CASE 1.

1

MATTEL, INC.

In 1945, Elliot and Ruth Handler, along with a friend, Harold Matson, founded a small toy company. Within a few months, Matson decided to pursue other interests and left Mattel, Inc., to the Handlers. For the next decade, the husband-andwife team struggled to make their small company a success. Elliot Handler, an artist, designed the toys the company produced, while Ruth Handler managed the company’s business affairs, concentrating much of her time on finding sales outlets for their products. By 1955, Mattel’s net worth was a little more than $500,000. That year, Ruth Handler decided to take a daring step to expand the size of the company. Her plan was to advertise Mattel’s toys on the popular children’s television program, The Mickey Mouse Club. The cost of the advertising campaign was several hundred thousand dollars and if unsuccessful could have bankrupted the small company; however, Ruth Handler’s gamble paid off handsomely. Within a few months, Mattel’s sales orders increased dramatically, and the company was on its way to establishing itself as a major player in the very competitive toy industry. In 1959, Ruth Handler took a second gamble by introducing a full-figured, teenage doll named after her daughter Barbara. Industry experts maintained that the doll would not appeal to its target market of three- to eleven-year-old girls. The experts were wrong. Barbie was an instant success, with more than 350,000 sold the first year it was on the market. By Barbie’s thirtieth birthday, more than 500 million dolls had been sold. Ruth Handler, the youngest of ten children of Polish immigrants, was never modest about explaining the success of Mattel. During an interview, she once noted matter-of-factly that she was “a marketing genius.” A short and intensely competitive woman, Ruth Handler hated failure and refused to accept it. During the early 1970s, however, she and her company encountered a set of circumstances that would eventually take Mattel to the verge of bankruptcy. 3

Rosenberg. which ended January 29. In that year. The Handlers and other key Mattel executives became fabulously wealthy as a result. Investors were so infatuated by the company and its prospects that Mattel common stock traded at an enormous price-earnings ratio. Finally. an intensive study of Mattel’s financial records by Spear revealed that the company had actually suffered a huge loss in fiscal 1973—larger than the loss reported the prior year. four of the six companies acquired by Mattel on the recommendation of Rosenberg proved to be very poor investments. one of the company’s large warehouses in Mexicali. Shortly after joining Mattel. formerly with Litton Industries. who was dismissed by the Handlers in late 1972. he convinced the Handlers to diversify into several industries and to completely overhaul the organizational structure of the company. Unfortunately. One month later. Mexico. These factors caused Mattel to register a loss of approximately $30 million in fiscal 1972. In October 1975. Mattel encountered a series of largely uncontrollable circumstances in the early 1970s that damaged the company’s profitability. Finally. Then. Besides the problems created by Rosenberg. A large banking syndicate that had significant loans outstanding to Mattel was instrumental in convincing the Handlers to dismiss Rosenberg. Shortly before Spear accepted his new position in early 1973. Following Rosenberg’s dismissal. the company began experiencing serious problems in the early 1970s. the outside directors on the Mattel board released a fivehundred page report that detailed a massive earnings manipulation scheme . the company reported pretax profits of $34 million on sales approaching $275 million. had earned a reputation for his skill in identifying and acquiringunderperÿÿrming companies and making them financial successes. and his decentralization plan increased Mattel’s operating costs tremendously. the following year.When Spear released this information to the public. panicked investors reacted immediately by dumping their Mattel stock. Spear’s disclosures also resulted in five class action lawsuits being filed against Mattel and its executives by angry stockholders. Despite the record earnings reported by Mattel for each successive year from 1967 through 1971. Spear’s revelations spurred the Securities and Exchange Commission (SEC) to begin an investigation of the company’s financial affairs. By 1971.. First. Mattel was recognized by financial analysts as one of the premier growth companies in the United States. 1972. the recession of the early 1970s cut significantly into the company’s sales.4 SECTION ONE COMPREHENSIVE CASES TRYING TIMES AT MATTEL By 1971. often exceeding 50 to 1. Albert Spear was named Mattel’s executive vice-president and placed in charge of the company’s day-to-day operations. Elliot and Ruth Handler resigned their positions with Mattel. Spear quickly discovered that Mattel’s financial status had been grossly misrepresented to the public. a dockworkers’ strike prevented the company from receiving any toy shipments from its large Hong Kong plant. the Mattel stock controlled by Elliot and Ruth Handler had a market value approaching $300 million. However. breaking its operations down into numerous decentralized divisions. Many of these problems could be traced to the Handlers’ decision in the late 1960s to hire Seymour Rosenberg as the company’s executive vicepresident and chief financial officer. burned to the ground in 1970. Mattel had issued a press release stating that the company had undergone a dramatic turnaround in fiscal 1973 compared with fiscal 1972.

. 4 November 1975.1 MATrEL. Handler submitted a plea of no contest to each of the ten counts of fraud filed against her. Sansweet. 5 masterminded by the company’s executive officers. Price Waterhouse. principally the Handlers and Rosenberg. 10.CASE 1. Later that year. as well as even larger payments by the insurance companies of these executives. The only defendant that refused to participate in the settlement was Arthur Andersen. In general. 3. The executives were charged with falsifying Mattel’s financial statements for the period 1969 to 1974. Seymour Rosenberg. In February 1978. however.” The New York Times.’ The lengthy report also discussed Arthur Andersen’s audits of Mattel during the period in which the company’s earnings were being manipulated. According to the report. Lindsey. harshly criticized Arthur Andersen. If this had been done. The SEC criticized Arthur Andersen’s audits of Mattel. S. Price Waterhouse concluded that Arthur Andersen’s audit procedures and tests weren’t as comprehensive as they should have been in many areas and that certain information contained in the accountant’s working papers should have been further pursued. Ruth Handler proclaimed her innocence and maintamed that she was “deeply offended” by the charges. 19 June 1988.000 fine. A similar plea bargain arrangement was made with Rosenberg in the fall of 1978. “Mattel Ex-Aides Tried Cover-Up. in April 1977. the Handlers and other key Mattel officials issued “financial statements that were deliberately false and misleading” to give an illusion of continued spectacular growth. In responding to the indictment. Report Asserts. a federal judge approved an out-of-court settlement to the class action lawsuits filed by Mattel’s stockholders. INC.’ ALLEGED DEFICIENCIES IN ARTHUR ANDERSEN’S AUDITS OF MATTEL In June 1981. the report said it could have led to the discovery of irregularities in the fiscal 1971 and 1972 financial statements. the SEC released the results of its lengthy investigation of Mattel’s fraudulent earnings manipulation scheme and its report on Arthur Andersen’s audits of Mattel. a federal grand jury indicted Ruth Handler.2 In March 1976. particu1.000 to Mattel stockholders to resolve the matter. The $30 million settlement required multimillion-dollar payments by several former executives of Mattel. Elliot Handler was never indicted for criminal fraud. “A Million-Dollar Business from a Mastectomy.” The Wall Street Journal. which maintained that it was not responsible for the huge losses suffered by Mattel’s stockholders following the disclosure of the eamings manipulation scheme. 2. R. Nevertheless. which reviewed the Mattel audits. Handler’s plea bargain agreement allowed her to escape a prison sentence but required her to perform 2.500 hours of community service and to pay a $57. The federal grand jury that investigated the Mattel earnings manipulation scheme apparently concluded that he was not involved in the fraud. F3. Arthur Andersen agreed to make a cash payment of approximately $900. and four other former Mattel executives.

5. Mattel’s illicit accounting methods and the related deficiencies in Arthur Anderson’s audits are discussed in the following sections. 2. When the bill and hold sales were recorded in January 1971. are reprinted from this source. numerous errors and oversights during those audits had prevented Arthur Andersen from discovering the fraudulent methods used by Mattel management to manipulate the company’s reported operating results. When the bill and hold goods were actually shipped. 3. 6. 22 June 1981. The magnitude of the bill and hold program created tremendous confusion for Mattel accounting personnel. 292. 1971.6 SECTION ONE COMPREHENSIVE CASES larly the 1971 and 1972 engagements. To inflate the company’s reported earnings. Mattel used this program to overstate its fiscal 1971 sales by almost $15 million and its pretax earnings by approximately $8 million. Mattel management was facing the unpleasant prospect of informing stockholders that the company had failed for the first time in several years to post record sales and earnings. or destruction of the merchandise. The customer did not have to make any payments until the goods were received and accepted. the inventory quantities for the items allegedly sold were a~Ijusted downward. The end result was that Mattel’s inventory records were unreliable. All subsequent quotations. According to the SEC. weeks or even months later. including the risk of loss due to damage.4 To provide documentary support for the bill and hold sales. The customer could cancel the order without penalty at any time prior to his receipt and acceptance of the merchandise. 1971. the invoices were prepared without prior consultation with. . The merchandise was not physically segregated from Mattel’s inventory nor labeled as the property of the customer. However. Mattel prepared customer order forms. This information was taken from Securities and Exchange Commission. the bill and hold program involved billing customers for future sales and then recording the sales immediately. The SEC identified the following six reasons why the bill and hold sales should not have been recorded by Mattel in January 1971: 1. In simple terms. The risks of ownership remained with Mattel. 4. for the bogus bills of lading. Improper Sales Cutoff at Year-End For fiscal year 1971. 4. which ended January 30. In many instances. Bills of lading normally required the signature of both a Mattel shipping employee and a representative of the common carrier transporting the goods. or participation by. the customer as to the content of the order. Accounting Series Release No. although the goods were not segregated from the remaining inventory items. theft. Mattel’s inventory records became laced with errors resulting from employees recording the inventory shipments a second time. unless indicated otherwise. Mattel’s top executives instituted in January 1971 what became known as the “bill and hold” program. Mattel shipping employees signed for both themselves and the common carrier. The merchandise was not shipped as of January 30. sales invoices. and bills of lading.

1971. Several of the accounts receivable confirmations mailed by Arthur Andersen during the 1971 audit were retumed with discrepancies noted by Mattel’s customers—discrepancies caused by bill and hold sales that had been charged improperly to the customers’ accounts as of January 30. the Arthur Andersen auditors obtained copies of the bills of lading for the disputed charges to determine whether the goods had actually been shipped as of January 30.CASE 1. This entry eliminated the large difference between the balance of the general ledger controUing account for receivables and the balance of the accounts receivable subsidiary ledger. a month in which Mattel typically experienced a very high volume of sales.000 between the two accounting records.000 general ledger sales entry recorded in May ot that year.5 The Arthur Andersen auditors also failed to notice that ‘the bills of lading they obtained to clear the confirmation discrepancies conspicuously lacked the required routing or delivery instructions. . 7 To resolve the inventory control probl~m~ created by the bill and hold sales. Mattel executives were forced to reverse those sales in fiscal 1972. not in the accounts receivable subsidiary ledger.” the Arthur Andersen auditors apparently never asked client personnel to explain the significance of that phrase.000 sale in May to conceal the large impact of the reversing entry on the recorded sales for that month. However. However. in September. Among these audit tests were Arthur Andersen’s receivables confirmation procedures. company management reversed the fictitious $11.000. Approximately one-half of this total was for bill and hold sales recorded in fiscal 1971. Finally. INC. while the other one-half was for bill and hold sales recorded near the end of the first quarter of fiscal 1972. The auditors eventually cleared the confirmation discrepancies caused by the bill and hold sales with the following tickmark explanation: “Traced to Mattel invoice and bill of lading noting agreement of amount and that shipment made prior to 1/30/71.000.000 of remaining bill and hold sales recorded in fiscal 1971. The large reversing entry created another problem: the net sales for May 1971 was suddenly a negative figure. In August 1971.” 5. This fictitious transaction was recorded only in the general ledger. The first reversing entry was booked in May 1971 and involved $12 million in sales. meaning that there was an unreconciled difference of $11. the SEC pointed to several audit tests performed by Arthur Andersen during the 1971 and 1972 Mattel audits that should have resulted in the discovery of the bill and hold sales. 1. The SEC pointed out that although these bills of lading were clearly marked “bill and hold. an Arthur Andersen manager who reviewed the accounts receivable workpapers wrote a review comment addressed to an audit senior: “What does ‘Bill and Hold’ mean?” This review comment was apparently never cleared by the audit senior.000. In resolving these discrepancies.1 MATrEL. Then. the auditors failed to recognize that the two required signatures on the bogus bills of lading were those of Mattel employees rather than one being the signature of a common carrier representative and the other being that of a Mattel employee. Mattel executives decided to book a fictitious $11. Arthur Andersen representatives staunchly maintained that their personnel were not aware of the fraudulent bill and hold sales until Mattel executives publiclv revealed the scheme in 1974.000. 1971. Mattel reversed the approximately $7. The net effect of this series of bogus entries and correcting entries was that eamings and sales for fiscal 1972 were understated by approximately the same amounts that those items were overstated for fiscal 1971.

Intentional Understatement of Inventory Obsolescence Reserve The SEC determined that Mattel’s management intentionally understated the company’s reserve for inventory obsolescence by several million dollars over the two-year period 1971—1972. At this time client does not know whether credit memos were issued or not. Client errors such as items not being shipped and wrong amount are the types found. the Mattel auditors would have discovered that the client’s monthly sales varied dramatically from 1970 through 1972. Mattel prepared weekly sales forecasts for the next several months for each toy that was considered an “excess inventory” item. A reserve for obsolescence was then recorded for those toys whose expected sales in the following months were less than the yearend inventory In 1971 and 1972. An Arthur Andersen staff person included in the audit workpapers the following explanation for this large difference—an explanation given to him by a Mattel employee: This amount is an offset to sales due to “invoicing errors” uncovered by client when comparing computer-prepared invoices to bills of lading. Despite the phrase “bill and hold” written distinctly on the face of each of these invoices. To his credit. Inventory obsolescence is historically a major problem for the large toy manufacturers. the SEC criticized Arthur Andersen for not utilizing analytical procedures to evaluate the overall reasonableness of Mattel’s monthly sales. May create a cutoff problem for accounts receivable at year-end. August was the month in which Mattel recorded one of the large reversing entries to eliminate a portion of the bill and hold sales booked in January 1971. During the internal control phase of the fiscal 1972 Mattel audit. For example.” The SEC could find no evidence in the audit workpapers that the problem had been further investigated. and despite the earlier-noted problems with the related bills of lading. Mattel was forced to dispose of approximately 5. which had traditionally been one of the company’s best-selling products. Ironically. The following year. Finally. Arthur Andersen selected the month of August 1971 to perform its tests of controls for the sales cycle. This looks like a big problem. In arriving at its year-end reserve for obsolete inventory. If such tests had been performed.6 million of the Hot Wheels toys by selling them to a large oil company at a loss of more than $11 million.8 SECTION ONE COMPREHENSIVE CASES Arthur Andersen tested Mattel’s year-end sales cutoff for fiscal 1971 by selecting eighty-two large sales invoices processed near the end of that yeara Twentysix of these invoices were for bill and hold sales. Arthur Andersen failed to recognize that these twenty-six sales were fictitious. the sales invoice register. Mattel executives faced a huge and unexpected inventory buildup of the Hot Wheels toy. the Arthur Andersen senior who reviewed this explanation noted that it was unsatisfactory and wrote the staff person the following note: “Need a better explanation. This volatility was largely a result of the errors introduced into the accounting records by the bill and hold program and the subsequent errors created when the bill and hold sales were reversed. in fiscal 1971. This reversing entry of nearly $7 million caused the total of August’s general ledger sales to be that much less than the corresponding monthly sales figure reported by a supplementary ledger maintained by Mattel. given the inherent difficulty of predicting children’s taste in toys. the SEC found that Mattel inflated the projected .

From 1970 through 1972. These costs include expenditures related to producing the molds and die casts needed for the new product and the expenditures required to establish the production line for the product. In 1971. In 1971. Mattel’s weekly sales forecasts prepared at the end of fiscal 1972 had projected significant sales for these items. For eight of the toys selected for testing during the 1972 audit. for example. INC. Mattel’s tooling costs are deferred in an asset account and amortized over the estimated useful life of the new toy. Among the most important of these audit tests were simple comparisons of actual current year sales to total forecasted sales for individual products to determine that the amount of tooling costs amortized during the year was reasonable. and three others actually had negative net sales during that time. According to the SEC. Arthur Andersen~s audit of Mattel’s deferred tooling costs for 1971 involved obtaining and reviewing client-prepared schedules of these costs by product. the misstatement of the deferred tooling costs in 1971 was accomplished by the following means: 1. By adjusting the ratio of various products’ current sales to their forecasted sales. Arthur Andersen did uncover at least two instances of material overstatements of Mattel’s deferred tooling costs. 4. By reallocating tooling costs from various products with low forecasted sales to those with sizable forecasted sales. When auditing the reserve for inventory obsolescence. The proportion of the tooling costs amortized each year for a given toy is equal to the ratio of that year’s sales for the toy to the total expected sales over the life of the toy. five had no recorded sales in the first several weeks of the new year. Despite the results of this audit test. 9 future sales of several excess inventory items to justify not recording a reserve for obsolescence for those toys. The SEC suggested that more extensive and rigorous audit tests should have been applied to Mattel’s deferred tooling costs during the 1971 audit.7 million. 3. the amortization of deferred tooling costs was understated by approximately $3.1 MATrEL. The auditors then tested the propriety of the amortization amounts for a small number of the products that had large deferrals. 2. for example. Arthur Andersen personnel compared the weekly sales forecasts for certain excess inventory toys to the actual sales realized by those toys in the first several weeks of the new fiscal year. the company incurs significant “tooling” costs~ during the developmental phase of the product. Arthur Andersen refused to accept certain of the revised sales forecasts that Mattel used to justify reducing the amount of deferred tooling costs written off for several products. given the large increase in those costs in 1971 and the inherently subjective nature of that item. Mattel executives manipulated the company’s deferred tooling costs to overstate Mattel’s reported earnings. By deferring certain tooling costs twice. Overstatement of Deferred Tooling Costs For each new toy Mattel produces. By deferring all tooling costs incurred during the last three months of the year. Arthur Andersen failed to challenge the sufficiency of Mattel’s inventory obsolescence reserve. Arthur Andersen’s workpapers documented a $2 million overstatement of deferred tooling costs resulting from improper revisions of certain products’ expected lifetime .CASE 1.

4 million in expenses added in 1970 to the schedule that summarized the operating results of the Hot Wheels product—expenses later proved to be fictitious.4 million. According to the SEC. In particular. Underpayment of Royalties Mattel acquired the production rights to its popular Hot Wheels product from the gentleman who invented that toy. The SEC charged that Arthur Andersen failed to properly investigate the contractual arrangement between the inventor and Mattel and the related financial statement implications. The SEC charged that neither Mattel nor Arthur Andersen should have expected the insurance company to pay the full amount of the claim. These expenses consisted primarily of bogus advertising expenditures and increases in the operating losses allegedly incurred by the product in the first few years following its introduction. was not credible. “Tooling write-off adjusted for this fact. In responding to the review comment. Mexico. 1971. Mattel avoided paying the inventor nearly $2 million in royalties that he had rightfully earned from 1970 through 1972. The federal agency argued that the method used by Mattel to compute the amount recoverable from the insurance company. nor did the workpapers provide any evidence suggs~sting that the $1.4 million in expenses related to that product.4 million adjustment was sufficient to correct the noted problem.” Despite this assertion. . Because of these fraudulent expenses. Mattel adjusted the account balance by only $1. however. a method approved by Arthur Andersen. In its financial statements for the fiscal year ended January 30. as were its contents. a figure that was accepted by Arthur Andersen. Arthur Andersen apparently did not question the additional $4. In fact. Improper Computation of Business Interruption Insurance Claim Mattel’s large warehouse in Mexicali. The contract between Mattel and the inventor called for him to begin receiving significant royalties on Hot Wheels sales when the product reached the break-even point. Mattel management fabricated an additional $4. Additionally. which was destroyed by a fire in September 1970. Mattel included a $10 million receivable from its insurance company for a business interruption insurance claim. the SEC determined that the adjustment was never made. the break-even point for the Hot Wheels toy was reached.2 million of tooling costs had been deferred twice. the auditors failed to obtain a copy of a computer-generated royalties report that disclosed the proper amount of royalties due the inventor. In 1970. who then wrote a review comment instructing a subordinate to make sure that the proper adjusting entry was recorded. However.4 million. This discovery was made by a senior member of the Arthur Andersen engagement team. to avoid paying royalties to the inventor. Arthur Andersen’s workpapers did not reveal how that figure was determined. the subordinate subsequently noted. The company’s insurance policy also included a business interruption clause providing up to $10 million in coverage for revenues lost as a result of damage to the facility or its destruction. Mattel did not receive any payment from its insurance company until 1977 and then was paid only $4. Mattel’s auditors also discovered during the 1972 audit that more than $1. was fully insured.10 SECTION ONE COMPREHENSIVE CASES sales.

more general deficiencies in those audits.” As an example. Second. have undergone mastectomies. the SEC was concerned that Arthur Andersen’s audit review process had failed to ensure that important problems discovered by staff auditors during the Mattel audits were resolved satisfactorily.1 MATTEL. the SEC made the following remarks: “Auditors must acquire and apply sufficient knowledge of their clients’ industries to enable them to intelligently audit their business operations and to evaluate the client’s explanations of those operations. An example noted earlier was the failure of the auditors to adequately research the nature of Mattel’s bill and hold sales. . Ruth Handler also staged a dramatic comeback following her traumatic experiences of the early 1970s.” The SEC also criticized Arthur Andersen for being overly willing to accept client representations as audit evidence “with little or no verification or documentation. Country Rose Barbie.CASE 1. For example. Two years later. In 1989. and Harley-Davidson Barbie. she founded a company. the firm would likely have recognized that Mattel’s large inventory of Hot Wheels at the end of 1970 required a significant write-down. 11 ADDITIONAL SEC CRITICISM OF ARTHUR ANDERSEN’S MATTEL AUDITS Besides the specific criticisms of Arthur Andersen’s Mattel audits already noted. the SEC noted the audit firm’s acceptance of the spurious explanation given for the large discrepancy between the sales reported for August 1971 by the general ledger controlling account and by the sales invoice register. given the inability of retailers to sell their own inventories of that product. Finally. Ruthton Corporation quickly established itself and within a few years was reporting annual sales of several million dollars. Although a small company with a relatively small market. In particular. coordination. Mattel’s annual revenues surpassed $4. Ruthton Corporation. the SEC also chastised the audit firm for other. if Arthur Andersen had been closely following its client’s sales markets.5 billion. the SEC criticized the Arthur Andersen auditors for repeatedly failing to sufficiently investigate suspicious transactions and documents coming to their attention. Among these dolls were Hula Hair Barbie. After her forced retirement from Mattel. nearly 40 percent of which was attributable to the Barbie product line. the SEC maintained that Arthur Andersen failed to “apply industry knowledge” during the course of the Mattel audits. INC. That product line included more than 100 different Barbie dolls by late 1997. Workin’ Out Barbie. Mattel slowly recovered from its nearly disastrous experiences of the early 1970s. Mattel overtook Hasbro as the nation’s largest toy maker. like herself. In 1994. the SEC observed that senior members of the Arthur Andersen engagement team had exhibited “insufficient control. In commenting on this point. First. EPILOGUE Under the leadership of new management. that manufactures prosthetic devices for women who. and supervision” during the Mattel audits. Ruth and Elliott Handler were recognized for their contributons to the toy industry by being inducted into the industry’s hall of fame.

royalty expense. In general. auditing procedures.the professions. identify circumstances in which revenues may be recognized on sales transactions even though one or more of these conditions are not met. the SEC censured Arthur Andersen for its alleged deficient audits of Mattel. the firm’s policies on Intra-firm consultatlonregarding complex or unusual transactions were formalized and restated in a single source providing concise guidelines on specific practice problems where consultation is appropriate.SECTION ONE COMPREHENSIVE CASES In 1981. key issues raised during the review of Mattel’s workpapers by Arthur Andersen personnel were not resolved satisfactorily prior to the completion of the audit. A similar requirement was subsequently adopted by the SEC Practice Section of the AICPA. Arthur Andersen established a Public Review board. 2. .and has in each year of its existence focused on a different area of the firm’s Practij~. in the early 1970s. is it appropriate to perform these tests at an interim date? Why or why not? 4. SAS No. andgovernment. Why is it important for an auditor to identify the underlying management assertions for each major account of a client? 5. • Second Partner Reviews. In 1974. 31. Arthur Andersen voluntarily adopted a policy requir- Mattel Audits ing rotation of audit engagement partners every five years. • Rotation of Audit Partners. accounting prindples. and the receivable recorded by Mattel for the business interruption insurance claim. This facility is used on a continuing basis to provide training for Arthur Andersen partners and professionaiejnployees. Identify and dis cuss the general conditions for recognizing revenue from sales transactions. Arthur Andersen updated all of its major practice and procedure manuals to provide a set of readily accessible guidelines to firm policy on financial reporting issues. in 1976. “Evidential Matter. The SEC apparently chose only to censure Arthur Andersen because the audit firm demonstrated that it had undertaken significant corrective measures to prevent the recurrence of the problems that had arisen during the Mattel audits. on a former college campus. 3. Arthur Andersen opened a large training facility in St.” identifies five key management assertions that underlie a set of financial statements. ~-~: The Board establishes its own program for reviewing the professional operations of the firm . Inc. CharIes~Illinois. QUESTIONS 1. and ethical issues. The SEC noted six reasons why the bill and hold sales recorded by Mattel did not qualify as consummated sales transactions. Exhibit 1 contains the list of these corrective measures that was appended to the SEC enforcement release in which Arthur Andersen was censured. In at least two instances. ~ • Personnel Training Programs. A similar rule was adopted by the SEC Practice Section of the AIOPA in 1977. Identify the key variables that influenced the level of inherent risk Arthur Andersen faced during the 1971 and 1972 audits of Mattel.~ -. an independent body consisting of indMduals from business. Identify the management assertions that would have been of primary concern to Arthur Andersen regarding the following items: the reserve for inventory obsolescence.’ ~ PublIc Review Board. Arthur Andersen began requiring an extensive review of audit reports and supporting materials by a second partner not engaged in the audit. Which member of the audit engagement team has the EXHIBIT 1 Measures Taken by Arthur Andersen to Strengthen Its Audit Process Following the • Consultation within the Firm. Identify and discuss the principal audit objectives associated with the performance of year-end sales cutoff tests. in 1978. Also. • Updating of Practice and Procedure Manuals. in 1975.

13 primary responsibility to ensure that such issues are properly resolved and documented in the audit workpapers? Defend your answer. . What additional audit procedures should Arthur Andersen have performed once it discovered the extreme volatility in these monthly sales figures? 7.CASE 1. Identify the conditions under which Arthur Andersen would have been justified in accepting this smaller adjusting entry. However. 6. Mattel adjusted the balance of that account by only $1.4 million. INC.1 MATTEL. Arthur Andersen proposed a $2 million adjusting entry to the deferred tooling costs account during its 1971 audit of Mattel. Assume that Arthur Andersen had compared Mattel’s monthly sales during the early 1970s with the comparable monthiy sales figures of prior years.

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