The summary analyzes the 1998 audit of Just For Feet Superstores. It identifies four main accounting misstatements in the financial statements that were not properly addressed by Deloitte & Touche during the audit. These included overstated advertising co-op credits receivable, vendor booth displays, inventory obsolescence allowance, and an advertising rebate receivable. The summary also notes penalties and settlements that resulted from the failures in the audit.

1. 1998 Audit
Daniel Reynolds
University of Texas at Arlington
July 2011
1

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. Rapid growth 1991-1998 1
Amounts in $ millions
1991 1992 1993 1994 1995 1996 1997 1998
Revenues 8 17 24 56 120 256 479 775
Net income 0 0 0 3 10 14 21 27
Superstores 2 3 5 15 27 50 73 132
3

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. 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. 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. Fraud Risk Factors
9
AU 316.85
7

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. 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. Oversight over financial reporting 10
• Good
– Audit Committee comprised of two outside directors
• Not so good
– One member was president of client's primary bank to
whom client owed $189 million
• Worse
– Audit Committee only met once during 1998
10

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. Negative cash flows 1
Amounts in $ millions 1994 1995 1996 1997 1998
Net income 3 10 14 21 27
Cash flow from operations -11 -6 -42 -26 -82
Cash on hand 36 97 139 82 12
Current liabilities 69 85 147 156 133
Quick ratio 0.52 1.14 0.95 0.53 0.09
12

13. Zone of Insolvency
Amounts in $ millions
Cash on hand 12.4
Annual revenues 774.9
Cash flow from operations (82.1)
857.0
Divide by 365
Daily cash requirement 2.3
Number of days cash on hand 5.3
13

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. 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. 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. 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. 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. 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. 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. 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. 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 used
against other purchases
DR Accounts Payable
CR Expenses
22

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. 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. 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. 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. 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. 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. 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. 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. Criminal and civil penalties
31

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. 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. Bankruptcy settlement 24
Ruttenberg Estate $15.0 million
Deloitte & Touche $24.0 million
Outside directors $41.5 million
Total $80.5 million
34

35. 1999 Super Bowl TV commercial
25
35

36. References
1
Just For Feet, Inc. (1999). Form 10-K for the Fiscal Year Ended January 30, 1999 (CIK: 00000918111). Retrieved
11 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 To
Premiere 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 PR
Newswire www.prnewswire.com.
4
Just For Feet, Inc. (1999). Just For Feet, Inc. Announces Comparable Store Sales for Quarter to
Date, Preliminary Estimates and Change in Fiscal Year. Retrieved 11 July 2011 from PR Newswire
www.prnewswire.com.
5
Just For Feet, Inc. (1999). Just For Feet To Give Away a New Hummer During Super Bowl. Retrieved 11 July
2011 from PR Newswire www.prnewswire.com.
6
Stuart Elliott (1999). At $1.6 million for 30 seconds, few commercials proved worthy of their Super Bowl
spotlight. The New York Times – February 2, 1999. Retrieved 11 July 2011 from PR Newswire
www.nytimes.com.
7
Just For Feet, Inc. (1999). Just For Feet, Inc. Announces Record Sales and Comp Store Sales For The Fourth
Quarter. Retrieved 11 July 2011 from PR Newswire www.prnewswire.com.
8
Securities and Exchange Commission (2005). Accounting and Auditing Enforcement Release No. 2238, April
26, 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. References
9
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. as
Borrower, 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. Jonathan
G. 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 Store
Difficulties. 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 11
July 2011 from Securities and Exchange Commission www.sec.gov.
37

38. References
18
Just For Feet, Inc. (1999). Just For Feet, Inc. Announces Filing for Relief Under Chapter 11 of the Bankruptcy
Code. 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 11
July 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 PR
Newswire 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 from
www.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 from
www.sec.gov.
23
Lattman, Peter (2007). Settlement in Just For Feet Case May Fan Board Fears. The Wall Street Journal – April
23, 2007. Retrieved 11 July 2011 from www.wsj.com.
25
Just For Feet, Inc. (1999). Super Bowl TV Commercial. Retrieved 11 July 2011 from YouTube
www.youtube.com.
38

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