Question

The 1997 Annual Report of Sunbeam Corp. reported net income of $ 109.4 million, with sales of $ 1.2 billion. According to CEO “chainsaw Al” Dunlap, “ we had an amazing year.” Mr. Dunlap was well known from his previous CEO positions for dramatic cost cut-ting, including firing much of senior management. Sunbeam’s share price had risen from $ 12.50 when he took over in July 1996 to $ 53 in March 1998.
However, in May 1998, when Sunbeam reported its first quarter 1998 results, the market was shocked by a loss of $ 44.6 million, compared with a profit of $ 6.9 million for the first quarter of 1997. Sales were reported as $ 244.5 million, down $ 9 million from the first quarter of 1997— a decline of 3.6%. The company’s share price quickly fell to $ 22. Reasons for this sudden decline in performance were analyzed by Jonathan Laing, writing in Barron’s. Laing claimed that Sunbeam’s 1997 earnings were “largely manufactured.” A revised summary of his analysis of the after- tax effect on 1997 net income of discretionary accruals is given in the following table.


Required
a. Sunbeam reported that 1997 operating cash flow was –$ 8.2 million. Do you agree with Laing’s statement that 1997 earnings “appear to be largely manufactured”? Explain why or why not.
b. Sunbeam had recently acquired several subsidiary companies, and had indicated that it would be recording a provision for restructuring of $ 390 million to integrate them into its operations. This suggests that Sunbeam still has scope to manage earnings. Use the earnings management tactics described by Hanna (Section 11.6.1 =) to explain how such a restructuring provision could be used to manage reported earnings.
c. Use the “iron law” of accruals reversal to help explain why there was a substantial first quarter 1998loss.


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  • CreatedSeptember 09, 2014
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