In 1989, two longtime sales reps in the toy industry, Joseph and Isaac Sutton, founded Happiness Express, Inc. The business model developed by the Sutton brothers involved acquiring the licensing rights to market toys and other merchandise featuring popular characters appearing in movies, television programs, and books and other publications intended principally for children. The company got off to a quick start, thanks to the uncanny ability of the Sutton brothers to identify children’s characters, such as The Little Mermaid and Barney, which would have tremendous appeal among children. By 1994, the company had annual sales of $40 million. That same year, the Sutton brothers took Happiness Express public with a successful IPO. By 1995, the company’s hottest line of merchandise featured the Mighty Morphine Power Rangers. In fact, 75 percent of the company’s reported revenues for fiscal 1995 resulted from sales of Power Rangers toys and merchandise. Unfortunately for the Sutton brothers and their fellow stockholders, sales of Power Rangers merchandise began falling dramatically near the end of the company’s 1995 fiscal year as children’s interest in the enigmatic crusaders subsided. To sustain their company’s impressive profit and revenue trends, Happiness Express booked several million dollars of fictitious sales and accounts receivable near the end of fiscal 1995. (Ironically, the fraudulent scheme resulted in Happiness Express being named the #1 Hot Growth Company’ in the United States by Business Week.) Public allegations of insider trading involving Happiness Express’ executives and hints of financial irregularities in its accounting records prompted an SEC investigation and ultimately resulted in the company filing for bankruptcy in the fall of 1996. A class-action lawsuit by Happiness Express’ stockholders targeted Coopers & Lybrand, which had issued unqualified opinions on the company’s financial statements each year through fiscal 1996. The principal thrust of the lawsuit was that Coopers & Lybrand had recklessly audited Happiness Express’ sales and accounts receivable, which prevented the firm from discovering the bogus sales and receivables entered in the company’s accounting records near the end of fiscal 1995. This case examines the audit procedures that Coopers & Lybrand applied to Happiness Express’ sales and receivables, with a particular focus on the firm’s receivables confirmation and sales cut-off procedures. Key Facts 1.
* In 1989, Joseph and Isaac Sutton founded Happiness Express, Inc., a small toy company that marketed licensed merchandise featuring popular children’s characters. * During the early 1990s, Happiness Express’ revenues grew rapidly; in May 1995, Happiness Express was named the #1 Hot Growth Company in the United States by Business Week. * Happiness Express was heavily dependent on the continued popularity of certain children’s characters for which it had purchased licensing rights; for example, in fiscal 1995, sales of Mighty Morphine Power Rangers merchandise accounted for 75% of the company’s total revenues. * Happiness Express began experiencing financial problems during the spring of 1995 when sales of its Power Rangers merchandise began falling sharply. * To conceal Happiness Express’ deteriorating financial condition, company executives booked several million dollars of fictitious sales near the end of fiscal 1995. * When the fraudulent scheme was uncovered, Happiness Express’ stockholders filed a class-action lawsuit against Coopers & Lybrand, which had issued unqualified opinions on the company’s financial statements through fiscal 1996. * The primary focus of the lawsuit was on the audit procedures that Coopers & Lybrand had applied to Happiness Express’ sales and year-end receivables for fiscal 1995. * Plaintiff attorneys argued that Coopers & Lybrand had overlooked key red flags regarding Happiness Express’ sales...
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