Answered Essay: Problem On a beautiful spring morning in 2015, Stephen Lowber, chief financial officer

Problem

On a beautiful spring morning in 2015, Stephen Lowber, chief financial officer of Cutter and Buck, Inc., slowly arose from his bed, walked across the bedroom floor, and gazed out the window. It was a surprisingly clear, sunny day in Seattle, Washington. Despite the beauty of the day, the expression on Mr. Lowber’s face was not positive. Cutter and Buck, a company that designs and markets upscale sportswear and outerwear, had enjoyed financial success. It recently announced revenue of $54.6 million for the fourth quarter and $152.5 million for the entire fiscal year. Cutter and Buck also announced it was rated as the hottest golf apparel brand from 2010 to 2014 by Gold World Business Magazine, a leading golf trade publication. Despite the success and positive publicity of his company, Lowber was haunted because he knew the company had engaged in fraud.

Cutter and Buck, Inc., had been encountering declining sales as it approached the end of its fiscal year. In the final days of the fiscal year, the company negotiated deals with three distributors under which Cutter and Buck would ship them a total of $5.7 million in products. The distributors were assured they had no obligation to pay for any of the goods until customers located by Cutter and Buck paid the distributors.

Sometime later, Lowber learned that these three distributors were operating as Cutter and Buck’s warehouses. Rather than restate and correct the company’s financial statements, Lowber concealed the transactions from Cutter and Buck’s independent auditors and board of directors by arranging for distributors to return $3.8 million in unsold inventory. The returns were accounted for as a reduction in sales during the following year. Additionally, Lowber instructed personnel to override the recorded business lines instead of the business line under which those sales were originally recorded to hide the magnitude of the returns.

As a result of these fraudulent transactions, Cutter and Buck’s management overstated true fourth quarter and annual revenue of fiscal year 2015 by 12 percent and 4 percent, respectively.

1. What were the main types of financial statement fraud committed at Cutter and Buck? Do these types of fraud occur often?

2. What should have been the appropriate accounting treatments?

3. The three parts of the fraud triangle are pressure, opportunity, and rationalization. List some of the pressures that may have led to this fraud.

Expert Answer

Answer

1. The main type of financial statement fraud committed at Cutter and Buck was Revenue recognition. Cutter and Buck improperly recognized as revenue $5.7 million in shipments to distributors functioning as company warehouses and later concealed the improper transactions from the auditors, board of directors, and shareholders. Improper revenue recognition is the most common type of financial statement fraud.

2. The said shipments were evidently made on a consignment basis, since distributors had no obligation to pay for the goods. Thus, shipments should not have been recorded as sales until the distributors had resold the merchandise.

3. Some of the pressures that may have led to this fraud are declining sales, tough competition, slow economy, shareholders who demand a higher stock return, and threat to management of being fired or demoted.

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