Case 10-10 An Offer You Can’t Refuse Fast Eddie, a publicly held company, manufactures and installs refrigeration systems for governmental and commercial applications. Fast Eddie is being investigated by a governmental agency for overpricing on government sales during the period from 2007 through 2009 as well as allegations of misrepresentations by one of Fast Eddie’s former officers, Sweet Lou. The criminal and civil investigations began in late 2009. In the prior fiscal year, the company’s auditors, CPAs-R-Us, obtained management’s representation and a letter from Fast Eddie’s independent legal counsel that indicated that the ultimate outcome of the investigation could not be determined and that any potential payment for the alleged breaches would not have a material effect on the financial statements. Accordingly, no accrual was recorded in the financial statements, and CPAsR-Us issued a standard unqualified opinion on Fast Eddie’s 2010 financial statements. Fast Eddie’s fiscal year-end is March 31. The government commenced its investigation into the allegations in late 2009 by obtaining a subpoena for all of Fast Eddie’s corporate records (both hard copy documents and computer files) related to government sales during the period in question. In 2010, the government provided Sweet Lou with a report detailing the allegations of defective pricing. At that time, Sweet Lou alerted the other officers at Fast Eddie of the manner in which he had prepared the documents in question. Fast Eddie immediately began an internal investigation to ascertain whether proper procedures had been followed when completing the governmental sales forms. Fast Eddie also retained an expert legal counsel in the field of procurement law in an attempt to determine whether the company had any legal exposure as a result of Sweet Lou’s actions. Fast Eddie determined that the sales forms had been completed incorrectly; however, the government was not overcharged for any equipment or services. As a result of its findings, Fast Eddie dismissed Sweet Lou after 18 years of service with the company. Since then, all of Fast Eddie’s officers and employees have fully cooperated with the federal investigators by providing testimony of their knowledge and involvement in the transactions. As of March 31, 2011 (current-year period), the government had not filed any charges or specified a monetary penalty against Fast Eddie for these matters. In April 2011, Fast Eddie documented in a letter an offer to settle the government’s investigation of the company for the sum of $3.7 million. This letter was delivered to government officials in April 2011, before CPAs-R-Us completed its procedures and issued the audit report for the year ended March 31, 2011. Management contends that this offer was made solely to accelerate the process and serve as grounds for a future claim against the government to recover attorneys’ fees. In addition, management contends that it believed this offer would be rejected on the basis of previous discussions with government officials.

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Management has demonstrated that the $3.7 million used in the settlement offer represents 100 percent of the pretax profits earned by Fast Eddie on government sales during the period from 2007 through 2009, plus an additional amount that is intended to represent a payment for penalties. Fast Eddie believes that if the investigation ultimately goes to trial, the government will not win entitlement to any monetary recovery. Fast Eddie’s defense includes the company’s inability to provide accurate pricing data because of the confusing nature of the forms and the technical requirements related to the standard contract price reductions clause. In addition, Eddie contends that since none of the equipment was defective and the prices charged were within the range of those charged by other government contractors for similar equipment, the government has not been harmed by this event. In fact, Fast Eddie has indicated that if anyone is guilty in this situation, it is Sweet Lou because he acted on his own in completing the forms without the company’s approval. Fast Eddie believes the first paragraph of the settlement offer adequately supports the company’s contention that this offer in no way obligates the company to the government and, therefore, the offer does not indicate that a liability should be accrued. The first paragraph states: Fast Eddie has offered a one-time payment of $3.7 million as a final settlement of the investigation in process by your department. If this amount is accepted by the government, it must represent a complete exoneration of all charges against Fast Eddie. The following letter summarizes the company’s understanding of our meeting in April 2011. At that time, you represented that the offer of settlement could not be accepted. Although we understand that the government does not generally accept offers to settle before finalizing its investigation, we believe it would be in everyone’s best interest to put this matter behind us. We believe that if this case goes to federal court, the company will be able to establish that it has no legal liability for this matter. However, CPAs-R-Us is concerned that the last paragraph of the settlement offer may indicate that the company fully intended the offer to represent an amount Fast Eddie was willing to pay to resolve the investigation. The last paragraph states: In conclusion, Fast Eddie believes the government has nothing further to gain by continuing to pursue the investigation, and in fact, will probably lose if the case goes to federal court. Accordingly, we believe you should give considerable thought to the final settlement offer that the company has submitted in the amount of $3.7 million. Further investigation by the government unfairly punishes the company, its employees, and its shareholders. We believe every effort should be made to bring this matter to an immediate conclusion. As demonstrated in this letter, the size of the offer that has been made by the company is more than adequate given the circumstances involved and acceptance of it is clearly in the best interest of all parties.

Copyright 2008 Deloitte Foundation All Rights Reserved.

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Additional information Fast Eddie believes it has always provided the government with a quality product at competitive prices. In fact, Fast Eddie has obtained a price list from its two primary competitors and determined that the prices it charges the government are actually less than those of its competitors. During the depositions taken from the government’s contracting officer that dealt with Sweet Lou, the officer indicated that he had no reason to believe the prices charged by the company were not fair and reasonable. In addition, Fast Eddie contends that there is no indication that the refrigeration products that it sold to the government were defective and it has never charged the government for products it did not deliver. Sweet Lou, acting in his role of vice president for the company, was solely responsible for completing and certifying the documents presented to the government. These documents were in Sweet Lou’s own handwriting and were not reviewed or approved by any other Fast Eddie officer.

Required: • Is Fast Eddie required to accrue a liability as of March 31, 2011, financial statements related to the ongoing government investigation? If so, how much? •

If Fast Eddie withdraws the settlement offer before it is accepted by the government and before the issuance of Fast Eddie’s financial statements, would that change your answer to the above question?

Copyright 2008 Deloitte Foundation All Rights Reserved.