CASE 1.

MATTEL, INC.

In 1945, Elliot and Ruth Handler, along with a friend, Harold Matson, founded a small toy company. Within a few months, Matson decided to pursue other interests and left Mattel, Inc., to the Handlers. For the next decade, the husband-andwife team struggled to make their small company a success. Elliot Handler, an artist, designed the toys the company produced, while Ruth Handler managed the companys business affairs, concentrating much of her time on finding sales outlets for their products. By 1955, Mattels net worth was a little more than $500,000. That year, Ruth Handler decided to take a daring step to expand the size of the company. Her plan was to advertise Mattels toys on the popular childrens television program, The Mickey Mouse Club. The cost of the advertising campaign was several hundred thousand dollars and if unsuccessful could have bankrupted the small company; however, Ruth Handlers gamble paid off handsomely. Within a few months, Mattels sales orders increased dramatically, and the company was on its way to establishing itself as a major player in the very competitive toy industry. In 1959, Ruth Handler took a second gamble by introducing a full-figured, teenage doll named after her daughter Barbara. Industry experts maintained that the doll would not appeal to its target market of three- to eleven-year-old girls. The experts were wrong. Barbie was an instant success, with more than 350,000 sold the first year it was on the market. By Barbies thirtieth birthday, more than 500 million dolls had been sold. Ruth Handler, the youngest of ten children of Polish immigrants, was never modest about explaining the success of Mattel. During an interview, she once noted matter-of-factly that she was a marketing genius. A short and intensely competitive woman, Ruth Handler hated failure and refused to accept it. During the early 1970s, however, she and her company encountered a set of circumstances that would eventually take Mattel to the verge of bankruptcy. 3

SECTION ONE

COMPREHENSIVE CASES

TRYING TIMES AT MATTEL

By 1971, Mattel was recognized by financial analysts as one of the premier growth companies in the United States. In that year, the company reported pretax profits of $34 million on sales approaching $275 million. Investors were so infatuated by the company and its prospects that Mattel common stock traded at an enormous price-earnings ratio, often exceeding 50 to 1. The Handlers and other key Mattel executives became fabulously wealthy as a result. By 1971, the Mattel stock controlled by Elliot and Ruth Handler had a market value approaching $300 million. Despite the record earnings reported by Mattel for each successive year from 1967 through 1971, the company began experiencing serious problems in the early 1970s. Many of these problems could be traced to the Handlers decision in the late 1960s to hire Seymour Rosenberg as the companys executive vicepresident and chief financial officer. Rosenberg, formerly with Litton Industries, had earned a reputation for his skill in identifying and acquiringunderperrming companies and making them financial successes. Shortly after joining Mattel, he convinced the Handlers to diversify into several industries and to completely overhaul the organizational structure of the company, breaking its operations down into numerous decentralized divisions. Unfortunately, four of the six companies acquired by Mattel on the recommendation of Rosenberg proved to be very poor investments, and his decentralization plan increased Mattels operating costs tremendously. Besides the problems created by Rosenberg, who was dismissed by the Handlers in late 1972, Mattel encountered a series of largely uncontrollable circumstances in the early 1970s that damaged the companys profitability. First, one of the companys large warehouses in Mexicali, Mexico, burned to the ground in 1970. Then, the following year, a dockworkers strike prevented the company from receiving any toy shipments from its large Hong Kong plant. Finally, the recession of the early 1970s cut significantly into the companys sales. These factors caused Mattel to register a loss of approximately $30 million in fiscal 1972, which ended January 29, 1972. A large banking syndicate that had significant loans outstanding to Mattel was instrumental in convincing the Handlers to dismiss Rosenberg. Following Rosenbergs dismissal, Albert Spear was named Mattels executive vice-president and placed in charge of the companys day-to-day operations. Spear quickly discovered that Mattels financial status had been grossly misrepresented to the public. Shortly before Spear accepted his new position in early 1973, Mattel had issued a press release stating that the company had undergone a dramatic turnaround in fiscal 1973 compared with fiscal 1972. However, an intensive study of Mattels financial records by Spear revealed that the company had actually suffered a huge loss in fiscal 1973larger than the loss reported the prior year..When Spear released this information to the public, panicked investors reacted immediately by dumping their Mattel stock. Spears disclosures also resulted in five class action lawsuits being filed against Mattel and its executives by angry stockholders. Finally, Spears revelations spurred the Securities and Exchange Commission (SEC) to begin an investigation of the companys financial affairs. In October 1975, Elliot and Ruth Handler resigned their positions with Mattel. One month later, the outside directors on the Mattel board released a fivehundred page report that detailed a massive earnings manipulation scheme

CASE 1.1

MATrEL, INC.

masterminded by the companys executive officers. According to the report, the Handlers and other key Mattel officials issued financial statements that were deliberately false and misleading to give an illusion of continued spectacular growth. The lengthy report also discussed Arthur Andersens audits of Mattel during the period in which the companys earnings were being manipulated. Price Waterhouse, which reviewed the Mattel audits, harshly criticized Arthur Andersen. In general, Price Waterhouse concluded that Arthur Andersens audit procedures and tests werent as comprehensive as they should have been in many areas and that certain information contained in the accountants working papers should have been further pursued. If this had been done, the report said it could have led to the discovery of irregularities in the fiscal 1971 and 1972 financial statements.2 In March 1976, a federal judge approved an out-of-court settlement to the class action lawsuits filed by Mattels stockholders. The $30 million settlement required multimillion-dollar payments by several former executives of Mattel, principally the Handlers and Rosenberg, as well as even larger payments by the insurance companies of these executives. The only defendant that refused to participate in the settlement was Arthur Andersen, which maintained that it was not responsible for the huge losses suffered by Mattels stockholders following the disclosure of the eamings manipulation scheme. Nevertheless, in April 1977, Arthur Andersen agreed to make a cash payment of approximately $900,000 to Mattel stockholders to resolve the matter. In February 1978, a federal grand jury indicted Ruth Handler, Seymour Rosenberg, and four other former Mattel executives. The executives were charged with falsifying Mattels financial statements for the period 1969 to 1974. In responding to the indictment, Ruth Handler proclaimed her innocence and maintamed that she was deeply offended by the charges. Later that year, however, Handler submitted a plea of no contest to each of the ten counts of fraud filed against her. Handlers plea bargain agreement allowed her to escape a prison sentence but required her to perform 2,500 hours of community service and to pay a $57,000 fine. A similar plea bargain arrangement was made with Rosenberg in the fall of 1978.

ALLEGED DEFICIENCIES IN ARTHUR ANDERSENS AUDITS OF MATTEL

In June 1981, the SEC released the results of its lengthy investigation of Mattels fraudulent earnings manipulation scheme and its report on Arthur Andersens audits of Mattel. The SEC criticized Arthur Andersens audits of Mattel, particu1. R. Lindsey, A Million-Dollar Business from a Mastectomy, The New York Times. 19 June 1988. F3. 2. S. Sansweet, Mattel Ex-Aides Tried Cover-Up, Report Asserts, The Wall Street Journal, 4 November 1975. 10. 3. Elliot Handler was never indicted for criminal fraud. The federal grand jury that investigated the Mattel earnings manipulation scheme apparently concluded that he was not involved in the fraud.

SECTION ONE

COMPREHENSIVE CASES

larly the 1971 and 1972 engagements. According to the SEC. numerous errors and oversights during those audits had prevented Arthur Andersen from discovering the fraudulent methods used by Mattel management to manipulate the companys reported operating results. Mattels illicit accounting methods and the related deficiencies in Arthur Andersons audits are discussed in the following sections.

Improper Sales Cutoff at Year-End

For fiscal year 1971, which ended January 30, 1971, Mattel management was facing the unpleasant prospect of informing stockholders that the company had failed for the first time in several years to post record sales and earnings. To inflate the companys reported earnings, Mattels top executives instituted in January 1971 what became known as the bill and hold program. Mattel used this program to overstate its fiscal 1971 sales by almost $15 million and its pretax earnings by approximately $8 million. In simple terms, the bill and hold program involved billing customers for future sales and then recording the sales immediately. The SEC identified the following six reasons why the bill and hold sales should not have been recorded by Mattel in January 1971: 1. The merchandise was not shipped as of January 30, 1971. 2. The customer did not have to make any payments until the goods were received and accepted. 3. The merchandise was not physically segregated from Mattels inventory nor labeled as the property of the customer. 4. The customer could cancel the order without penalty at any time prior to his receipt and acceptance of the merchandise. 5. The risks of ownership remained with Mattel, including the risk of loss due to damage, theft, or destruction of the merchandise. 6. In many instances, the invoices were prepared without prior consultation with, or participation by, the customer as to the content of the order.4 To provide documentary support for the bill and hold sales, Mattel prepared customer order forms, sales invoices, and bills of lading. Bills of lading normally required the signature of both a Mattel shipping employee and a representative of the common carrier transporting the goods. However, for the bogus bills of lading, Mattel shipping employees signed for both themselves and the common carrier. The magnitude of the bill and hold program created tremendous confusion for Mattel accounting personnel. When the bill and hold sales were recorded in January 1971, the inventory quantities for the items allegedly sold were a~Ijusted downward, although the goods were not segregated from the remaining inventory items. When the bill and hold goods were actually shipped, weeks or even months later, Mattels inventory records became laced with errors resulting from employees recording the inventory shipments a second time. The end result was that Mattels inventory records were unreliable.
4. This information was taken from Securities and Exchange Commission, Accounting Series Release No. 292, 22 June 1981. All subsequent quotations, unless indicated otherwise, are reprinted from this source.

CASE 1.1

MATrEL, INC.

To resolve the inventory control probl~m~ created by the bill and hold sales, Mattel executives were forced to reverse those sales in fiscal 1972. The first reversing entry was booked in May 1971 and involved $12 million in sales. Approximately one-half of this total was for bill and hold sales recorded in fiscal 1971, while the other one-half was for bill and hold sales recorded near the end of the first quarter of fiscal 1972. The large reversing entry created another problem: the net sales for May 1971 was suddenly a negative figure. Mattel executives decided to book a fictitious $11,000,000 sale in May to conceal the large impact of the reversing entry on the recorded sales for that month. This fictitious transaction was recorded only in the general ledger, not in the accounts receivable subsidiary ledger, meaning that there was an unreconciled difference of $11,000,000 between the two accounting records. In August 1971, Mattel reversed the approximately $7,000,000 of remaining bill and hold sales recorded in fiscal 1971. Then, in September, a month in which Mattel typically experienced a very high volume of sales, company management reversed the fictitious $11,000,000 general ledger sales entry recorded in May ot that year. This entry eliminated the large difference between the balance of the general ledger controUing account for receivables and the balance of the accounts receivable subsidiary ledger. The net effect of this series of bogus entries and correcting entries was that eamings and sales for fiscal 1972 were understated by approximately the same amounts that those items were overstated for fiscal 1971. Arthur Andersen representatives staunchly maintained that their personnel were not aware of the fraudulent bill and hold sales until Mattel executives publiclv revealed the scheme in 1974. However, the SEC pointed to several audit tests performed by Arthur Andersen during the 1971 and 1972 Mattel audits that should have resulted in the discovery of the bill and hold sales. Among these audit tests were Arthur Andersens receivables confirmation procedures. Several of the accounts receivable confirmations mailed by Arthur Andersen during the 1971 audit were retumed with discrepancies noted by Mattels customersdiscrepancies caused by bill and hold sales that had been charged improperly to the customers accounts as of January 30, 1971. In resolving these discrepancies, the Arthur Andersen auditors obtained copies of the bills of lading for the disputed charges to determine whether the goods had actually been shipped as of January 30, 1971. The SEC pointed out that although these bills of lading were clearly marked bill and hold, the Arthur Andersen auditors apparently never asked client personnel to explain the significance of that phrase.5 The Arthur Andersen auditors also failed to notice that the bills of lading they obtained to clear the confirmation discrepancies conspicuously lacked the required routing or delivery instructions. Finally, the auditors failed to recognize that the two required signatures on the bogus bills of lading were those of Mattel employees rather than one being the signature of a common carrier representative and the other being that of a Mattel employee. The auditors eventually cleared the confirmation discrepancies caused by the bill and hold sales with the following tickmark explanation: Traced to Mattel invoice and bill of lading noting agreement of amount and that shipment made prior to 1/30/71.
5. However, an Arthur Andersen manager who reviewed the accounts receivable workpapers wrote a review comment addressed to an audit senior: What does Bill and Hold mean? This review comment was apparently never cleared by the audit senior.

1.

SECTION ONE

COMPREHENSIVE CASES

Arthur Andersen tested Mattels year-end sales cutoff for fiscal 1971 by selecting eighty-two large sales invoices processed near the end of that yeara Twentysix of these invoices were for bill and hold sales. Despite the phrase bill and hold written distinctly on the face of each of these invoices, and despite the earlier-noted problems with the related bills of lading, Arthur Andersen failed to recognize that these twenty-six sales were fictitious. During the internal control phase of the fiscal 1972 Mattel audit, Arthur Andersen selected the month of August 1971 to perform its tests of controls for the sales cycle. Ironically, August was the month in which Mattel recorded one of the large reversing entries to eliminate a portion of the bill and hold sales booked in January 1971. This reversing entry of nearly $7 million caused the total of Augusts general ledger sales to be that much less than the corresponding monthly sales figure reported by a supplementary ledger maintained by Mattel, the sales invoice register. An Arthur Andersen staff person included in the audit workpapers the following explanation for this large differencean explanation given to him by a Mattel employee: This amount is an offset to sales due to invoicing errors uncovered by client when comparing computer-prepared invoices to bills of lading. Client errors such as items not
being shipped and wrong amount are the types found. At this time client does not know whether credit memos were issued or not. May create a cutoff problem for accounts receivable at year-end.

To his credit, the Arthur Andersen senior who reviewed this explanation noted that it was unsatisfactory and wrote the staff person the following note: Need a better explanation. This looks like a big problem. The SEC could find no evidence in the audit workpapers that the problem had been further investigated. Finally, the SEC criticized Arthur Andersen for not utilizing analytical procedures to evaluate the overall reasonableness of Mattels monthly sales. If such tests had been performed, the Mattel auditors would have discovered that the clients monthly sales varied dramatically from 1970 through 1972. This volatility was largely a result of the errors introduced into the accounting records by the bill and hold program and the subsequent errors created when the bill and hold sales were reversed.

Intentional Understatement of Inventory Obsolescence Reserve The SEC determined that Mattels management intentionally understated the companys reserve for inventory obsolescence by several million dollars over the
two-year period 19711972. Inventory obsolescence is historically a major problem for the large toy manufacturers, given the inherent difficulty of predicting childrens taste in toys. For example, in fiscal 1971, Mattel executives faced a huge and unexpected inventory buildup of the Hot Wheels toy, which had traditionally been one of the companys best-selling products. The following year, Mattel was forced to dispose of approximately 5.6 million of the Hot Wheels toys by selling them to a large oil company at a loss of more than $11 million. In arriving at its year-end reserve for obsolete inventory, Mattel prepared weekly sales forecasts for the next several months for each toy that was considered an excess inventory item. A reserve for obsolescence was then recorded for those toys whose expected sales in the following months were less than the yearend inventory In 1971 and 1972, the SEC found that Mattel inflated the projected

CASE 1.1

MATrEL, INC.

future sales of several excess inventory items to justify not recording a reserve for obsolescence for those toys. When auditing the reserve for inventory obsolescence, Arthur Andersen personnel compared the weekly sales forecasts for certain excess inventory toys to the actual sales realized by those toys in the first several weeks of the new fiscal year. For eight of the toys selected for testing during the 1972 audit, five had no recorded sales in the first several weeks of the new year, and three others actually had negative net sales during that time. Mattels weekly sales forecasts prepared at the end of fiscal 1972 had projected significant sales for these items. Despite the results of this audit test, Arthur Andersen failed to challenge the sufficiency of Mattels inventory obsolescence reserve.

Overstatement of Deferred Tooling Costs

For each new toy Mattel produces, the company incurs significant tooling costs~ during the developmental phase of the product. These costs include expenditures related to producing the molds and die casts needed for the new product and the expenditures required to establish the production line for the product. Mattels tooling costs are deferred in an asset account and amortized over the estimated useful life of the new toy. The proportion of the tooling costs amortized each year for a given toy is equal to the ratio of that years sales for the toy to the total expected sales over the life of the toy. From 1970 through 1972, Mattel executives manipulated the companys deferred tooling costs to overstate Mattels reported earnings. In 1971, for example, the amortization of deferred tooling costs was understated by approximately $3.7 million. According to the SEC. the misstatement of the deferred tooling costs in 1971 was accomplished by the following means: 1. By reallocating tooling costs from various products with low forecasted sales to those with sizable forecasted sales. 2. By adjusting the ratio of various products current sales to their forecasted sales. 3. By deferring all tooling costs incurred during the last three months of the year. 4. By deferring certain tooling costs twice. Arthur Andersen~s audit of Mattels deferred tooling costs for 1971 involved obtaining and reviewing client-prepared schedules of these costs by product. The auditors then tested the propriety of the amortization amounts for a small number of the products that had large deferrals. Among the most important of these audit tests were simple comparisons of actual current year sales to total forecasted sales for individual products to determine that the amount of tooling costs amortized during the year was reasonable. The SEC suggested that more extensive and rigorous audit tests should have been applied to Mattels deferred tooling costs during the 1971 audit, given the large increase in those costs in 1971 and the inherently subjective nature of that item. Arthur Andersen did uncover at least two instances of material overstatements of Mattels deferred tooling costs. Arthur Andersen refused to accept certain of the revised sales forecasts that Mattel used to justify reducing the amount of deferred tooling costs written off for several products. In 1971, for example, Arthur Andersens workpapers documented a $2 million overstatement of deferred tooling costs resulting from improper revisions of certain products expected lifetime

10

SECTION ONE

COMPREHENSIVE CASES

sales. However, Mattel adjusted the account balance by only $1.4 million. According to the SEC. Arthur Andersens workpapers did not reveal how that figure was determined, nor did the workpapers provide any evidence suggs~sting that the $1.4 million adjustment was sufficient to correct the noted problem. Mattels auditors also discovered during the 1972 audit that more than $1.2 million of tooling costs had been deferred twice. This discovery was made by a senior member of the Arthur Andersen engagement team, who then wrote a review comment instructing a subordinate to make sure that the proper adjusting entry was recorded. In responding to the review comment, the subordinate subsequently noted, Tooling write-off adjusted for this fact. Despite this assertion, the SEC determined that the adjustment was never made.

Underpayment of Royalties
Mattel acquired the production rights to its popular Hot Wheels product from the gentleman who invented that toy. The contract between Mattel and the inventor called for him to begin receiving significant royalties on Hot Wheels sales when the product reached the break-even point. In 1970, the break-even point for the Hot Wheels toy was reached; however, to avoid paying royalties to the inventor, Mattel management fabricated an additional $4.4 million in expenses related to that product. These expenses consisted primarily of bogus advertising expenditures and increases in the operating losses allegedly incurred by the product in the first few years following its introduction. Because of these fraudulent expenses, Mattel avoided paying the inventor nearly $2 million in royalties that he had rightfully earned from 1970 through 1972. The SEC charged that Arthur Andersen failed to properly investigate the contractual arrangement between the inventor and Mattel and the related financial statement implications. In particular, Arthur Andersen apparently did not question the additional $4.4 million in expenses added in 1970 to the schedule that summarized the operating results of the Hot Wheels productexpenses later proved to be fictitious. Additionally, the auditors failed to obtain a copy of a computer-generated royalties report that disclosed the proper amount of royalties due the inventor.

Improper Computation of Business Interruption Insurance Claim Mattels large warehouse in Mexicali, Mexico, which was destroyed by a fire in September 1970, was fully insured, as were its contents. The companys insurance
policy also included a business interruption clause providing up to $10 million in coverage for revenues lost as a result of damage to the facility or its destruction. In its financial statements for the fiscal year ended January 30, 1971, Mattel included a $10 million receivable from its insurance company for a business interruption insurance claim, a figure that was accepted by Arthur Andersen. The SEC charged that neither Mattel nor Arthur Andersen should have expected the insurance company to pay the full amount of the claim. The federal agency argued that the method used by Mattel to compute the amount recoverable from the insurance company, a method approved by Arthur Andersen, was not credible. In fact, Mattel did not receive any payment from its insurance company until 1977 and then was paid only $4.4 million.

CASE 1.1

MATTEL, INC.

11

ADDITIONAL SEC CRITICISM OF ARTHUR ANDERSENS MATTEL AUDITS

Besides the specific criticisms of Arthur Andersens Mattel audits already noted, the SEC also chastised the audit firm for other, more general deficiencies in those audits. First, the SEC criticized the Arthur Andersen auditors for repeatedly failing to sufficiently investigate suspicious transactions and documents coming to their attention. An example noted earlier was the failure of the auditors to adequately research the nature of Mattels bill and hold sales. Second, the SEC maintained that Arthur Andersen failed to apply industry knowledge during the course of the Mattel audits. For example, if Arthur Andersen had been closely following its clients sales markets, the firm would likely have recognized that Mattels large inventory of Hot Wheels at the end of 1970 required a significant write-down, given the inability of retailers to sell their own inventories of that product. In commenting on this point, the SEC made the following remarks: Auditors must acquire and apply sufficient knowledge of their clients industries to enable them to intelligently audit their business operations and to evaluate the clients explanations of those operations. The SEC also criticized Arthur Andersen for being overly willing to accept client representations as audit evidence with little or no verification or documentation. As an example, the SEC noted the audit firms acceptance of the spurious explanation given for the large discrepancy between the sales reported for August 1971 by the general ledger controlling account and by the sales invoice register. Finally, the SEC observed that senior members of the Arthur Andersen engagement team had exhibited insufficient control, coordination, and supervision during the Mattel audits. In particular, the SEC was concerned that Arthur Andersens audit review process had failed to ensure that important problems discovered by staff auditors during the Mattel audits were resolved satisfactorily.

EPILOGUE
Under the leadership of new management, Mattel slowly recovered from its nearly disastrous experiences of the early 1970s. In 1994, Mattel overtook Hasbro as the nations largest toy maker. Two years later, Mattels annual revenues surpassed $4.5 billion, nearly 40 percent of which was attributable to the Barbie product line. That product line included more than 100 different Barbie dolls by late 1997. Among these dolls were Hula Hair Barbie, Workin Out Barbie, Country Rose Barbie, and Harley-Davidson Barbie. Ruth Handler also staged a dramatic comeback following her traumatic experiences of the early 1970s. After her forced retirement from Mattel, she founded a company, Ruthton Corporation, that manufactures prosthetic devices for women who, like herself, have undergone mastectomies. Although a small company with a relatively small market, Ruthton Corporation quickly established itself and within a few years was reporting annual sales of several million dollars. In 1989, Ruth and Elliott Handler were recognized for their contributons to the toy industry by being inducted into the industrys hall of fame.

SECTION ONE COMPREHENSIVE CASES

In 1981, the SEC censured Arthur Andersen for its alleged deficient audits of Mattel, Inc. The SEC apparently chose only to censure Arthur Andersen because the audit firm demonstrated that it had undertaken significant corrective measures to prevent the recurrence of the problems that had arisen during the Mattel audits. Exhibit 1 contains the list of these corrective measures that was appended to the SEC enforcement release in which Arthur Andersen was censured.

QUESTIONS
1. Identify the key variables that influenced the level of inherent risk Arthur Andersen faced during the 1971 and 1972 audits of Mattel. 2. The SEC noted six reasons why the bill and hold sales recorded by Mattel did not qualify as consummated sales transactions. Identify and dis cuss the general conditions for recognizing revenue from sales transactions. Also, identify circumstances in which revenues may be recognized on sales transactions even though one or more of these conditions are not met. 3. Identify and discuss the principal audit objectives associated with the performance of year-end sales cutoff tests. In general, is it appropriate to perform these tests at an interim date? Why or why not? 4. SAS No. 31. Evidential Matter, identifies five key management assertions that underlie a set of financial statements. Identify the management assertions that would have been of primary concern to Arthur Andersen regarding the following items: the reserve for inventory obsolescence, royalty expense, and the receivable recorded by Mattel for the business interruption insurance claim. Why is it important for an auditor to identify the underlying management assertions for each major account of a client? 5. In at least two instances, key issues raised during the review of Mattels workpapers by Arthur Andersen personnel were not resolved satisfactorily prior to the completion of the audit. Which member of the audit engagement team has the

EXHIBIT 1 Measures Taken by

Arthur Andersen to Strengthen Its Audit Process Following the

Consultation within the Firm. in 1978, the firms policies on Intra-firm consultatlonregarding complex or unusual transactions were formalized and restated in a single source providing concise guidelines on specific practice problems where consultation is appropriate. Rotation of Audit Partners. in 1976, Arthur Andersen voluntarily adopted a policy requir-

Mattel Audits

ing rotation of audit engagement partners every five years. A similar rule was adopted by the SEC Practice Section of the AIOPA in 1977. Second Partner Reviews, in 1975, Arthur Andersen began requiring an extensive review of audit reports and supporting materials by a second partner not engaged in the audit. A similar requirement was subsequently adopted by the SEC Practice Section of the AICPA. ~ Personnel Training Programs. in the early 1970s, Arthur Andersen opened a large training facility in St. CharIes~Illinois, on a former college campus. This facility is used on a continuing basis to provide training for Arthur Andersen partners and professionaiejnployees. Updating of Practice and Procedure Manuals. Arthur Andersen updated all of its major practice and procedure manuals to provide a set of readily accessible guidelines to firm policy on financial reporting issues, accounting prindples, auditing procedures, and ethical issues. ~ PublIc Review Board. In 1974, Arthur Andersen established a Public Review board, an independent body consisting of indMduals from business,the professions, andgovernment. ~-~: The Board establishes its own program for reviewing the professional operations of the firm ,and has in each year of its existence focused on a different area of the firms Practij~.~
-,

CASE 1.1 MATTEL, INC.

13

primary responsibility to ensure that such issues are properly resolved and documented in the audit workpapers? Defend your answer. 6. Assume that Arthur Andersen had compared Mattels monthly sales during the early 1970s with the comparable monthiy sales figures of prior years. What additional audit procedures should Arthur Andersen have performed once it discovered the extreme volatility in these monthly sales figures? 7. Arthur Andersen proposed a $2 million adjusting entry to the deferred tooling costs account during its 1971 audit of Mattel. However, Mattel adjusted the balance of that account by only $1.4 million. Identify the conditions under which Arthur Andersen would have been justified in accepting this smaller adjusting entry.