"An 'Oh Shit' Moment": Mattell Accounting Coverup Prompts Questions Of Chronic Audit Fraud

All hell is breaking loose at Mattel after the company disclosed in late October the result of an internal investigation that revealed material weaknesses in the company's accounting. And now, it's not just the company that's under scrutiny for possibly ignoring accounting errors in early 2018 that would have substantially worsened the company's financials, but its auditors as well. PwC is now being reviewed by the top accounting watchdog, the Public Company Accounting Oversight Board, according to Bloomberg

The scrutiny comes after Mattel's disclosure last week that some financial statements from 2017 "should no longer be relied upon due to material misstatements". The company also said in the last week of October that it found "material weaknesses" in its internal controls for reporting. 

The PCAOB is the primary regulator for audits done by Big Four accounting firms. The review of PwC is still preliminary and may not lead to disciplinary measures, but the PCAOB has the authority to fine or sanction firms, should it deem necessary. These actions can also lead to SEC enforcement actions. 

Recall, last week, the Wall Street Journal published an article where a former executive from Mattel accused PwC and the company of covering up accounting errors. The accounting problem was tied to Mattel's ownership of Thomas & Friends, an animated show about talking trains.

The accounting error was tied to a $562 million valuation allowance—a reserve for a potential loss in value—that Mattel created against its deferred tax assets in September 2017. The allowance was reduced by $109 million, which came from deferred tax liabilities related to the company’s 2011 acquisition of HIT Entertainment Ltd., which included Thomas & Friends, Barney & Friends, and Bob the Builder. Reducing the allowance lowered Mattel’s loss for the quarter.

Soon after, the company did an internal review of its intangible assets. Finance executives discovered that because of the way the HIT liability had been categorized, it shouldn’t have been used to reduce Mattel’s loss, according to an internal memo reviewed by the Journal.

Whitaker described finding the issue: “It was definitely an ‘oh, shit’ moment. I offered my job, that’s how big it was.”

The finance team had discussed fixing the problem and restating earnings, but senior finance executives and PwC decided to change the accounting treatment of the asset instead, effectively covering up the problem. The executives also agreed to not share the problem with Mattel's CEO or Board of Directors, an internal investigation revealed. 

Whistleblower Brett Whitaker, who was Mattel’s director of tax reporting at that time: “It was known within Mattel that if we took this approach, at worst we might get a slap on the wrist from the Securities and Exchange Commission. But if the company disclosed a material weakness, a senior executive said to me it would be ‘the kiss of death.’ ”

He said Mattel called the issue “a complex issue that required assessment…by appropriate experts.” At the same time, “A PwC partner told me that they were looking for a way to say this isn’t a material weakness,” he said.

Whitaker said that Mattel's inaction on the issue amounted to a coverup. “My team was dumbfounded by it,” he said. A PwC tax partner was "walking down the hall, high-fiving people," after the accounting decision was made, Whitaker claims. 

Whitaker/WSJ

Whitaker resigned from Mattel in March of last year. 

Mattel, prompted to investigate by a (separate) whistleblower letter sent to the company, called the error an "honest mistake" and said its accounting treatment of Thomas & Friends was appropriate. The letter questioned PwC's independence and Mattel's investigation found that the PwC partner assigned to Mattel had violated some independence rules by recommending candidates for Mattel's senior finance positions. 

Mattel says PwC will continue to be its auditor. PwC earned more than $9 million in fees from Mattel last year. 

Mattel said in a press release: “The error in the 2017 third quarter was not properly assessed when it was discovered, nor were the findings and conclusions documented as they should have been at that time.”

Mattel also said on October 29 that its CFO would be leaving the company. Meanwhile, at PwC, the partner in charge of Mattel's audits has been placed on administrative leave.

PwC said through a spokeswoman: “We will always strive to do the right thing and we will continue to take the appropriate actions in response to any allegations of misconduct.”

She continued, saying PwC took "immediate action" after the firm became aware of the complaint. PwC reviewed nearly 45,000 documents and conducted 30 interviews to help with its reporting of the investigation's results, she concluded.