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 http://www.sec.gov/litigation/admin/34-47261.htm.
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.
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
UNITED STATES OF AMERICA
Before the
SECURITIES AND EXCHANGE COMMISSION
Securities Exchange Act of 1934
Release No. 47261 / January 27, 2003
Accounting and Auditing Enforcement
Release No. 1706 / January 27, 2003
Administrative Proceeding
File No. 3-11020
:
:
In the Matter of
:
:
PHILLIP E. HARLOW, CPA :
:
Respondent.
:
:
:
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
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
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
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
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 yearend 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
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
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
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
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 yearend 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 §§
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
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:
A. 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
B. 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:
A. Respondent is denied the privilege of appearing or practicing before the
Commission as an accountant.
B. 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:
1. 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
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
2. 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.
C. 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
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
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."
http://www.sec.gov/litigation/admin/34-47261.htm
Modified: 01/27/2003