– Auditor’s Liablity Essay, Research Paper

Certified Public Accountants are expected to conduct themselves at a higher level than most other members of society and are held to the highest of ethical standards. The American Institute of Certified Public Accountants provides general accepted auditing standards and the code of professional conduct as a framework of guidance for CPAs to follow in performing audit procedures. The following audit case demonstrates potential problems that can occur when the client, Mattel, and the auditing firm, Arthur Anderson, are both at fault.

In 1945, Mattel Inc. was established by Elliot and Ruth Handler and Harold Matson, who shortly after left the company for other employment opportunities. Elliot Handler invented and produced the toy products for Mattel while Ruth Handler oversaw and controlled the financial status of the company. Ten years after Mattel was introduced, its net worth increased to more than $500,000. Ruth decided to launch advertisements on children’s television networks. Costs for this project were high but the benefits greatly outweighed them. By 1971 market value reached $300 million and , “financial analysts recognized Mattel as one of the premier growth companies in the United States” (4).

The early 1970’s also brought about serious problems for Mattel. The company hired Seymour Rosenberg as the company’s executive vice president and chief financial officer. He wanted to make changes in how Mattel operated, so Rosenberg chose to reorganize the structure of the company by breaking down operations into different divisions of business. This process in turn increased operating costs. Rosenberg’s investments and decision-making were unsuccessful and he was dismissed from Mattel a few years later.

Three other factors also contributed to the weakening of Mattel’s profitability and a loss of $30 million. First, in 1970, a large warehouse stationed in Mexico was burnt down and destroyed. Followed by a workers’ strike that halted toy shipments from Hong Kong. Finally, the recission of the early 1970’s decreased sale for Mattel.

“Mattel issued a press release stating that the company had undergone a dramatic turnaround in fiscal 1973 compared with fiscal 1972″ (4). Shortly after, Albert Spear was hired to replace Rosenberg as executive vice-president. After reviewing the financial statements, he quickly noticed several misrepresentations. In actuality, Mattel had sustained an even bigger loss in 1973 as compared to 1972. As Spear revealed this to the public, stockholders and investors immediately sold their stock and filed lawsuits against Mattel. This led to an investigation by the Securities and Exchange Commission.

Mattel’s outside directors issued a report stating, “ The company’s executive officers and key officials issued financial statements that were deliberately false and misleading to give an illusion of continued spectacular growth” (5). By the fall of 1975, the Handlers resigned from Mattel. Lawsuits against the company were settled, which left Mattel paying about $30 million and Arthur Anderson, who performed the audits in the early 1970’s, paying $900,000 to stockholders. Ruth Handler did not have to serve a prison term, but was given 2,500 hours of community service and $57,000 fine. Elliot Handler was never indicted since he was not in direct connection with the fraud.

Price Waterhouse reviewed and the SEC investigated the audits issued by Arthur Anderson during the early 1970’s. Both criticized the audit techniques of Arthur Anderson and the lack of professional judgement in accumulating sufficient relevant data and evidence that prevented them from discovering “Mattel’s fraudulent earnings manipulation scheme” (5). The audits were conducted poorly, numerous errors were overlooked, inadequate tests were performed, and Mattel’s financial statements were not thoroughly investigated and researched. The following are examples of the deficiencies that occurred in Arthur Anderson’s audits of


Mattel’s executives created the “bill and hold” program to expand reported earnings. Customers were charged for future sales and then these sales were recorded immediately. Order forms, invoices and bills were falsely prepared and signed by employees. This eventually led to confusion, errors, and oversights in both the accounting and inventory departments. In attempt to correct this executives reversed sales creating another bigger problem, net sales were in the negative. Arthur Anderson states that they were not aware of the bill and hold program until it was made public. The SEC recognizes that if sufficient tests were performed, Arthur Anderson would have realized the bill and hold procedure. For instance, copies of the bills had written “bill and hold” on them and Arthur Anderson failed to address Mattel’s executives as to what that exactly meant. As a result, customers’ accounts were charged improperly and inaccurate sales were recorded. Arthur Anderson also neglected to recognize that the invoices had improper routing and delivery instructions and the signatures were forged by Mattel employees for both customers and the carriers.

Arthur Anderson neither understood their client’s internal control nor asked any questions regarding how sales were recorded. August 1971 was tested and this happen to be a month were the largest reversing entry took place to “eliminate a portion of the bill and hold sales booked in January 1971″ (8). This effected the general ledger sales to be $7 million less than the monthly sales figure. Arthur Anderson willingly accepted the client’s explanations as audit evidence without further investigating the problem themselves.

As new products originated, costs to produce them were deferred and amortized over the products useful life. During 1970 through 1972, Mattel’s management understated these costs by

$3.7 million which in turn overstated reported earnings. Arthur Anderson did accumulate and test these deferred costs and amortization amounts and also examined the comparison of annual sales to forecasted sales. Two material overstatements were recognized by Arthur Anderson. However, a more thorough investigation was greatly needed since deferred costs increased immensely in 1971.

“The SEC charged that Arthur Anderson did not properly investigate the contractual arrangement between the inventor and Mattel and the related financial statement

implications” (10). Once Mattel obtains the production rights of a product, the inventor of that product is to receive royalties when sales reach the break-even point. In 1970, this occurred for the product, Hot Wheels, and Mattel was inclined to pay such royalties but did not fulfill the agreement by charging an additional $4.4 million in expenses. Arthur Anderson neglected to ask what these expenses included and failed to examine and determine the exact amount of royalties due to the inventor.

Mattel miscalculated an insurance claim for a large warehouse in Mexico that was destroyed by fire. The policy enables Mattel to gain up to $10 million as result of the loss and damages. This total amount was included in the financial statements for the fiscal year ending January 30, 1971. Both Mattel and Arthur Anderson should not have assumed that the full amount would be recovered. “The federal agency argued that the method used by Mattel to compute the amount recoverable from the insurance company, a method approved by Arthur Anderson, was not credible” (10 ). Six years later Mattel was granted only $4.4 million for the insurance claim

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