the Company reverse the improper accounting entries. Harlow proposed adjustments for these entries, which management rejected, and Harlow passed on the proposed adjustments after incorrectly applying a materiality analysis.
Also at year-end 1996, members of Sunbeam management recorded a $12 million reserve for a lawsuit that alleged Sunbeam's potential obligation to cover a portion of the cleanup costs for a hazardous waste site. Harlow, as the engagement partner on the Andersen audit of Sunbeam's 1996 financial statements, relied on statements from Sunbeam's General Counsel, and failed to take additional steps to determine that the litigation reserve level was sup-portable under GAAP. In fact, at year-end 1996, it was improbable that Sunbeam would incur liability for the reserved amount.
Harlow caused Andersen to render an unqualified audit report on the 1996 financial statements included in Sunbeam's annual report on Form 10-K for fiscal year 1996. The report represented that Andersen conducted its audits "in accordance with generally accepted auditing standards " and that: "[i]n our opinion, the financial statements … present fairly, in all material respects, the financial position of Sunbeam Corporation and subsidiaries as of December 29, 1996…and the results of its operations and its cashflows … in conformity with generally accepted accounting principles…".
As described in this Order, however, Andersen's audit of the Company's 1996 year-end financial statements was not conducted in accordance with GAAS, and Sunbeam's 1996 financial statements were not prepared in conformity with GAAP.
2. Sunbeam Manipulated Its Results of Operations in 1997.
Throughout 1997, Sunbeam reported year-to-year and quarter-by-quarter trend improvements in sales and profits. The impression of successful financial performance, however, rested in part on the improper use of excess reserves, the failure to recognize period expenses and the recognition of revenue from sales that did not meet revenue recognition requirements under GAAP.
First, the restructuring charges and excessive litigation reserves improperly recognized at year-end 1996 increased Sunbeam's reported income and earnings in fiscal year 1997.3 These accounting errors, alone and together with the additional errors described below, resulted in the material misstatement of Sunbeam's reported results of operations.
During 1997, the Company offered financial incentives to various customers to provide purchase orders substantially in advance of their actual need for the product. Further, Sunbeam offered to hold the merchandise in its warehouses until the normal time for delivery. For revenue recognition purposes, Sunbeam treated these transactions as "bill and hold" sales. The criteria for recognition of revenue on bill and hold sales, however, require, among other things, that the buyer, not the seller, have requested a sale on a bill and hold basis and that the buyer, not the seller, have a substantial business purpose for doing so. Sunbeam's bill and hold sales did not meet these and other relevant criteria for revenue recognition. In particular, Sunbeam's customers had not requested sales on a bill and hold basis and, moreover, had no substantial business purpose for doing so.
In the course of Andersen's audit of Sunbeam's 1997 year-end financial statements, Harlow failed to ensure that the Andersen audit team performed procedures adequate to verify that the Company's bill and hold sales complied with GAAP requirements for revenue recognition.
At year-end 1997, Sunbeam recorded $11 million in revenue and $5 million in income from a purported sale of spare parts inventory to its warranty and spare parts fulfillment house. This "sale" did not comport with GAAP requirements for revenue recognition because, inter alia, critical terms of the transaction had not been agreed upon and Sunbeam had guaranteed a specified profit margin to the customer. In connection with Andersen's audit of Sunbeam's year-end 1997 financial statements, Harlow proposed a $3 million adjustment to reverse the accounting entries reflecting the revenue and income recognition for this transaction. Management declined to make the adjustment and Harlow passed on the adjustment after quantitative materiality analysis.
In connection with Andersen's audit of Sunbeam's year-end 1997 financial statements, Harlow proposed adjustments to reverse $2.9 million related to inventory over-valuation in Mexico and $563,000 related to various miscellaneous items. Management refused to make the adjustments and Harlow passed on the adjustments after quantitative materiality analysis.
Harlow caused Andersen to render an unqualified audit report on the financial statements included in Sunbeam's annual report on Form 10-K for fiscal year 1997. The report represented that Anderson conducted its audits "in accordance with generally accepted auditing standards" and that: "[i]n our opinion, the financial statements … present fairly, in all material respects, the financial position of Sunbeam Corporation and subsidiaries in the period ended December 29, 1997… in conformity with generally accepted accounting principles…".
As described in this Order, however, Andersen's audit of the Company's 1997 year-end financial statements was not conducted in accordance with GAAS. Moreover, Harlow, in the exercise of reasonable diligence, should have known that Sunbeam's financial statements had not been prepared in conformity with GAAP. Indeed, at year-end 1997, approximately 16% of Sunbeam's reported 1997 income came from the aggregation of items that Harlow had proposed as adjustments in 1996 and 1997 and had passed after quantitative materiality analysis.

E. Improper Professional Conduct

In connection with Andersen's audits of Sunbeam's 1996 and 1997 year end financial statements, Harlow failed to exercise professional skepticism when performing audit procedures and gathering and analyzing audit evidence. Codification of Statements on Auditing Standards ("AU") § 230.07. In some instances, moreover, Harlow accepted uncorroborated representations of Sunbeam's management in lieu of performing appropriate audit procedures, in contravention of AU section 333.
Harlow failed to exercise due professional care in performing the audit and preparing the audit report as required by AU § 230.01. Harlow failed to plan and perform audit procedures necessary to have a reasonable basis for its opinion. Although Harlow identified a number of audit risks and accounting issues associated with the Sunbeam engagement and should have known these items could have a material impact on the financial statements, he failed to perform sufficient audit procedures to determine whether the financial statements were in conformity with GAAP. Specifically, Harlow did not adequately address the Company's excessive restructuring and litigation reserves at year-end 1996, which resulted in the overstatement of the Company's income in 1997. Similarly, his lack of care in conducting the 1997 year-end audit allowed management to recognize revenue on sales that did not comport with applicable accounting standards.
In addition, Harlow failed to obtain sufficient competent evidential matter through inspection, observation, inquiries, and confirmations to afford a reasonable basis for an audit opinion regarding the financial statements under audit. (AU Section 326.01).4 For example, Harlow failed to obtain sufficient evidentiary material to support management's treatment of Sunbeam's 1997 bill and hold sales.
In conducting an audit, an auditor is required to state in the auditor's report whether the financial statements are presented in conformity with GAAP. (AU §§ 410 and 411). An auditor may express that the financial statements are presented in conformity with GAAP only when the audit has been performed in accordance with GAAS. (AU Section 508.07). Based on the above, in connection with the audit of Sunbeam's year-end 1996 and 1997 financial statements, Harlow failed to render an accurate audit report. To the contrary of the representations made by Harlow, the financial statements were not in conformity with GAAP, and the audit was not performed in accordance with GAAS. Harlow, therefore, engaged in "improper professional conduct" for purposes of Rule 102(e) of the Commission's Rules of Practice.

F. Findings

Based upon the foregoing, the Commission finds that:
  1. Harlow practiced before the Commission within the meaning of Rule 102(f) of the Commission's Rules of Practice (17 C.F.R. § 201.102); and
  2. In connection with the audit of financial statements of Sunbeam, Harlow engaged in improper professional conduct for purposes of Rule 102(e) of the Commission's Rules of Practice.

IV.

Accordingly, the Commission hereby accepts Harlow's Offer and hereby ORDERS, effective immediately, that:
  1. Respondent is denied the privilege of appearing or practicing before the Commission as an accountant.
  2. After three years from the date of this order, Respondent may request that the Commission consider his reinstatement by submitting an application (attention: Office of the Chief Accountant) to resume appearing or practicing before the Commission as:
  3. a preparer or reviewer, or a person responsible for the preparation or review, of any public company's financial statements that are filed with the Commission. Such an application must satisfy the Commission that Respondent's work in his practice before the Commission will be reviewed either by the independent audit committee of the public company for which he works or in some other acceptable manner, as long as he practices before the Commission in this capacity; and/or
  4. an independent accountant. Such an application must satisfy the Commission that:
(a) / Respondent, or the firm with which he is associated, is a member of the SEC Practice Section of the American Institute of Certified Public Accountants Division for CPA Firms ("SEC Practice Section") or an organization providing equivalent oversight and quality control functions ("equivalent organization");
(b) / Respondent, or the firm, has received an unqualified report relating to his, or the firm's, most recent peer review conducted in accordance with the guidelines adopted by the SEC Practice Section or equivalent organization; and
(c) / As long as Respondent appears or practices before the Commission as an independent accountant he will remain either a member of, or associated with a member firm of, the SEC Practice Section or equivalent organization, and will comply with all applicable SEC Practice Section or equivalent organization requirements, including all requirements for periodic peer reviews, concurring partner reviews, and continuing professional education.
  1. The Commission will consider an application by Respondent to resume appearing or practicing before the Commission provided that his state CPA license is current and he has resolved all other disciplinary issues with the applicable state boards of accountancy. However, if state licensure is dependent on the reinstatement by the Commission, the Commission will consider an application on its merits. The Commission's review may include consideration of, in addition to the matters referenced above, any other matters relating to Respondent's character, integrity, professional conduct, or qualifications to appear or practice before the Commission.
By the Commission.
Jonathan G. Katz
Secretary
1
Rule 102(e) (1) of the Commission's Rules of Practice provides, in pertinent part, that the Commission may deny, temporarily or permanently, the privilege of appearing or practicing before it in any way to any person who is found by the Commission: "... (ii) . . . to have engaged in …improper professional conduct…."
2
The findings herein are made pursuant to the Respondent's Offer of Settlement and are not binding on any other person or entity in this or in any other proceeding.
3
In connection with the year-end audit of Sunbeam's 1997 financial statements, Harlow learned of the use of restructuring reserves to reduce fourth quarter 1997 period expenses, and proposed appropriate audit adjustments. Management, however, refused to make the proposed adjustments. Harlow passed on the proposed adjustments after quantitative materiality analysis.
4
AU § 326.01 states that the third standard of field work is that "sufficient competent evidential matter is to be obtained through inspection, observation, inquiries, and confirmations to afford a reasonable basis for an opinion regarding the financial statements under audit."

Modified: 01/27/2003