Income Smoothing: Management Consequences and Auditor Responsibilites in the Case of Beazer Homes

CASE DESCRIPTION The primary subject matter of this case concerns auditor responsibilities when their clients engage in earnings management to achieve income smoothing. Secondary issues examined include internal controls, the accounting for s ale-leas eback transactions, the impact of Sarbanes-Oxley (SOX), and the role of industry-level risk assessment in audit planning. The case requires students to access and review U.S. Securities and Exchange Commission (SEC) documents filed by and regarding Beazer Homes USA, Inc. The case has a difficulty level of four or five and can be used in either undergraduate or graduate auditing courses. The case can also be used in advanced financial accounting, financial statement analysis, or accounting research courses in accounting masters degree programs. The case is designed to be taught in two class hours and is expected to require four hours of outside preparation by students. CASE SYNOPSIS This case provides students with a real world example of alleged income smoothing and its consequences. Students learn how earnings were allegedly manipulated, why they were allegedly manipulated, and what the ultimate results of these alleged tactics were for the company. They are asked to analyze the earnings management techniques used and identify ways in which the auditors might have identified the activity and how their audit planning could have been modified given the industry-specific risks and the requirements of SOX. The case raises issues related to internal controls, auditor responsibility and professional and ethical principles and standards. INTRODUCTION Beazer Homes USA, Inc. (Beazer Homes) has been accused of using specific earnings management techniques to smooth income. Income smoothing is the result of carefully managing earnings (net income) to show a smooth, steady growth in earnings each year rather than dramatic ups and downs. Companies with volatile earnings are considered to be more risky and therefore less valuable than companies with stable patterns of income growth. Earnings management practices include understating income during good periods by deferring income or accelerating expenses and overstating income during bad business years by accelerating income or deferring expenses. In this case, you will learn about Beazer Homes, the home building industry in general, and income smoothing in general. Then you will learn how Beazer Homes allegedly used specific earnings management practices to smooth its income. You will then be asked to answer questions about the actions and responsibilities of Beazer Homes' top management team and its independent auditor. BEAZER HOMES Beazer Homes builds and sells predominately single-family residences in 17 states across the United States. In recent years, the company has been ranked consistently as one of the top ten residential home builders in the country, based on number of homes built and sold (Beazer Homes, 2002; Beazer Homes, 2005; Beazer Homes, 2008). Beazer has grown continually since its 1985 entry into the U.S. residential housing market. The company has followed a strategy of doing business primarily in communities that have higher than average population growth and builds homes in a price range that appeals to first-time home buyers or buyers making their first move to a better home. Beazer also sells title insurance in some markets and, until February of 2008, offered home mortgage loans through a finance subsidiary. Beazer' s success has led to its many homebuilding honors and awards and its listings as one of Forbes 400 Best Big Companies in 2005 and 2006 and as one of the Forbes Global 2000 in 2005, 2006 and 2007 (Funding Universe, 2009; Hoover's, 2009). The company started as Beazer PLC, a home builder in the United Kingdom. Beazer Homes entered the U.S. residential housing markets in 1985 with the purchase of Atlanta home builder, Cohn Communities. Shortly thereafter the company acquired two more home builders in the Southeast. …