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Just for Feet, Inc.

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Just for Feet, Inc.
Abstract
Just for Feet, Inc. (JFF), its executive vice president; Don-Allen Ruttenberg, and the company’s auditing firm; Deloitte & Touche, LLP, and its associates; Steven H. Barry, CPA and Karen T. Baker, CPA, were all found guilty, on some level, in the fraud of Just for Feet, Inc. Ruttenberg purposely gave the company’s accounting department false financial information causing the accountants to record over $5 million in fictitious accounts receivable. This, in turn, caused the income statement to be overstated by $5 million (Knapp, M., 2009). The company’s auditors Deloitte, Barry, and Baker included the false information in JFF’s 1998 financial reports. These false reports were prepared for public filing with the Securities and Exchange Commission, which resulted in shareholders of JFF to be defrauded. Ruttenberg, Deloitte, Barry, and Baker were brought to justice, and the company’s shareholders settled for $32.4 million in a class-action lawsuit (Knapp, M., 2009).

Just for Feet Based in Birmingham, Alabama, Just for Feet (JFF) was established in 1977 and became a publicly traded company in 1994. Despite a period of slow growth in the retail industry, JFF expanded rapidly from 1994 to 1999. By 1998, the company’s exceptional revenue growth deemed it as the top-selling retailer of athletic shoes and apparel in the United States. In JFF’s 1998 financial statements, the company reported $689.4 million in assets, $774.9 million in revenue, and $26.6 million in net income (Securities and Exchange Commission v. Deloitte & Touche, LLP, 2005). However, shortly after presenting this positive financial growth, JFF filed for protection under Chapter 11 bankruptcy in November, 1999. According to the Securities and Exchange Commission v. Deloitte & Touche, LLP (2005), “Just for Feet’s bankruptcy case was converted to a Chapter 7 liquidation proceeding in 2000” (pp. C.8). After filing for bankruptcy protection, JFF’s secret to its rising sales and dramatic growth during a period of a weak economy was revealed. Allegations of financial mismanagement and accounting irregularities began to arise. JFF’s 1998 financial statements were materially false, net income and assets were overstated, and did not comply with generally accepted accounting principles. It was found that JFF falsified its financial statements by improperly recognizing unearned revenue and fictitious receivables from its vendors, failed to properly account for excess inventory, and improperly recoded the value of display booths provided by its vendors as income (Knapp, M., 2009). The emergence of JFF’s fraud and schemes to misstate its revenue resulted in several civil and criminal prosecutions by the Securities and Exchange Commission as well as the Department of Justice against, not only JFF, but the its auditors as well; Deloitte & Touche, LLP.

Deloitte & Touche, LLP Deloitte & Touche, LLP was hired in 1993 as the independent auditing firm for JFF, and was responsible for the auditing of the Just for Feet, Inc. 1998 financial statements. For the purposes of this audit, the firm appointed Steven H. Barry, CPA and Karen T. Baker, CPA as engagement manager and audit manager respectively. On April 26, 2005, the Securities and Exchange Commission instituted public and administrative proceedings against Deloitte, Barry, and Baker for the failed audit of JFF’s 1998 financial statements. Deloitte, Barry, and Baker were charged by the Commission with failing to detect JFF’s financial statements were not in accordance with generally accepted accounting principles (GAAP). It was also found that Deloitte, Barry, and Baker were not in compliance with generally accepted auditing standards in their performance in the JFF 1998 financial statement audit (Securities and Exchange Commission v. Deloitte & Touche, LLP, 2005).
Risk Assessment Auditors have a responsibility and are required to plan and perform an audit to obtain reasonable assurance about whether the financial statements are free of material misstatement by assessing the risk of material misstatement (Whittington & Pany, 2014). The National Risk Management Program, maintained by Deloitte & Touche, LLP, was designed to keep record of clients with higher than average risk. From 1997 going forward, JFF had been included in this program. According to Deloitte’s National Risk Management Program, it had previously been reported that JFF’s management willingly took on high levels of risk, placed considerable importance on income, and interpreted accounting standards rather aggressively (Securities and Exchange Commission v. Deloitte & Touche, LLP, 2005). Therefore, Deloitte, Barry, and Baker were aware of specific identified audit risks pertaining to JFF. Despite appropriately identifying the risks related to JFF’s accounting practices, and appropriately planning the conduct of the audit, Deloitte, Barry, and Baker failed to properly implement the plan. They failed to exercise due professional care and skepticism, failed to obtain competent evidential matter, and placed undue reliance on estimates provided by JFF’s management (Securities and Exchange Commission v. Deloitte & Touche, LLP, 2005).
Auditing Standards In the matter of JFF’s 1998 financial statements, Deloitte, Barry, and Baker negligently issued an unqualified report. The report indicated the company’s statements were not materially misstated, and it also claimed they were prepared and presented in accordance with generally accepted accounting principles. Furthermore, the report claimed the firm was in compliance with generally accepted auditing standards (Securities and Exchange Commission v. Deloitte & Touche, LLP, 2005). According to the Securities and Exchange Commission v. Deloitte & Touche, LLP (2005), “Deloitte, Barry, and Baker reasonably should have known that JFF’s 1998 financial statements had not been prepared in accordance with GAAP” (pp. A.3). As a result, the Securities and Exchange Commission found the firm to be in violation of several auditing standards. Generally accepted auditing standards (GAAS) provides that, under AU Section 230, in the performance and preparation of the audit and audit report, auditors must exercise due professional care. Under AU Section 326, auditors are required to obtain sufficient evidence through various procedures, such as confirmations, to afford a reasonable basis for an opinion regarding the financial statements being audited (AICPA, 2013). Deloitte, Barry, and Baker were in violation of both of these standards in regard to JFF’s accounting for co-op receivables, reserve for excess or obsolete inventory, and vendor booths (Securities and Exchange Commission v. Deloitte & Touche, LLP, 2005). Regarding the co-op receivables, Deloitte, Barry, and Baker failed to exercise due professional care and skepticism and failed to obtain sufficient evidence. As a part of the auditing procedures, the auditors sent out confirmation requests on $16 million of the $28.9 million in receivables claimed by JFF. The auditors received several non-standard and ambiguous responses from several vendors as well as responses that were related to vendor allowances, which were not what they were attempting to confirm (Securities and Exchange Commission v. Deloitte & Touche, LLP, 2005). Deloitte, Barry, and Baker failed to perform further tests to confirm the amount of JFF’s receivables, and instead accepted the amount claimed by the company’s management as correct. According to AU Section 230.08, accepting less than persuasive evidence because of a belief that management is honest is not exercising professional skepticism (AICPA, 2013). In regard to JFF’s reserve for excess or obsolete inventory and the company’s accounting for vendor booths, Deloitte, Barry, and Baker; again, failed to exercise due professional care and skepticism and failed to obtain evidence sufficient for issuing an opinion. The auditors did not perform proper procedures to test the adequacy of JFF’s reserves, and instead accepted a defective obsolescence reserve estimate provided by the company’s management. The auditors did not sufficiently identify indications that JFF was inappropriately recording income through the acquisition of vendor display booths and failed to consider this revenue recognition as nonconforming with GAAP (Securities and Exchange Commission v. Deloitte & Touche, LLP, 2005). Violation of the above standards also puts Deloitte, Barry, and Baker in violation of AU Sections 401 and 508. AU Section 401 requires auditors to state whether or not their clients financial statements are presented according to the standards of GAAP. AU Section 508 states that the above conclusion may be expressed only if the audit was performed in accordance with GAAS (AICPA, 2013). JFF’s 1998 financial statements were not in accordance with GAAP and Deloitte, Barry, and Baker did not perform the audit according to auditing standards. Therefore, Deloitte, Barry, and Baker are in violation of AU Sections 401 and 508.
Just for Feet’s Internal Control Internal control is a process that is affected by an entity’s board of directors, audit committee, and management. It is intended to provide reasonable assurance that management maintains a high level of integrity toward the accomplishment of achieving the company’s objectives; including compliance with regulations in regard to financial reporting (Whittington & Pany, 2014). JFF’s management failed to communicate and display an appropriate attitude regarding internal control and the financial reporting process (State of Wisconsin v. Harold Ruttenberg, 2000). A company’s control environment is significantly influenced by the effectiveness of its board of directors or its audit committee, which are responsible for overseeing the actions of management (Whittington & Pany, 2014). JFF’s Board of Directors and Audit Committee failed to meet on a regular basis. Without these compensating controls Ruttenberger dominated the management of the company (State of Wisconsin v. Harold Ruttenberg, 2000). Ruttenberger created his own management philosophy and operating style. His management style was extremely aggressive as he set excessively aggressive financial targets and high expectations for operating personnel (State of Wisconsin v. Harold Ruttenberg, 2000). With his management philosophy, Ruttenberg was willing to take high risks that had potential of high returns.

Current Accounting Policies Since the failed audit of JFF’s 1998 financial statements, the United States Senate and House of representatives have passed the Sarbanes-Oxley Act of 2002 (SOX). In an attempt to restore public confidence in the reliability of financial reporting, SOX was created to enhance the reliability and improve the quality of financial reporting and the auditing respectively (Sarbanes-Oxley Act, 2002). Section 302 is a component of SOX designed to prevent similar audit failures and corporate fraud from occurring again. Section 302 has many aspects that relate to corporate responsibility for financial reporting. This section requires management to take responsibility for the content of financial statements. Management must certify they have reviewed the report, the report is free of material misstatements, and they are responsible for internal controls (Sarbanes-Oxley Act, 2002). With this policy in place, JFF’s management may have been structured in a way that divided authority and responsibilities among other members in the organizations rather than centralizing crucial management decision to one person; Ruttenberger.
Conclusion
As a result of the $5.13 million Just for Feet, Inc. (JFF) accounting fraud, Don-Allen Ruttenberg, Deloitte & Touche, LLP, and its associates were all found guilty at some degree. The Securities and Exchange Commission found Deloitte, Barry, and Baker repeatedly engaged in improper professional conduct that resulted in violations of applicable auditing standards Barry and Baker were denied to work as accountants before the Commission for two years (Securities and Exchange Commission v. Deloitte & Touche, LLP, 2005). Ruttenberg was convicted of conspiracy to commit wire fraud, securities fraud, and submitting false statements to JFF’s auditors. He was sentenced by the United States Department of Justice to 20 months in a federal prison (Knapp, M., 2009).

References
AICPA. (2013). ET section 100 – Independence, integrity, and objectivity. Retrieved from http://www.aicpa.org/Research/Standards/CodeofConduct/Pages/sec100.aspx
Knapp, M. (2009). Contemporary auditing (17th ed). New York, NY: McGraw-Hill Irwin.
Sarbanes-Oxley Act 2002 (2002). A guide to the Sarbanes-Oxley Act. Retrieved from http://www.soxlaw.com/
Securities and Exchange Commission v. Deloitte & Touche LLP. File No. 3-11911. (2005). Retrieved from http://www.sec.gov/litigation/admin/34-51607.pdf.
State of Wisconsin v. Harold Ruttenberg File No. 99-BU-3097-S. (2000). Retrieved from securities.stanford.edu/1034/FEET99_01/2000615_r04c_9903097.pdf.
Whittington, R., & Pany, K. (2014). Principles of auditing & other assurance services (19th ed.). New York, NY: McGraw-Hill Irwin.…...

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...deliberate violation of GAAP and the negative figures for the company cash flow could have been a clear warning and as such was not expected to record profits as it happened. The management through Harold, his wife and son got rid of a large part of their securities worth $49.5 million. However, the CEO still continued to give positive projections about the future prospects of the company. It could have not been possible that a major shareholder like Ruttenberg would have taken such action without having prior knowledge of what’s on goings in the company. This is an issue that could have raised a red flag to the auditing firm. The next event by the management was the sale of junk bond for $200 million which are normally very risky and just after few weeks the company sent profit warnings. The company management went ahead and announced a possibility of defaulting on the first payment of interest to investors. These three events were clear indications of a problem in financial reporting and hence the auditing firm could have been keen to notice them. One of the key items that were high risk in the financial statements of the company is the inventory. The company also had a substantial amount of slow moving goods. The management, especially the accounting department could not apply the market rule or the lower cost in arriving at the end year market valuation. The company therefore ended up with a low value for the provision of inventory obsolescence in 1997 and 1998......

Words: 1164 - Pages: 5