In May 2001, the Securities and Exchange Commission sued the former top executives at Sunbeam, chargingthe group with financial reporting fraud that allegedly cost investors billions in losses. Sunbeam Corporationis a recognized designer, manufacturer, and marketer of household and leisure products, including Coleman,Eastpak, First Alert, Grillmaster, Mixmaster, Mr. Coffee, Oster, Powermate, and Campingaz. In the mid-1990s,Sunbeam needed help: its profits had declined by over 80% percent, and in 1996, its stock price was down over50% from its high. To the rescue: Albert Dunlap, also known as “Chainsaw Al” based on his reputation as aruthless executive known for his ability to restructure and turn around troubled companies, largely by eliminating jobs.The strategy appeared to work. In 1997, Sunbeam’s revenues had risen by 18 percent. However, in April 1998,the brokerage firm of Paine Webber downgraded Sunbeam’s stock recommendation. Why the downgrade? PaineWebber had noticed unusually high accounts receivable, massive increases in sales of electric blankets in the thirdquarter 1997, which usually sell best in the fourth quarter, as well as unusually high sales of barbeque grills forthe fourth quarter. Soon after, Sunbeam announced a first quarter loss of $44.6 million, and Sunbeam’s stock pricefell 25 percent.It eventually came to light that Dunlap and Sunbeam had been using a “bill-and-hold” strategy with retail buyers. This involved selling products at large discounts to retailers before they normally would buy and then holdingthe products in third-party warehouses, with delivery at a later date.Many felt Sunbeam had deceived shareholders by artificially inflating earnings and the company’s stock price.A class-action lawsuit followed, alleging that Sunbeam and Dunlap violated federal securities laws, suggestingthe motivation to inflate the earnings and stock price was to allow Sunbeam to complete hundreds of millions ofdollars of debt financing in order to complete some ongoing mergers. Shareholders alleged damages when Sunbeam’s subsequent earnings decline caused a huge drop in the stock price.Required:1. How might Sunbeam’s 1997 “bill-and-hold” strategy have contributed to artificially high earnings in 1997?2. How would the strategy have led to the unusually high accounts receivable Paine Webber noticed?3. How might Sunbeam’s 1997 “bill-and-hold” strategy have contributed to a 1998 earnings decline?4. How does earnings management of this type affect earnings quality?
In May 2001, the Securities and Exchange Commission sued the former top executives at Sunbeam, charging
the group with financial reporting fraud that allegedly cost investors billions in losses. Sunbeam Corporation
is a recognized designer, manufacturer, and marketer of household and leisure products, including Coleman,
Eastpak, First Alert, Grillmaster, Mixmaster, Mr. Coffee, Oster, Powermate, and Campingaz. In the mid-1990s,
Sunbeam needed help: its profits had declined by over 80% percent, and in 1996, its stock price was down over
50% from its high. To the rescue: Albert Dunlap, also known as “Chainsaw Al” based on his reputation as a
ruthless executive known for his ability to restructure and turn around troubled companies, largely by eliminating jobs.
The strategy appeared to work. In 1997, Sunbeam’s revenues had risen by 18 percent. However, in April 1998,
the brokerage firm of Paine Webber downgraded Sunbeam’s stock recommendation. Why the downgrade? Paine
Webber had noticed unusually high accounts receivable, massive increases in sales of electric blankets in the third
quarter 1997, which usually sell best in the fourth quarter, as well as unusually high sales of barbeque grills for
the fourth quarter. Soon after, Sunbeam announced a first quarter loss of $44.6 million, and Sunbeam’s stock price
fell 25 percent.
It eventually came to light that Dunlap and Sunbeam had been using a “bill-and-hold” strategy with retail buyers. This involved selling products at large discounts to retailers before they normally would buy and then holding
the products in third-party warehouses, with delivery at a later date.
Many felt Sunbeam had deceived shareholders by artificially inflating earnings and the company’s stock price.
A class-action lawsuit followed, alleging that Sunbeam and Dunlap violated federal securities laws, suggesting
the motivation to inflate the earnings and stock price was to allow Sunbeam to complete hundreds of millions of
dollars of debt financing in order to complete some ongoing mergers. Shareholders alleged damages when Sunbeam’s subsequent earnings decline caused a huge drop in the stock price.
Required:
1. How might Sunbeam’s 1997 “bill-and-hold” strategy have contributed to artificially high earnings in 1997?
2. How would the strategy have led to the unusually high accounts receivable Paine Webber noticed?
3. How might Sunbeam’s 1997 “bill-and-hold” strategy have contributed to a 1998 earnings decline?
4. How does earnings management of this type affect earnings quality?
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