Too many GAAPS

Date:12/08/2010 Too many 'GAAPS' MOHAN R. LAVI Entities have taken unfair advantage of the hazy accounting norms making the ordinary shareholder an innocent sufferer. Here's an anecdote on how business is conducted in the US: "You have two cows. You sell three of them to your publicly listed company, using letters of credit opened by your brother-in-law at the bank, then execute a debt/equity swap with an associated general offer so that you get all four cows back, with a tax exemption for five cows." The remark could also reflect on the state of accounting standards in the US considering the frequent announcements regarding accounting restatements and relapses. IT majors Dell and HP have both been in the news for accounting alarms. THE DELL EPISODE A year-long investigation at Dell revealed that accountants and senior management cooked the books for more than three years, moving funds between accounts; hence, the company could show that it was meeting its quarterly targets. Dell's malfeasance included creating and releasing accrual and reserves for the purpose of enhancing internal performance measures, transferring excess accruals between liability accounts, and using excess balances to offset unrelated expenses in later periods. The adjustments were as much as several million dollars per quarter and went as deep as the accountant who passed the journal entry for quarterly sales. In addition, business unit executives provided incomplete finances to headquarters, and purposefully lied to auditors, providing incorrect or incomplete information. The company identified two major deficiencies: Control and reporting. Most of those involved have been given the boot, internal control procedures are being ring-fenced, and a $100 million penalty to the Securities and Exchange Commission (SEC) will mitigate further damage. REVENUE RECOGNITION The happenings at Dell reignite the debate between the rule-based and industry-specific US GAAP and the principle based International Financial Reporting Standards (IFRS). Entities such as Dell can typically have multiple arrangements in a normal sale transaction, ranging from hardware bundled with software to warranties. Dell adopted the Guidance from the Financial Accounting Standards Board (FASB) which allowed the use of the management's best estimate of selling price for individual elements of an arrangement, when neither vendor-specific objective evidence nor third-party evidence was available. In conjunction with the new guidance on multiple deliverable arrangements, the FASB also issued a new pronouncement that modifies the scope of the software revenue recognition guidance to exclude tangible products that contain both software and non-software components that function together to deliver the product's essential functionality. It is apparent that the bean counters at the company used the exhaustive guidance above as well as in SOP-97-2 on Software Revenue Recognition in the manner beneficial to them. While it is not appropriate to comment on audit without evidence, there have been instances wherein the Public Company Accounting Oversight Board (PCAOB) have mentioned in their inspection reports on audit firms about instances of sales-boosting to meet result expectations. Any document on risk management considers the tendency to fudge books to fulfil revenue targets a perceptible risk. The impact of the restatement for Dell could be 1 per cent of revenue and $50 million on net results. The last two persons at the corner office at HP have left under a cloud. Earning millions of dollars but tweaking expense reports for a few thousand dollars is a phenomenon that can be explained in psychological, and not accounting terms. The efficacy of the internal control mechanism can be questioned here, too. Hazy norms There have been far too many accounting accidents in the US, post-Enron for anyone to term the country's accounting and regulatory standards spotless. Entities have taken unfair advantage of the hazy accounting norms for special purpose entities or the vague disclosure norms for collaterised debt obligations, which has made the ordinary shareholder an innocent sufferer. There appear to be far too many accounting standards and pronouncements in the US, permitting an entity to tweak them as per its whims. The recent codification initiative of the FASB has merely organised the standards better, but it has done little to simplify them and has not reduced the problem of plenty. The US permits IFRS-compliant financial statements for non-US filers. But it is pussyfooting on accepting IFRS as an acceptable alternative for all. A change for change's sake could well do the trick in the US. (The author is a Bangalore-based chartered accountant.) URL: http://www.thehindubusinessline.com/2010/08/12/stories/2010081250191100.htm