1998 Audit       Daniel ReynoldsUniversity of Texas at Arlington           July 2011                                   1
Just For Feet Superstores• 1988 – opens first superstore in  Birmingham, AL1• 1994 – initial public offering  (IPO) 1• 199...
Rapid growth 1991-1998                                             1                            Amounts in $ millions     ...
Key events    November 1998 – February 1999• November 16 – announces first national advertising campaign  to cost $25-30 m...
Why change fiscal year-end?• January year-ends are  common in the retail  industry• 52/53 week years ending  Saturday or S...
1998 audit          8• Firm – Deloitte & Touche LLP,  Birmingham, AL• Partner – Steven H. Barry –  with firm since 1976 – ...
Fraud Risk Factors              9   AU 316.85                     7
Attitudes/rationalizations           9• Nonfinancial management’s determination of  significant estimates• Excessive inter...
Opportunities         9• Assets, liabilities, revenues or expenses based on  significant estimates or subjective judgments...
Oversight over financial reporting               10• Good  – Audit Committee comprised of two outside directors• Not so go...
Incentives/pressures         9• Recurring negative cash flows from operations  while reporting earnings and earnings growt...
Negative cash flows             1Amounts in $ millions       1994   1995   1996       1997   1998Net income               ...
Zone of InsolvencyAmounts in $ millionsCash on hand                                   12.4Annual revenues               77...
Debt covenants                                              1• Borrowed $189 million December 1998                        ...
Accounting misstatements                        8                                             8• Advertising co-op credits...
Advertising co-op credits receivable• Common in retail industry  – Manufacturers help pay for advertising costs  – To ince...
Advertising co-op credits receivable            8• Balance of “receivable”  – $28.9 million compared to  – $0.4 million pr...
Advertising co-op credits receivable         8• Sufficient appropriate audit evidence is to be                        9  o...
Advertising co-op credits receivable• Auditors attempted to confirm balances with                      8  vendors (AU 330....
Advertising co-op credits receivable                8• For confirmation evidence to be appropriate it must                ...
Vendor booth displays          8• Vendors setup their own merchandise booths  inside the stores to feature their own produ...
Vendor booth displays, 1996-1997                                  8•Vendor invoiced client for“purchase” of booth   DR Boo...
Vendor booth displays, 1998                        8• Eliminated vendor involvement• Client executive simply estimated ann...
Vendor booth displays audit                8• Since there was no evidence supporting $9 million  assets, auditors decided ...
Allowance for inventory obsolescence• Just For Feet was in the fashion retail industry• Inventory had almost doubled   – $...
Allowance for inventory obsolescence• Auditor evaluated reasonableness of estimate (AU          9  342.09)• Based on incom...
Advertising rebate receivable• This scam was not cited in SEC action regarding  auditors8• A client executive:   – Arrange...
National review partner• As a high-risk audit the workpapers were  supposed to be reviewed by the National  Office prior t...
1999 SEC filings made    Which included auditor consent• The SEC becomes involved when the auditor  consents to having his...
Key events post-audit• June 14 – Form 10-Q17   – Disclosure of $50 million “excess inventory”   – Disclosure of possible l...
Criminal and civil penalties                               31
Criminal penalties       21• Just For Feet executives   – Don-Allen Ruttenberg   – Adam Gilburne   – Stephen Davis• Vendor...
SEC civil penalties• Just For Feet executives  – Eric Tyra, chief financial officer     • Fined $67,500; 10-year suspensio...
Bankruptcy settlement 24Ruttenberg Estate   $15.0 millionDeloitte & Touche   $24.0 millionOutside directors   $41.5 millio...
1999 Super Bowl TV commercial                            25                                 35
References1 Just For Feet, Inc. (1999). Form 10-K for the Fiscal Year Ended January 30, 1999 (CIK: 00000918111). Retrieved...
References9    AICPA (2010). Professional Standards, Volume 1, as of June 1, 2010.10  Just For Feet, Inc. (1999). Proxy St...
References18  Just For Feet, Inc. (1999). Just For Feet, Inc. Announces Filing for Relief Under Chapter 11 of the Bankrupt...
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Just For Feet

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Case study on the 1998 audit of failed retail chain Just For Feet, Inc.

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Just For Feet

  1. 1. 1998 Audit Daniel ReynoldsUniversity of Texas at Arlington July 2011 1
  2. 2. Just For Feet Superstores• 1988 – opens first superstore in Birmingham, AL1• 1994 – initial public offering (IPO) 1• 1997 - expands into mall/specialty segment with Athletic Attic & Imperial Sports acquisitions1• 1998 – expands into northeast U.S. with Sneaker Stadium acquisition1 2
  3. 3. Rapid growth 1991-1998 1 Amounts in $ millions 1991 1992 1993 1994 1995 1996 1997 1998Revenues 8 17 24 56 120 256 479 775Net income 0 0 0 3 10 14 21 27Superstores 2 3 5 15 27 50 73 132 3
  4. 4. Key events November 1998 – February 1999• November 16 – announces first national advertising campaign to cost $25-30 million2• December 10 – announces $200 million three-year credit facility3• January 21 – announces change in fiscal year end from January 31 to January 304• January 22 – announces Super Bowl TV commercial and Hummer giveaway promotion5• January 31 - begins new fiscal year with Super Bowl TV 6 commercial/promotion• February 2 - announces 1998 fourth quarter “record sales”7 4
  5. 5. Why change fiscal year-end?• January year-ends are common in the retail industry• 52/53 week years ending Saturday or Sunday are common in the retail industry• Just For Feet also could defer into fiscal 1999 about $6.7 million in costs for the Super Bowl TV commercial 5
  6. 6. 1998 audit 8• Firm – Deloitte & Touche LLP, Birmingham, AL• Partner – Steven H. Barry – with firm since 1976 – partner since 1988 – managing partner since 1996• Manager – Karen T. Baker – with firm since 1989 – © 2011 Deloitte Global Services Limited manager since 1995 6
  7. 7. Fraud Risk Factors 9 AU 316.85 7
  8. 8. Attitudes/rationalizations 9• Nonfinancial management’s determination of significant estimates• Excessive interest in maintaining stock price or earnings trend• Practice of committing to analysts, creditors to achieve aggressive or unrealistic forecasts 8
  9. 9. Opportunities 9• Assets, liabilities, revenues or expenses based on significant estimates or subjective judgments that are difficult to corroborate• Significant transactions, especially those close to period end that pose “substance over form” questions• Domination of management by a single person• Ineffective oversight over the financial reporting process 9
  10. 10. Oversight over financial reporting 10• Good – Audit Committee comprised of two outside directors• Not so good – One member was president of clients primary bank to whom client owed $189 million• Worse – Audit Committee only met once during 1998 10
  11. 11. Incentives/pressures 9• Recurring negative cash flows from operations while reporting earnings and earnings growth• Need to obtain additional debt or equity financing for capital expenditures• Marginal ability to meet debt repayment or other debt covenant requirements 11
  12. 12. Negative cash flows 1Amounts in $ millions 1994 1995 1996 1997 1998Net income 3 10 14 21 27Cash flow from operations -11 -6 -42 -26 -82Cash on hand 36 97 139 82 12Current liabilities 69 85 147 156 133Quick ratio 0.52 1.14 0.95 0.53 0.09 12
  13. 13. Zone of InsolvencyAmounts in $ millionsCash on hand 12.4Annual revenues 774.9Cash flow from operations (82.1) 857.0Divide by 365Daily cash requirement 2.3Number of days cash on hand 5.3 13
  14. 14. Debt covenants 1• Borrowed $189 million December 1998 1• Borrowed $80 million February 1999 11• Required by bank to maintain – Leverage ratio – 3.00 to 1.00 – Fixed charge coverage ratio – 1.75 to 1.00 – Minimum tangible net worth - $230 million – Funded debt to capitalization – 0.50 to 1.00 – Capital expenditures limit - $25 million 14
  15. 15. Accounting misstatements 8 8• Advertising co-op credits receivable – $28.9 million ($19 million net of tax) 8• Vendor booth displays – $9 million ($6 million net of tax) 8• Allowance for inventory obsolescence – $0.4 million ($0.3 million net of tax) 12• Advertising rebate receivable – $5.3 million ($3.6 million net of tax) 15
  16. 16. Advertising co-op credits receivable• Common in retail industry – Manufacturers help pay for advertising costs – To incentive retailers to buy their products and – To promote them in their local markets• Accounting varies – Some companies credit advertising expense to offset cost of advertising – Others credit inventory purchases to ultimately offset cost of goods sold 16
  17. 17. Advertising co-op credits receivable 8• Balance of “receivable” – $28.9 million compared to – $0.4 million prior year• Client executive caused accounting to record – $23.8 million, of which – $14.4 million was booked in March 1999 17
  18. 18. Advertising co-op credits receivable 8• Sufficient appropriate audit evidence is to be 9 obtained (AU 326.01)– No supporting documentation for the year- end entries was provided to test the Existence 8 assertion (AU 326.15.b.ii)– None of the purported “receivables” collected 8 by the Report Date – April 23 18
  19. 19. Advertising co-op credits receivable• Auditors attempted to confirm balances with 8 vendors (AU 330.04) – 13 vendors owing $22 million of the $28.9 million8 – Most of the vendors returned ambiguous or contradictory confirmations8 – Some of the vendors returned false confirmations8 – At least one false confirmation was received April 22 - one day before the report date13 19
  20. 20. Advertising co-op credits receivable 8• For confirmation evidence to be appropriate it must 9 be reliable and relevant (AU 330.11)• When the auditor has not received replies to positive confirmation requests, he or she should apply 9 alternative procedures (AU 330.31)• Auditors apparently evaluated the results of the confirmation procedure as having provided "sufficient audit evidence" (AU 330.33); therefore, 8• The balance was accepted without adjustment 20
  21. 21. Vendor booth displays 8• Vendors setup their own merchandise booths inside the stores to feature their own products• No written contracts and little documentation• Prior to 1996 the booths were simply provided at no charge 21
  22. 22. Vendor booth displays, 1996-1997 8•Vendor invoiced client for“purchase” of booth DR Booth Assets CR Accounts Payable•Vendor then issued credit for“cost” of booth to be usedagainst other purchases DR Accounts Payable CR Expenses 22
  23. 23. Vendor booth displays, 1998 8• Eliminated vendor involvement• Client executive simply estimated annual booth value, then divided by 12 for monthly journal entry DR Booth Assets $174,000 CR Expenses $174,000• Result –First 8 months ($174,000 x 8) $1.4 million –October 31, 1998 $5.4 million –November 1998 – January 1999 $2.2 million –Total for year $9.0 million 23
  24. 24. Vendor booth displays audit 8• Since there was no evidence supporting $9 million assets, auditors decided to confirm the value of booths (AU 330.11.d)9• Sent confirmations for $8.4 million of Booth Assets to vendors• Auditors received and accepted ambiguous replies to these confirmations• The response of at least one vendor prompted auditors to propose an adjustment (AU 330.33)9, which was rejected by client 24
  25. 25. Allowance for inventory obsolescence• Just For Feet was in the fashion retail industry• Inventory had almost doubled – $400 million, from – $206 million prior year1• Leaving almost one-year supply on hand – Cost of goods sold was $452 million for 19981• Yet, allowance for obsolescence – Only $150,000 (0.0375%) – Same amount as prior year8 25
  26. 26. Allowance for inventory obsolescence• Auditor evaluated reasonableness of estimate (AU 9 342.09)• Based on incomplete analysis prepared by client that was apparently overlooked by the auditors (AU 8 342.10)• Auditor proposed $441,000 increase to allowance 8 (AU 342.14) ; however, 8• Management refused to record the adjustment• In June 1999 client announced that it had 14 – $50 million excess inventory as of May 1 26
  27. 27. Advertising rebate receivable• This scam was not cited in SEC action regarding auditors8• A client executive: – Arranged a fiscal 1999 rebate with outside advertising agency, then – Caused that amount to be accrued as receivable for fiscal 1998, then – Arranged to have agency overbill client by $250,000, so – The agency would have the funds, to then – Make a partial payment on the bogus receivable, to – Deceive the auditors into accepting the balance13 27
  28. 28. National review partner• As a high-risk audit the workpapers were supposed to be reviewed by the National Office prior to report issuance8• Intended to provide reasonable assurance that 9 the audit conformed with GAAS (AU 161.02) ; however,• There was no documentation that this review was done for the 1998 audit8 28
  29. 29. 1999 SEC filings made Which included auditor consent• The SEC becomes involved when the auditor consents to having his/her opinion included in a client filing under the 1933 and/or 1934 Acts• April 27 1 – Form 10-K annual report – Form S-8 to register stock for employee benefit 15 plan• June 4 16 – Form S-4 to register junk bonds 29
  30. 30. Key events post-audit• June 14 – Form 10-Q17 – Disclosure of $50 million “excess inventory” – Disclosure of possible loan covenant violations• June 16 - announcement14 – Expected 2nd quarter loss – Credit frozen by bank due to covenant violations• November 4- announcement18 – Chapter 11 bankruptcy reorganization• December 7 – Form 8-K19 – Auditor resignation• January 27, 2000 – announcement20 – Bankruptcy converted to Chapter 7 liquidation 30
  31. 31. Criminal and civil penalties 31
  32. 32. Criminal penalties 21• Just For Feet executives – Don-Allen Ruttenberg – Adam Gilburne – Stephen Davis• Vendor executives – Jonathan Epstein, Fila USA – Timothy McCool, Adidas – Thomas Shine, Logo Athletic – Steven Dodge, Converse 32
  33. 33. SEC civil penalties• Just For Feet executives – Eric Tyra, chief financial officer • Fined $67,500; 10-year suspension by SEC22 – Peter Berman, controller • Fined $51,32723• Deloitte & Touche8 – Firm paid $375,000 fine – Steven Barry suspended for 2 years – Karen Baker suspended for 1 year 33
  34. 34. Bankruptcy settlement 24Ruttenberg Estate $15.0 millionDeloitte & Touche $24.0 millionOutside directors $41.5 millionTotal $80.5 million 34
  35. 35. 1999 Super Bowl TV commercial 25 35
  36. 36. References1 Just For Feet, Inc. (1999). Form 10-K for the Fiscal Year Ended January 30, 1999 (CIK: 00000918111). Retrieved11 July 2011 from Securities and Exchange Commission www.sec.gov.2 Just For Feet, Inc. (1998). Just For Feet Hires Agency To Create Launch Ad For National Branding Campaign ToPremiere On Superbowl. Retrieved 11 July 2011 from PR Newswire www.prnewswire.com.3 Just For Feet, Inc. (1998). Just For Feet, Inc. Closes $200,000,000 Credit Facility. Retrieved 11 July 2011 from PRNewswire www.prnewswire.com.4 Just For Feet, Inc. (1999). Just For Feet, Inc. Announces Comparable Store Sales for Quarter toDate, Preliminary Estimates and Change in Fiscal Year. Retrieved 11 July 2011 from PR Newswirewww.prnewswire.com.5 Just For Feet, Inc. (1999). Just For Feet To Give Away a New Hummer During Super Bowl. Retrieved 11 July2011 from PR Newswire www.prnewswire.com.6 Stuart Elliott (1999). At $1.6 million for 30 seconds, few commercials proved worthy of their Super Bowlspotlight. The New York Times – February 2, 1999. Retrieved 11 July 2011 from PR Newswirewww.nytimes.com.7 Just For Feet, Inc. (1999). Just For Feet, Inc. Announces Record Sales and Comp Store Sales For The FourthQuarter. Retrieved 11 July 2011 from PR Newswire www.prnewswire.com.8 Securities and Exchange Commission (2005). Accounting and Auditing Enforcement Release No. 2238, April26, 2005, in the Matter of Deloitte & Touche LLP, Steven H. Barry, CPA and Karen T. Baker, CPA, Respondents.Retrieved 11 July 2011 from www.sec.gov. 36
  37. 37. References9 AICPA (2010). Professional Standards, Volume 1, as of June 1, 2010.10 Just For Feet, Inc. (1999). Proxy Statement Pursuant to Section 14(a) of the Securities Exchange Act of 1934(CIK: 00000918111). Retrieved 11 July 2011 from Securities and Exchange Commission www.sec.gov.11 Just For Feet, Inc. (1999). Credit Agreement dated as of December 10, 1998 among Just For Feet, Inc. asBorrower, and The Lenders Named Herein, Compass Bank, et al. (Exhibit 10.5 to 1999 Form 10-K, CIK:00000918111). Retrieved 11 July 2011 from Securities and Exchange Commission www.sec.gov.12 Securities and Exchange Commission (2003). Securities and Exchange Commission v. Adam Gilburne.Litigation Release No. 18139, May 15, 2003. Retrieved 11 July 2011 from www.justice.gov.13 United States District Court for the Northern District of Alabama (2004). United States of America v. JonathanG. Epstein, Defendant. Retrieved 11 July 2011 from www.justice.gov.14 Just For Feet, Inc. (1999). Just For Feet, Inc. Responds to News Releases and Elaborates on Specialty StoreDifficulties. Retrieved 11 July 2011 from PR Newswire www.prnewswire.com.15 Just For Feet, Inc. (1999). Form S-8 Registration Statement under the Securities Act of 1933. CIK:00000918111. Retrieved 11 July 2011 from www.sec.gov.16 Just For Feet, Inc. (1999). Form S-4 Registration Statement under the Securities Act of 1933. CIK:00000918111. Retrieved 11 July 2011 from www.sec.gov.17 Just For Feet, Inc. (1999). Form 10-Q for the Quarter Ended May 1, 1999 (CIK: 00000918111). Retrieved 11July 2011 from Securities and Exchange Commission www.sec.gov. 37
  38. 38. References18 Just For Feet, Inc. (1999). Just For Feet, Inc. Announces Filing for Relief Under Chapter 11 of the BankruptcyCode. Retrieved 11 July 2011 from PR Newswire www.prnewswire.com.19 Just For Feet, Inc. (1999). Form 8-K Current Report as of December 7, 1999 (CIK: 00000918111). Retrieved 11July 2011 from Securities and Exchange Commission www.sec.gov.20 Just For Feet, Inc. (2000). Just For Feet, Inc. Announces Asset Auction. Retrieved 11 July 2011 from PRNewswire www.prnewswire.com.21 United States Department of Justice (2004). Corporate Fraud Task Force Second Year Report to the President.Retrieved 11 July 2011 from www.justice.gov.22 Securities and Exchange Commission (2005). Securities and Exchange Commission v. Eric Tyra, Scott Wynne,Peter Berman and Scott Carey. Litigation Release No. 19438, October 20, 2005. Retrieved 11 July 2011 fromwww.sec.gov.23 Securities and Exchange Commission (2005). Securities and Exchange Commission v. Eric Tyra, Scott Wynne,Peter Berman and Scott Carey. Litigation Release No. 19163, March 31, 2005. Retrieved 11 July 2011 fromwww.sec.gov.23 Lattman, Peter (2007). Settlement in Just For Feet Case May Fan Board Fears. The Wall Street Journal – April23, 2007. Retrieved 11 July 2011 from www.wsj.com.25 Just For Feet, Inc. (1999). Super Bowl TV Commercial. Retrieved 11 July 2011 from YouTubewww.youtube.com. 38
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