7'

cAsE 2.2

Golden Bear Golf, Inc.

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.

Floyer of the eentury

Jack Nicklaus began playing golf as a young boy and had mastered the game by his

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

AUDITS OF HIGH.RISK ACCOUNTS

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.

With the help of a professionalsports agent, Nicklaus worked hard to develop a

softer, more appealing public image. By the mid-1970s, Nicklaus's makeover was
complete and his popularity rivaled that of Palmer. As his popularity with the public
grew, Nicklaus was able to cash in on endorsement deals and other business opportunities. Eventually, Nicklaus founded GBI to serve as the corporate umbrella for his
business interests.

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.

,ii

Nicklaus chose his trusted associate Richard Bellinger to serve as Golden Bear's

i,

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.

Triple Bogey for Golden Beor

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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

GoLosN BEan Com,

INc.

r55

:::ffifi:,.*,;,i'rifl,,,"#:jotalestimated

construction costs incurred

in a siven acthe totarrevenue

earnid on th" p;;;;.;;

d,J;..* iront) to
il:f":1'"TJ:?;or
During the second q'u'i".
or tir."liggi, eoyd
paragon,w_ourd
and curbero derermined
have u iu.!" opurating
that
ross rt ihJ Io1, ,o_cost
on thelorf'course construction-folects. method was used to
.,:::ffi11t:venue
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be

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percentage-of-completion

estimates una"r,r_r"

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method, paragon reried

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olnrrur rbgi
ir,o fiscar.199g, paragon,s
ment routinely overstated
manage_
""ri
the percentage-ot-compre"tiol
golf course,construction
pro;""t, each quarter. ili;;rh",estimates for Ihe .*puny,,
enhance paragon,s operat_
ing resurts, rhe company'i
st;ff in;;te;',i" .onr.u",uar
".""r",irs p-;".i,
revenue amounts

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recoqnizecl
purogon hod
in
connection
wilh potential projects thot
.reuenue
idenrihed
i;nirg
n, n"r"*o'*r."oTo, ,nougn porogon
ogreements in connection
rtad ,o
with these prolects. In other
cosc

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During the spnng of 1998,

John Boycl and se'eral
of his top suborclinates.
ing ChLi'stoprlrer cuil,eilo,
includ,ii","oi"o to purchase pr."g",
,r*.nationar

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t,ut
A subsequent investigaiio;;;;;;
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in corcrerr Bear issuing
regar firm r.esirrecl
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and for the fir'st quartrr
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ported a $z s.11,io1
Bear had initiary re_
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net.ross

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its own investigarion or

$16

Trrose

construction revenues
of $8.3 millon.

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SECTIoN

Two

Auons or HIcH.Rnx

ACCOUNTS

partner who served as the Golden Bear enqagement

partner. sullivan had been em_
ployed by Andersen since r9z0 and had been a partner
in the firm since 1984.

The SEC enforcement release that disclosed the results

itr i""Jgation of

Andersen's Golden Bear audits included a section entitled "sullivan's

"r
Audit Failures.,,
According to the SEC, Sullivan was well aware that the
decision to use the earned
value method "accelerated revenue recognition by material
amounts" for paragon.a
In fact, Sullivan was very concerned by Palagon's decision
to switch from the cost-tocost method to the "new and untested" earned value
method. This concern prompted
him-to warn Paragon's management that he expected the
earned value method to
produce operating results approximately in line with those
that would have resulted

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from the continued application of the cost-to-cost method. To

monitor the impact
of the earned value method on Paragon's operating results, Sullivan
required the
client's accounting staff to "provide detailed schedu"les showing parugor:,
projectby-project results under both methods for each reporting periJa
from the second
quarter of 1997 through the first quarter of 1999.',
By the end of fiscal rgg7, the comparative schedures prepared
by paragon,s accountants clearly revealed that the earned value methoa
was allowing paiagon to
book much larger amounts of revenue and gross profit on its
construction projects
than it would have under the cost-to-cost method. when
Sullivan questioned
Paragon's executives regarding this issue, those executives
maintained that ,,uninvoiced" construction costs had caused the cost-to-cost method
to significantly
understate the stages of completion of the construction projects.
To quell Sullivan,s
concern, in early fiscal 1998 paragon,s management recorded
$4 million of uninvoiced
construction costs in a year-end adjusting entry for fiscal 19g7.
These costs caused
the revenue that would have been recorded under the cost-to-cost
method to ap_

proximate the revenue that paragon actually recorded

by applying the earned value
method Unknown to Sullivan. the $4 miilion of un;nvoiied clnstruction
costs
booked by Paragon were fictitious.5
The SEC criticized Sullivan and his subordinates for failing
to adequately investigate the $4 million of uninvoiced construction
costs that materialized at the end of
fiscal 1997' According to the SEC, Sullivan reliecl almost exclusively
on manaqement,s
oral representations to corroborate those costs.
Sullit:an hrLetu tltol Pttragon bookeci costs for uilrich no int;olc,es
hctd been rec:eiued
ond uhich aere not reflected in the company's occounts poynbte
iystem, ,nd tl.tot
recording these uninuoiced costs would houe substontially reaucea
ine gap between
the results produced by the two estimotion methods . . . wnite prorndurn,
with respect
to inuoiced ctnd poid costs were performed, Suiliuan did
not emproy iiy pror"dur", to
determine whether the uninuoicecl costs hod octually been
incurrecl as'of yeor-end.

Paragon's scheme to overstate its reported revenues and proflts

by apprying the
earned value method resulted in a dramatic increase in unbilled
revenues by the end

of 1997. Approximately 30 percent of the revenues reported in Golden

Bear,s 1997
income statement hacl not been billed to its customers. when paragon,s
executives
switched to the earned value method, they had assured sullivan
that thev would bill

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

rnethorJ

CASE

2.2

GoloeN BsAn GoLn, INc.

their customers on that

Lrasis. Despite that commitment, Paragon continued to bill

their customers effectively on a cost-to-cost basis. (Paragon could not bill customers for
the full amount of revenue that it was recording on the construction projects since
those customers were generally aware of the octual stages of completion of those

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.

sEcTIoN

TWo Auolrs

op HrcpRrsr

AccouNrs

may have resulted in Andersen discoverinq that some of paragon,s projects

were
purely imaginary. In addition, Andersen *outa likely have deteri'rined
that paragon
was overstating the stages of completion of most of its existing projects.
The SEC reprimanded Andersen for not visiting any of earaglr's job
sites or discussing those projects with knowledgeable parties. "Failing to aiscuss project
status, including percentage-of-completion estimates, with project managers and
other on-site
operating personnel was, under the circumstances, a reckless departure
from GAAS.,,
The SEC also criticized Sullivan for not insisting that Golden Beir
disclose in its 1g97
financial statements the change from the cost-to-cost to the earned value method
of applying percentage-olcompletion accounting. Likewise, the SEC contended
that
Sullivan should have required Golden Bear to disclose material related-party
transactions involving Paragon and Jack Nicklaus, Golden Bear's majority stockholder.
Finally, the SEC noted that Sullivan failed to heed his o*n.on."rns while planning
the 1997 Golden Bear audit. During the initial planning phase of that audit,
Sullivan
had identified several factors that prompted him to designate the 1997
Golden Bear
audit a "high-risk" engagement. These factors included ihe subjective nature
of the
earned value method, Paragon's large unbilled revenues, the aggressive
revenue rec_
ognition practices advocated by Golden Bear management, and severe
weaknesses
in Paragon's cost accounting system. Because of these factors, the sEC maintained
that Sullivan and his subordinates should have been particularly cautious
during the
1997 Golden Bear auclit and employed a rigorous and thorough
set of substantive

audit procedures.

In August 1998, angry Golden Bear stockhold_

ers filed a class-action lar,r,suit against the company, its major officer-s. and its principal owner,
Jack Nicklaus. That same month, the NASDAe

delisted the company's common stock. which

rvas tr"ading for less than $1 per share, consicl_
erably below its all-time high of $20. Richard
Bellinger resigned as Golden Bear's CEO two
months later to "pursue other interests.,, In
December 1999, Golden Bear announced that
it had reached an agreement to settle the classaction lawsuit. That settlement required the
company to pay its stockholders $3.5 million in
total and to purchase their shares at a price of
$0.75. In 2000, Colden Bear. by then a privare
company, was folded into Nicklaus Companies,
a new corporate entity that Jack Nicklaus created to manage his business interests.

In November 2002, lVlichael Sullivan was

suspended from practicing before the SEC for

one year. Sullivan's employer, Andersen, had

effectively been put out of business a few

months earlier when a federal jLrry found it

guilty of obstruction of justice for destroying

sion from practicing before the SEC. At the same

time, the SEC sanctioned three former Golden
*cease
Bear executives by ordering them

to

and desist" from any future violations of the

federal securities laws. One of those executives
was Richard Bellinger. The SEC maintained that
Bellinger approved Paragon's change from the

cost-to-cost to the earned value method. Acldi-

tionally, the SEC charged that Bellinger knew

the change would materially increase Golden
Bear's reported revenues and gross profit but
failed to recluire that the char-rqe be disclosed
in the company's financial statements.

7' AsciiscusscdinCasel.l.Andersen'sconrrictionwassLrbserluenth'overlrrrnecl
Court.

au_

dit documents pertaining to its bankrupt client

Enron Cttrporation.; ln ALrgi-rst 2002. par.aqon,s
former controller received a two-yeat- suspen-

bylheU.S.Supreme

CASE

2.2

GomtN Bean Gou,. INc.

Finally, in March 2003, a federal grand jury

indicted John Boyd and Christopher Curbello
on charges of securities lraud and conspiracy to commit securities fraud. Curbello was
arrested in San Antonio, Texas, on March 14,
2003, while Boyd was apprehended in Bogota,
Columbia, a few days later by Secret Service

I59

and FBI agents who immediately flew him

to the United States. In June 2003, Curbello
pleaded guilty to conspiracy to commit
securities fraud and was sentenced to 3Zz years
in prison. A few months later, Boyd pleaded
guilty to similar charges and was given a five_
year prison sentence.

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Questions

1.

s,4sNo. 106, 'Audit Evidence," identifies the "management assertions,,that

commonly underlie a set of financial statements. Which of these assertions

were
relevant to Paragon's construction projects? For each of the assertions
that you
listed, describe an audit procedure that Arthur Andersen could
have employed
to corroborate that assertion

2'

The SEC referred to several "audit failures" that were allegedly

the responsibility
of Michael Sullivan. Define what you believe the SEC meint by the phrase *audit
failure." Do you believe that sullivan, alone, was responsible for the
deficiencies
that the SEC noted in Andersen's 1997 audit of Golden Bear? Defend your
answer.

3. sullivan identified

4'

5.

Golden Bear audit as a ,,high-risk,, engagement. How

do an audit engagement team's responsibilities differ, if at alt, on
a high-risk
engagement compared with a ,,normal,, engagement? Explain.
The AICPA has issued set,eral Auclit ancl Accounting Guictes for
specializecl
industries. Do aLiditors have a responsibility to ref& to these guides
when
auditing clients in those industries? Do these guides override"or replace
the
authoritative guidance included in Stotenents on Auditing stondarcls?
was the change that paragon made in applying the percentage-of-completion
accounting method a "change in accounting principle,' or a .-change
in
:rccountinq estirnate"? Bliefly clescribe the accounting iLnd financial repoi-ting
treatment that must be applied to each type of change.

the

1997