1. Analyze the changes that Al Dunlap had initiated at Sunbeam after being hired from a strategic perspective. Did the changes started by Dunlap allow him opportunities to manage earnings?
First, after Al Dunlap was hired, Dunlap wanted to surround himself with loyal executives, such as Mr. Kersh, and fired the existing senior managers. This strategy make Dunlap easily get consensus for his points. Second, his immediate strategy was to aggressively cut the costs by eliminating excessive staffs, divest unprofitable divisions and consolidate headquarters as well as production facilities.
This strategy could result in lower cost, higher profits. Then he turned his strategy to growth and expansion of core business after the downsizing strategy. This strategy focused on growing the core business by product differentiation to diversifying through both concentric and conglomerate acquisitions. Also company announced a huge restructuring charge.
There are three opportunities to manage earnings. First, Dunlap took large one time charges. In November 1996 the company announced a huge restructuring charge of $337.6 million. Second, Dunlap could manage income through managing transactions, which is “channel loading”. It transferred products to retailers and retained the physical inventory in its warehouses. Third, Dunlap built a loyal team, which could effectively control the total company.
2. Focus on the allegations made by Barron's about Sunbeam's accounting. Do you find any red flags that may support these allegations by looking at the "as reported" financials of Sunbeam?
There are some red flags that support these allegations:
1. Unusual increase in Accounts Receivable in relations to sales increase - relaxing credit or channel loading. In 1997, the receivables increased %38.5 ($82M) to 295.55M. From Barron’s article, the company extensively use of “bill and Hold” sales.
2. Unusual increase in Inventory in relations to sales increase. In 1997, the closing inventories increased by %40 to 92M. From Barron’s article, it defer the charge for fixed expense and maneuver could increase net income by 10M.
3. Unexpected large asset write off inventory. In 1997 the company rote off 90M worth of inventory from discontinuedbusiness lines and havenetted about 45M of profits.
4. Write off of the PPE. From Barron’s article, there is lower depreciation charge because of writing off of PPE. This resulted in a lower depreciation chage of about 6M during 1997.
3. Compare the "as reported" and "restated" financials of Sunbeam. Do you see any evidence supporting the allegations in the differences between these statements?
1. Overstate in Accounts Receivable. In 1997 reported B/E, Accounts Receivable overstated 67M (295.55M in “reported” and 228.46M in “restated”).
2. Large write offof inventory. In 1997 reported B/E, inventory was wrote off 48.72M (256.18M in “reported” and 304.9M in “restated”)
3.Write off of the PPE.In 1997 reported B/E, PPE was wroteoff 8.627M(240.897M in “reported” and 249.524M in “restated”).
4. Decrease in Other Current Liabilities for ploughing back product warranties. The Other Current Liabilities understated in 1997 about 37.986M.