Campbell Soup Case Essay

SynopsisThe Campbell dope up Company has dominated the dope up industry since the ac caller developed a cost-effective method of producing condensed soup products in 1899. Throughout most of the twentieth century, Campbell was cognise as one of the most conservative companies in the United States. In 1980, Campbell startled the job field by selling debt securities for the first time and by embarking on a class to lengthen and glow its historically short product line. Despite a sizable increase in revenues, the diversification program failed to improve Campbells profitability, which prompted the bon tons executives to refocus their attention on their core profession, namely, manufacturing and marketing soup products. Unfortunately, by the balance of the twentieth century, the publics interest in soup was waning.Faced with a shrinking market for its indigenous product, Campbells management team allegedly began using a series of questionable business practices and accoun ting gimmicks to prop up the companys reported profits. A class-action drive filed in early 2000 by disgruntled Campbell stockholders supercharged top company executives with misrepresenting Campbells operating runs in the late 1990s. The principal allegation was that the executives had used a variety of methods to billow the companys revenues, coarse margins, and profits during that time frame. Eventually, PricewaterhouseCoopers (PwC), Campbells independent study firm, was named as a co-suspect in the sheath.The plaintiffs in the class-action casing claimed that PwC had recklessly examineed Campbell, which effectively allowed Campbells executives to continue their adulterous schemes. This case examines the allegations filed against PwC by Campbells stockholders with the primary purpose of illustrating the analyse objectives and procedures that finish and should be applied to a nodes revenue and revenue-related accounts. The case also provides students with important insights on how the PrivateSecurities Litigation Reform Act of 1995 has affected auditors civil indebtedness in lawsuits filed under the Securities and Exchange Act of 1934.Campbell Soup CompanyKey Facts1.During much of its history, Campbell Soup was cognise as one of the most conservative gargantuan companies in the U.S. economy.2. Campbells conservative corporate market-gardening abruptly changed in the 1980s when the company sold debt securities for the first time and embarked on an ambitious program to diversify and expand its product line.3.In the late 1990s, after the diversification program had produced disappointing financial results and when market data indicated that the publics interest in soup was waning, Campbell executives allegedly began using several illicit methods to meet Wall Streets winnings targets for the company.4.A class-action lawsuit filed in 2000 charged that Campbell had offered customers large, period-ending discounts to artificially inflate sales , accounted improperly for those discounts, recorded bogus sales, and failed to record appropriate reserves for anticipated sales returns.5.PwC, Campbells audit firm, was named as a defendant in the class-action lawsuit and was charged with recklessly auditing Campbells financial statements.6.Because the class-action lawsuit was filed under the Securities Exchange Act of 1934, the federal judge presiding over the case had to decide whether the allegations involving PwC satisfied the brisk plead received established by the Private Securities Litigation Reform Act of 1995.7.The PSLRAs pleading standard requires plaintiffs to plead or allege factssuggesting that there is a strong inference of scienter on the part of a condition defendant.8.To satisfy the PSLRA pleading standard in the Third Circuit of the U.S. regulate Court in which the Campbell lawsuit was filed, a plaintiff, at a minimum, must allege that the given defendant acted with recklessness.9.After reviewing PwCs audit w orkpapers, the federal judge ruled that the plaintiffs had failed to satisfy the PSLRA pleading standard, which resulted in PwC being reject as a defendant in the case.10.In February 2003, Campbell settled the class-action lawsuit by agreeing to pay the plaintiffs $35 million, although company executives denied any wrongdoing.Instructional Objectives1.To demonstrate that even the largest and highest profile audit clients can pose significant audit risks.2.To identify discretionary business practices and accounting gimmicks that can be used to distort a companys reported operating results.3.To identify audit procedures that should be applied to a clients sales and sales-related accounts.4.To examine the implications that the Private Securities Litigation Reform Act of 1995 has for the civil liability of independent auditors in lawsuits filed under the Securities Exchange Act of 1934.5.To examine the concepts of recklessness and negligence in the context of auditors civil liability.S uggestions for white plagueThe high-risk accounts that are the focus of this case are sales and sales-related accounts. This case focuses students attention on schemes that companies can use to enhance their reported operating results. These schemes involve both discretionary business practices and accounting gimmicks. Auditing textbooks broadly ignore the fact that audit clients often manage or manipulate their reported profits by using discretionary business practicessuch as delaying advertising or maintenance expenditures. This case requires students to cost this possibility and consider the resulting audit implications. After discussing this case, I hope my students recognize that companies that use discretionary business practices to rig their profits are likely inclined to use accounting gimmicks for the same purpose.As an out-of-class assignment, you competency ask students to find in the business press recent examples of companies that ready attempted to manage their earnings without violating any accounting or financial reporting rules. Have students present these examples and then discuss them when addressing case question No. 1. I think you testament find that students have very different opinions on whether it is ethical for public companies to massage their income statement data while complying with the technical requirements of GAAP. You might consider advancement this case with the Health Management, Inc., case (Case 1.4). The Health Management case provides a world(a) discussion of the PSLRA. The Campbell Soup case contributes to students understanding of the PSLRA by examining in more than depth the pleading standard established by that federal statute and the impact that standard has on lawsuits filed against auditors under the Securities Exchange Act of 1934.Suggested Solutions to Case Questions1. here are a few examples of discretionary business practices that corporate executives can use to influence their companys revenues an d/or expenses.Deferring advertising, maintenance, or other discretionary expenditures until the following period.Slowing down (or accelerating) work on long-term construction projects or contracts for which the percentage-of-completion accounting method is used to recognize revenue.Using economic incentives to stimulate sales nest the end of an accounting period (a technique used by Campbell).Are the practices just listed ethical? Typically, students suggest that since these practices do not violate any laws, GAAP, or other black and white rules, the practices cannot be considered unethicala roundabout way of arguing that they are ethical. That general point-of-view seems consistent with the following remark that Judge Irenas made regarding Campbells period-ending dole out lode There is nothing internally improper in pressing for sales to be made earlier than in the normal course . . . there whitethorn be any number of real reasons for attempting to achieve sales earlier.For what it is worth, I believe that corporate executives who draw out needed maintenance expenses or who postpone advertising programs that would likely produce sizable sales in future periods are not acting in the best interests of their stockholders. In other words, I do not believe such practices are proper or ethical. Likewise, corporate executives who take advantage of the inherent flexibility of the percentage-of-completion accounting method, ostensibly to serve their own economic interests, are not individuals who I would privation serving as stewards of my investments.In my view, it is a little more difficult to characterize the trade loading practices of Campbell as unethical. Why? Because, allegedly, the companys competitors were using the same practice. If Campbell chose not to offer large, period-ending discounts to their customers, the company would likely have lost sales to its competitors. Note Campbells CEO who resigned in 2000 announced in mid-1999 that his company w as discontinuing trade loading.2. I would suggest that companies that use various legitimate business practices to manage their earnings are more given over to use illicit methods (accounting gimmicks, etc.) for the same purpose. As a result, auditors could reasonably consider such business practices as a red flag that mandates more extensive and/or rigorous audit tests. Note passe-partout auditing standards suggest that corporate executives who place excessive emphasis on achieving earnings forecasts whitethorn be prone to misrepresentingtheir companys financial statement data.3.SAS No. 106, Audit Evidence, identifies three categories of management boldnesss implicit in an entitys financial statements that independent auditors should attempt to corroborate by collecting sufficient appropriate audit evidence. The third of these categories is presentation and disclosure. Included in the latter category is the following item Classification and understandability. pecuniary informat ion is appropriately presented and described and disclosures are clearly expressed. AU 326.15 Likewise, one of the five transaction-related assertions is entitled Classification. This latter assertion suggests that, Transactions and events have been recorded in the proper accounts.Here are examples of spin techniques that can be used to enhance income statement data without changing net incomeClassifying cost of goods sold components as SG&A expenses to inflate gross profit on sales.Reporting items that qualify as operating expenses/losings as nonoperating expenses/losses to inflate operating income. (One of the most common variations of this trick in recent years has been including legitimate operating expenses in restructuring losses.)Treating other losses as extraordinary losses to inflate income from continuing operations.4.Shipping to the tempo Year-end sales cutoff tests are intended to identify misclassification of sales occurring near the end of a clients fiscal year. Audit ors will typically choose a small sample of sales that the client recorded in the final few days of the fiscal year and a similar sample of sales that occurred in the first few days of the new fiscal year. Then, the relevant fare and other accounting documents for those sales will be inspected to get back that they were recorded in the proper period. This standard test might have revealed the fact that Campbell was booking some unusually large sales near the end of accounting periods.Even though the shipping documents for these sales might have suggested that they were valid period-ending sales, a curious auditor might haveinvestigated the sales further. For example, that auditor might have attempted to determine whether the resulting receivables were collected on a timely basis. During the course of such an investigation, the auditor would likely have observed that the sales were reversed in the following period or dealt with in some other unaccepted way.Accounts receivable co nfirmation procedures might also have resulted in the find of these sales. Customers to whom such sales were charged would likely have identified them as differences or discrepancies on returned confirmations. Subsequent investigation of these items by the auditors may have revealed their true nature. As pointed out by the plaintiffs in this case, during physical inventory counting procedures auditors typically take notice of any inventory that has been segregated and not countedfor example, inventory that is sitting in set trucks. If there is an unusually large fare of such segregated inventorywhich was apparently true in this case, the auditors should have inquired of the client and obtained a reasonable explanation. The old, reliable scanning year-end transactions to identify large and/or unusual transactions might also have led to the discovery of Campbells sales shipped to the yard.Guaranteed sales During the first few weeks of a clients new fiscal year, auditors should revi ew the clients sales returns and allowances account to determine whether there are any unusual trends apparent in that account. Auditors should be particularly cognizant of unusually high sales returns and allowances, which may signal that a client overstated reported sales for the prior accounting period. Accounts receivable confirmation procedures may also result in auditors discovering an unusually high rate of charge-backs by the clients customers.In some cases, clients will have written contracts that document the key features of sales contracts. Reviewing such contracts may result in the discovery of guaranteed sales or similar transactions. Finally, simply discussing a clients sales policies and procedures with client force out may result in those personnel intentionally or inadvertently tipping off auditors regarding questionable accounting practices for sales, such as shipping to the yard or guaranteed sales.5. Here are definitions of negligence and recklessness that I hav e referred to in suggested solutions for questions in other cases. These definitions were taken from the following source D.M. Guy, C.W. Alderman, and A.J. Winters, Auditing, Fifth Edition (San Diego Dryden, 1999), 85-86. failure The failure of the CPA to perform or report on an engagement with the due professional burster and competence of a prudent auditor. Recklessness A serious occurrence of negligence tantamount to a flagrant or reckless departure from the standard of due care.After reviewing the definition of negligence, ask your students to dress or describe a prudent auditor. Then, ask them whether they believe that definition/description applies to the PwC auditors assigned to the 1998 Campbell audit.Here are two hypothetical examples drawn from this case involving what I would characterize as reckless auditors.A client employee tells PwC auditors that many year-end sales are guaranteed and that no reserve has been established for the large amount of returns that will lik ely be produced by those sales. PwC decides not to investigate this allegation because of manpower constraints on the engagement. bit reviewing receivables confirmations returned by Campbell customers, PwC auditors discover that approximately one-fourth of those customers indicate that their balances include charges for large amounts of product purchased near the end of the year, product that they did not order or receive. PwC dismisses this unusually large number of similar reported differences as a coincidence.6.Here is a list of key parties that have been affected by the PSLRA.Investors who suffer large losses that they believe were caused by reckless or fraudulent conduct on the part of a given companys management team, its auditors, or other parties associated with the companys financial statements. At least(prenominal) some of these investors have likely found it moredifficult and costly to recover their losses because of the rampart to securities lawsuits erected by the PSL RA. Note Granted, the PSLRA has little impact on the ability of investors to recover losses in those cases involving obvious gross fraud or malfeasance by corporate management or other parties.Some parties have argued that the PSLRA diminishes the boilers suit efficiency of the stock market. These parties argue that by making it more difficult for investors to file lawsuits under the 1934 Securities Act, the PSLRA has resulted in a larger portion of scarce investment capital being squandered by despotic corporate executives, which, in the long run, diminishes the strength of our economy and our nations standard of living.Generally, corporate executives have benefited from the PSLRA since it has reduced, to some degree, their exposure to civil liability.As pointed out in the Health Management, Inc., case (Case 1.4), the PSLRA apparently has not been very beneficial to large accounting firms. For whatever reason, in recent years, there has been a general upward trend in federal secu rities cases alleging accounting irregularities. Not only are independent auditors more likely to be named as defendants in such cases, the settlements in those cases tend to be considerably high than in other lawsuits filed under the federal securities laws.