Deck 39: Sunbeam: Completeness of the Restructuring Reserve

Question 1

Consult Paragraphs 13-21 of PCAOB Auditing Standard No. 15. What is meant by a restructuring reserve? As an auditor, what type of evidence would you want to examine to determine whether a company was inappropriately accounting for its restructuring reserve?

Answer 1

Audit evidence
It is the information collected by audit team while reviewing company's financial transactions, internal controls, and other factors and which are recorded in working papers to be used as the basis for making a conclusion and giving an opinion.
In the present case, S Company named Mr. A as its CEO who immediately initiated company restructuring which included the elimination of half of its employees and 87% of the products. As a result S company suffered huge loss and Mr.A was fired. Ultimately, S Company announced that it would restate its financial statement.
A restructuring reserve is a reserve which is created to recognize the expenses which incur during the planned reorganization of company's operations, assets or manufacturing units. It is a liability account and is disclosed separately in the financial statement. It is used in when actual restructuring takes place to recognize the costs.
In this case, the restructuring reserve included expenses related to employee severance, lease obligations and exit costs associated with facility closure. However, the reserve also included non-cash items which would benefit S Company in the future, such as package redesign costs, relocation cost of employees and equipment and consultant fees which were not allowed as per GAAP.
The paragraphs 13 to 21 of PCAOB Auditing Standard number 15 prescribe various types of procedures to obtain and examine audit evidence for auditing purposes. An audit evidence should be relevant and reliable.
Audit evidence is considered to be relevant when it relates to the financial statement which is being verified and examined. Such evidence must allow the auditor to reach the conclusions for expressing an opinion.
An evidence can be considered reliable when it truly represents the assertions which are being tested. Evidence is more reliable when it is received from an external source in its original format.
An auditor should perform different types of audit procedures in order to assess the appropriateness of the restructuring reserve. Such audit procedures include substantive analytical procedure and test of details. The auditor can also examine the minutes from Board meetings to verify the items included in the restructuring reserve.
An auditor should note down each item included in the restructuring reserve and obtain sufficient and appropriate evidence for each item from both internal and external sources. The evidence obtained in such manner would both be relevant and reliable to check whether the items included in the restructuring reserve are allowed as per GAAP or not.

Question 2

Consult Paragraphs 29 and 32 of PCAOB Auditing Standard No. 5. As an auditor, do you believe that the different componenets of the restructuring reserve might be subject to significantly differing levels of inherent risk? Why or why not?

Answer 2

For the Sunbeam restructuring reserve, the different components definitely have differing levels of inherent risk.  For example, the restructuring reserve involves both nonroutine and estimation transactions, which both have a higher level of inherent risk than routine transactions.  In particular, the estimated loss from discontinued operations represents a highly subjective estimate that carries an elevated inherent risk. In regards to the restructuring reserve, there were several nonroutine transactions such as severance and other employee costs, facility closure costs, and start-up costs.  In addition, there were several estimation transactions such as asset write-downs. Both nonroutine transactions and estimation transactions have an elevated inherent risk and demand more audit attention during the testing procedures. This is why it is critical to consider the restructuring reserve as a series of components. Different components of the restructuring reserve will likely be associated with different levels of inherent risk.

Question 3

Consult Paragraphs 28-30 of PCAOB Auditing Standard No. 5. Identify at least one relevant financial statement assertion related to the restructuring reserve account? Why is it relevant?

Answer 3

For Sunbeam's restructuring reserve, valuation or allocation would clearly be a relevant financial statement assertion as this reserve requires a number of different estimates of future expenses related to restructuring.  It is important for an auditor to consider the qualities of the valuation or allocation assertion when applying the assertion to Sunbeams restructuring reserve. Particularly, related to the estimates required for the reserve.  In addition, given the nature of the restructuring plan established by CEO Dunlap, there were many product lines that were being cut by Sunbeam. As a result, Sunbeam was subject to a number of product lines in the inventory becoming obsolescent. As a result, the question of inventory valuation is paramount for Sunbeam.

Question 4

This case describes a situation where a company overstated its recorded expenses in 1996 (as compared to understating recorded expenses). Why would a company choose to overstate its expenses and understate its net income?