North Face Case

Topics: Auditing, Audit, Chief financial officer Pages: 7 (1806 words) Published: December 19, 2013
Financial accountants and independent
auditors commonly face challenges
Financial accountants and independent auditors commonly face challenging technical and ethical dilemmas while carrying out their professional responsibilities. This case profiles an accounting and financial reporting fraud orchestrated by the chief financial officer (CFO) of a major public company and his subordinates. The CFO, who was a CPA, took extreme measures to conceal the fraud from his company’s audit committee and independent auditors. Despite those measures, the independent auditors identified suspicious entries in the company’s accounting records that were a result of the CFO’s fraudulent scheme but did not properly investigate those items. Shortly before the fraud was publicly revealed, a partner of the company’s audit firm instructed his subordinates to alter prior year audit workpapers for the client to conceal improper decisions made by himself and his firm.

Hap Klopp founded North Face in the mid-1960s to provide a ready source of hiking and camping gear. In 1970, North Face began designing and manufacturing its own line of products after opening a small factory in nearby Berkeley.

In 1980, North Face began sponsoring mountain-climbing expeditions across the globe. And North Face became the only supplier in the United States to offer a comprehensive collection of high-performance outerwear, skiwear, sleeping bags, packs and tents.

Sales Growth vs. Quality Control
By the mid-1980s, North Face’s overburdened manufacturing facilities could not satisfy the steadily growing demand for the company’s merchandise or maintain the high quality production standards established by management.

New Era
In July 1996, a new management team took North Face public, listing the company’s common stock on the NASDAQ exchange.
The management team established a goal of reaching annual sales of $1 billion by 2003. Later when the actual revenues and profits of North Face failed to meet management’s expectations, the company’s chief financial officer (CFO) and vice president of sales booked a series of fraudulent sales transactions.

Barter for Success at North Face

In December 1997, North Face’s CFO Christopher Crawford negotiated a $7.8 million “sale” of excess inventory to a barter company in exchange for trade credits. Crawford knew that the authoritative accounting literature generally precluded the recognition of revenue on such transactions.

Crawford, however, structured the transaction to recognize a profit on the trade credits. An Oral “Side Agreement”
Crawford required the barter company to pay a portion of the trade credits in cash. To further obscure the true nature of the large barter transaction, Crawford split it into two parts. 1. On December 29,1997, a $5.15 million sale recorded($3.51 million in cash & $1.64 million trade credit) 2. On January 8, 1998, the remaining $2.65 million portion of the barter transaction was booked. Consignments

In the third and fourth quarters of fiscal 1998, Todd Katz, North Face’s vice president of sales, arranged two large sales to inflate the company’s revenues, transactions that were actually consignments rather than consummated sales.

The first of these transactions involved $9.3 million of merchandise “sold” to a small, apparel wholesaler in Texas.
Katz negotiated a similar $2.6 million transaction with a small California wholesaler a few months later. Erasing the Past
Richard Fiedelman served for several years as the “advisory” partner for the North Face audit engagement and during early 1998 served for a brief time as the audit engagement partner. During the 1997 audit, the Deloitte audit engagement partner proposed an adjustment to reverse the portion of the $7.8 million barter transaction recorded in December 1997 because he realized that the profit could not be recognized on a barter transaction when the seller is paid exclusively in “trade credits.” The...
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