Professional Documents
Culture Documents
cAsE 2.2
Jack Nicklaus electrified sports fans worldwide in 1986 when he won the prestigious
Masters golf tournament at the ripe old age of 46. Over the previous several years, the
"Golden Bear" had been struggling to remain competitive with the scores of talented
young players who had earned the right to play in the dozens of golf tournaments
sponsored each year by the Professional Golfers' Association (PGA).
Regaining his golden touch on the golf course was not the only challenge that
Nicklaus faced during the mid-1980s. ln 1985, Richard Bellinger, an accountant
employed by colden Bear International, Inc. (GBI), the private company that oversaw
the famous golfer's many business interests, mustered the courage to approach his
employer. Bellinger told Nicklaus that his company was on the verge of bankruptcy.
Nicklaus, lvho had allowed subordinates to manage his company's operations, was star-
tled by the revelation. In a subsequent interview with The Woll Street Joumal, Nicklaus
admitted that after a brief investigation he realized that he had allowed his company
to become a tangled knot of dozens of unrelated businesses. "We were an accounting
nightmare . . . I didn't know what any ef 15". did and neither did anyone else."l
Nicklaus immediately committed himself to revitalizing his company. The flrst step
that he took to turn around his company was naming himself as its chief executive
officer (cEo) Nicklaus then placed Bellinger in charge of GBI's day-to-day operations. within a few years, the two men had returned cBI to a profitable condilion
b1'focusing its resources on lines of business that Nicklaus knew best. such as golf
, o{ljs( r Ir'sir<rr. {ulf sclruols. errtl llre licensir,q uf g,,lI cquipmcnt.
In the late 1990s, however, Jack Nicklaus once again found himself coping with an
"accounting nightmare." This time, Nicklaus coulcl not blame himself for the predicament ile faced. Ittstead, the responsibilitl, for the nerv crisis rested squarely on the
shoulclers of tr,iro of Nicklausls 1<e1'subordinates rvi'ro had orchestrated a fraudulent
acconntirrg scheme that jeopardized their" emplover's corporate empire.
mid-teens. After graduating from high school. the golf prodigy accepted a scholarship to play collegiatelv for ohio State Universitl,'in his hometown of Columbus. At
the aqe of 2i, Nicklar-rs joined the professional golf tour and was an instant success,
racking up more than one dozen victories within a fer,v years.
Shortly after joining the prrofessional goif tour. the business-minded Nicklaus realized that winning golf tournaments rvas not the rnost lucrative way to profit flom his
enormous skills. At the time, the undi-sputed "king" of golf was Arnold Palmer, who
endeared himsell to the golfing public with his easy smile and affable manner on the
golf course. Adoring legions of fans known as "Arnie's Army" tracked Palmer's er"
l'y 11'rou" during a tournament. Palmer''s popularit-v with the public translated into a
1. R. l,ou'enstein. "A Golfei Becomes an Executive: .lacli Nicl<lauss Business Flclucatiorr." The Walt Street
2i Januarv i987. 34.
loLu no l.
SECTION
TWO
series of high-proflle and profitable endorsement deals. On the other hand, golf fans
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generally resented Nicklaus's no-nonsense approach on the golf course. Those same
fans resented Nicklaus even more when it became evident that the burly Ohioan
with the trademark crew cut would likely replace Palmer as the world's best golfer,
which he did. Nicklaus would ultimately win a record 18 major golf championships
and edge out Palmer for the "Player of the Century" award in the golfing world.
In 1996, Nicklaus decided to expand his business operations by spinning off a subsidiary from GBIvia an initialpublic offering (lPO). Nicklaus named the new public
company Golden Bear Golf, Inc. (Golden Bear). One of Golden Bear's principal lines
of business would be the construction of golf courses. GBI would remain a privately
owned company that would continue to manage Nicklaus's other business ventures.
Because Nicklaus planned to retain more than 50 percent of Colden Bear's common
stock, he and his subordinates would be able to completely control the new company's operations.
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Nicklaus chose his trusted associate Richard Bellinger to serve as Golden Bear's
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CEO. Bellinger then appointed John Boyd and Christopher Curbello as the two top ex-
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ecutives of Paragon International, Golden Bear's wholly owned subsidiary that would
be responsible for the company's golf course construction business. Boyd became
Paragon's president and principal operating officer, while Curbello assumed the title
of Paragon's vice president of operations. On August 1, 1996, Golden Bear went public.
The company's stock traded on the NASDAQ exchange under the ticker symbol JACK.
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Shortly after Golden Bear's successful IPO, Paragon International's management team
was inundated with requests to build Jack Nicklaus-designed golf courses. In a few
months, the company had entered into contracts to build more than one dozen golf
courses. Wall Street analysts, portfolio managers. and individual investors expected
these contracts to translate into sizable profits for Golden Bear. Unfortunately, those
profi ts never materialized.
Less than one year after Golden Bear's IPO, Boyd and Curbello realized that they
had been much too optimistic in forecasting the gross profit margins Paragon would
earn on its construction projects. Instead of earning substantial profits on those projects, Paragon would incur large losses on many of them. To avoid the embarrassment
of publicly revealing that they had committed Paragon to a string of unprofitable construction projects, the two executives instructed Paragon's accounting staff to embellish the subsidiary's reported operating results.
A key factor that may have contributed to Boyd and Curbello's decision to conceal
Paragon's financial problems was the incentive compensation package each had
received when they signed on with the company. The two executives could earn
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sizable bonuses if Paragon met certain operating benchmarks. In addition, Boyd had
been granted a large number of Colden Bear stock options.
Because Paragon's construction plojects required considerably more than one year
to complete, the company used percentage-olcompletion accounting to recognize
the revenues associated with those projects. Initially, Paragon applied the widely used
"cost-to-cost" percentage-of-completion method that requires a company to determine
CASE
2.2
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4 The remainirig quotations in this case rvere taken from Securities and Exchange
Commission.
Accounting onc! Aucliting Enbrcement Release No. 1676.2tj Novernber
2002
5 Recoqnize that the $'1 million of uninvoiced constrr:ction costs that r,vere aco-uecl
in the adjusting
entry did not reduce Coiden Bear's gross profit that it hacl recoqnized
for fiscal 19g7 under the earnecl
Valrtetnethod rhe$''1 millionof constructioncostssirnpiyreplacedanequal
amogntof expensestSat
hacl beell recordecl lo protluce the "proper" arnollnl ofgross
unrierthe earnecl value
Jrloht
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CASE
2.2
projects)
The SEC maintained that Sullivan and his subordinates should have rigorously
tested Paragon's large amount of unbilled revenues at the end of 1997. 'A significant
unbilled revenue balance requires adequate testing to determine the reason that
the company is not billing for the work it reports as complete and whether unbilled
amounts are properly recognized as revenue." Instead, the SEC charged that Sullivan
relied "excessively" on oral representations from Paragon management to confirm
the unbilled revenues and corresponding receivables.
In at least one case, the SEC reported that members of the Golden Bear audit team
asked the owner of a Paragon project under construction to comment on the reasonableness of the $2 million unbilled receivable that Paragon had recorded for that project at the end of 1997. The owner contested that amount, alleging that Paragon had
overestimated the project's stage of completion. "Despite this significant evidence
that a third party with knowledge of the project's status disputed Paragon's estimated
percentage-olcompletion under the contract, the audit team did not properly investigate this proiect or otherwise expand Andersen's scope of testing of Paragon's unbilled revenue balances." According to the SEC, Sullivan did not believe the unbilled
revenue posed major audit issues but instead was a "business issue" that Paragon
had to resolve with its clients.
A second tactic Paragon used to inflate its reported profits was to overstate the total revenues to be earned on individual construction projects. During the 1997 audit,
Andersen personnel selected 13 of Paragon's construction projects to corroborate the
total revenue figures the companv was using in applying the earned vahre percenta.geof-compietion accounting method to its unfinished projects. For 11 of the 13 projects
selected, the Andersen auditors discovered that the total revenue beinq used in the
percentage-of-cornpletion computations by Paragon exceeded the revenue figure documented in the construction contract. Paragon's management attributed tlrese differences to unsigned change orders that had been processed for the given projects "but
coi-rld not prodLtce an1'documents supporting ihese oral representations.'' Sullirran accepted the client's representations that the given revenue amounts were valid. "ln each
instance, Sullivan failed to properly follow up on a single undocumented amount; instead, Sullivan relied solely on Paragon management's oral representations that the
estimated revenue amounts accurately reflected the economic status of the iobs."
Another scam used by Paragon to inflate its revenues and profits was to record revenue for nonexistent projects. In the enforcement release that focused on Sullivan's
role in the Paragon scandal, SEC officials pointed out that the publicationA|CPA
Audit ond Accounting Guide-Construction Cctntrocts is clearly relevant to the audits
of construction companies such as Paragon. This publication recommends that auditors visit construction sites and discuss the given projects with project manaqcrs,
architects, and other appropriate personnel. The purpose of these procedures is to
assess "the representations of management (for example, representations about the
stage of completion and estimated costs to complete)." Despite this quidance, the
Andersen auditors did not visit any project sites dr-rring the 1997 auclit.o Such visits
6. As a1roint ol irrflirnralion, rrost of Paragon's golf constrr-rction projects r.l,ere outside of lhe [Jnited
Slates. Duiing 1996, auditois emltloyed bi for.tt,, af filiates of Andcrserr visitecl sorle of these sites.
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CASE
2.2
I59
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Questions
1.
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3. sullivan identified
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1997