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Internal Controls

2. List and describe the two most alarming issues that you see after reviewing your company and identify possible improvements in the internal control system to correct the issues.

No internal Audit Team:
The most significant problem that became apparent in this exercise is the fact that AME does not have an internal audit team. The lack of this significant resource leaves many gaps that may be exploited for fraudulent activities or prevent expedient discovery of issues.
This problem has a simple solution, that may be difficult to carry out. Building an internal audit team is the correct solution. Gaining the resources both in knowledgeable people and financial/time allotment required from top management will be a challenge. The company owner places low value on the accounting department in general and has many times stated that “it would be better if they were not around to drain resources”.
If AME were able to allocate the required resources, the next step would be to define the procedures and schedule meetings to be conducted. Some of the required policies would include:
1)Improved follow-up processes for improvement suggestions/requirements
2)Communication process for reporting suspected internal problems
3)Risk assessment for financial misstatements
4)A clear statement of responsibilities for each person on the team

Management Financial Philosophy:
The second area that should be addressed is the importance of having a strong respect for the finances of the business. Business decisions should actively involve the current and future impacts on the company financial position. This part of the decision process is missing on the planning end. It is only taken into account after a plan has been made to move in a specific direction. It is then up to the accounting department to find a way to “make it happen”.
Employee performance is judged on how well a manager (or employee) is able to accomplish the goal. This can be problematic for accounting employees, because anyone who asks too many questions is labeled as a “cancer spreader”, and once that happens it is only a matter of time before they are no longer employed. Talk about incentives!











Resources:

aicpa.org (2005). Internal control: A tool for the audit committee. Retrieved February 10th, 2010 from : http://www.aicpa.org/audcommctr/toolkitsnpo/internal_control.htm

Burman & Knight (2006). Financial intelligence: A Managers guide to knowing what the numbers really mean. Boston, Mass: Harvard Business School Press.

Statement of Cash Flows- Sears

Week Four – Sears Holding Corporation:
Statements of Cash Flows

Based on your analysis of the statement of cash flows, articles you read and industry reports write a brief analysis (1-3 pages) identifying
1. Strengths of the company you see in their financial statements.
The most positive performance indicator was the $1.003 billion that was converted from inventory to cash. Having money sitting on the shelf is not positive for any business unless it is preventing a stock-out situation. There is a fine balance to how much inventory to hold. According to some analysts, there is concern that this inventory situation was required to be prepared for the 2010 debt situation in which Sears is loosing half it's $5 billion in short term financing (bnet.com).
2. Weaknesses of the company you see in their financial statements.
The most significant weakness of SHLD is the fact that they cannot generate income. The net income decreased by 93.6%. That means the income for 2008 was only 6.4% of what it was the previous year and 3.5% of two years prior. That is not a good trend. What does that mean? Well most of the positive cash generated was not from selling product. When a business does not make money at its core competency, there is trouble.
There are people however that believe Sears is undervalued from a shareholder perspective. One such investor shared his opinion about the cash value of the company if it were to be sold off (myvalueidea.blogspot.com). Although this person has no credibility (that I know of) his examples make sense.
3. Possible emerging issues with the company and/or industry.
It is possible that Sears is more valuable as parts an pieces sold to the highest bidder. I think it would be difficult to say that a rebound for Sears is likely. There are several actions that lead me to believe that SHLD is prepping for an exit from retail. Their board continues to authorize stock buy-backs which keep stock prices high. They continue to acquire other businesses that have high valued assets (Sears 10k). They are spending little to invest in the operations of their company by compared to stock buy-backs (chicagotribune.com).
4. Questions you might ask the company if you were interviewing them to write an article about their future.
1)Why are you re-purchasing stock?
2)What is the vehicle that caused the nearly 500% increase in cash from 'credit issuances'?
3)Please explain how you had positive 'merchandise payables' in 2007. Why are they at nearly $400 million now?
4)What steps are you taking to avoid such a large impact from exchange rate differences?
5)Do you project similar improvements in cash improvement this year?







Resources:

Burman & Knight (2006). Financial intelligence: A Managers guide to knowing what the numbers really mean. Boston, Mass: Harvard Business School Press.
http://www.chicagotribune.com/business/chi-fri-notebook-sears-1218dec18,0,7721969.story
http://industry.bnet.com/retail/10005255/perspectives-may-obscure-sears-real-needs/

http://myvalueidea.blogspot.com/2008/03/i-have-wrote-about-shld-being-value.html

Balence Sheet Analysis

Financial Statement Analysis: Sears Holdings Corporation (SHLD)

Based on your analysis of the balance sheet, articles you read and industry reports write a brief analysis (1-3 pages) identifying:

1.Strengths of the company you see in their Balance Sheet.
Sears has done an excellent job of reducing their Liabilities by nearly 5%. Most categories have been dramatically trimmed except for 'short term liabilities' and 'current portion of long term debt'. This short term debt is not great because it may be indicating the lack of cash available to operate the business.
The second strength may be the increased accounts receivable. This may indicate weakness in that Sears may be having difficulty collecting monies or that it is trying to boost 2008 profits by selling product in advance, recording the sale but waiting for payment sometime in the future.
2.Weaknesses of the company you see in their Balance Sheet.
As we saw in the Income Statement Analysis last week, a majority of items are trending down year over year. It appears by the trend in the vertical analysis that Sears has increased the depreciation of assets. I was unable to find any disclosures about this, but it may be a way of reducing assets to be in better condition for taxes (??? I'm out on a twig here???).
Probably the most significant finding here was that the 'interest coverage' ratio was well below one. This indicates that all of the companies profits (plus some additional monies) are going to pay for interest on debt. This paired with the exponential increase on short term debt spells nothing but trouble. Short term debt is typically borrowed at a higher interest rate than long-term secured debts.
3.Possible emerging issues with the company and/or industry.
Although it was not one of the ratios calculated I noticed the 'profit per employee” for Sears was -$10. The industry average was well over $15,000 per employee. Talk about a scary ratio. All the signs are pointing to failure, unless there is a miracle turnaround.
4. Questions you might ask the company if you were interviewing them to write an article about their future.
a) What are your plans to reduce short-term debt?
b) When will you deal with the reality that your 'goodwill' values are overstated?
c) What steps are you taking to improve your profit margin?
d) How do you plan to consolidate (or differentiate) your marketing strategies between Kmart and Sears?
e) If you had the opportunity to Merge with Sears today, would you take it?


Note: My calculated ratios were well off of the published numbers, so I don't know what happened there. The only thing I can think is that the published numbers were from 2009 not 2008 as I calculated them... I suppose their fiscal year just ended so it is possible.

Resources:
http://www.searsholdings.com/invest/
http://moneycentral.msn.com/investor/invsub/results/compare.asp?Symbol=JCP
http://moneycentral.msn.com/investor/invsub/results/compare.asp?Symbol=WMT
http://moneycentral.msn.com/investor/invsub/results/compare.asp?Symbol=SHLD

Kmart Accounting Scandal

Week One – Kmart Accounting Scandal


During the past two decades there have been many accounting related scandals and fraud that have changed the landscape of the financial community and accounting professionals.
Unfortunately accounting is more visible in times of scandal. Fortunately these scandals can be interesting learning opportunities.
Your assignment is to research an accounting, scandal, fraud, misappropriation, or whatever it might have been called. The paper should include the following:
1. A brief narrative of the issue. What happened, how was it caught, etc.
2. What accounting principles, assumptions, estimates and biases played a role in the scandal ?
3. What was the aftermath of the issue ? How did the accounting profession and regulatory bodies respond ? What happened to the individuals and companies involved ?
4. Consider the individuals involved, Could that be you ? Where in the circumstances for these individuals would you have made different choices and why ?
Please pick a specific company that was involved in a scandal and write a 3-5 page paper addressing these questions.
I've provided a link to an article in Forbes that highlights some of the more prominent scandals.  There are others out there.


After winning some gains in the late 1990's, Kmart faced some intense competition from companies like Walmart. As profits began to fall a new CEO, Charles Conway, was hired to breath new life into the organization. Despite Conway's efforts at cleaning house and some creative marketing programs the losses continued to the point that major suppliers quit shipping to Kmart (fundinguniverse.com). Kmart was forced into bankruptcy in 2002. During bankruptcy investigations it became apparent that there had been some “creative accounting” going on that had inflated revenue figures by $42.3 million for the second quarter of 2001 (findarticles.com, Feds Indict). This lead to identifying similar discrepancies (more than $24 million) in the third and forth quarters as well (sptimes.com).

The improperly reported earnings were in the form of vendor “promotional allowances” (nytimes.com). These were all fees paid by Kmart vendors to secure shelf space, fund advertizing and keep their own competition off Kmart's shelves. They were recorded incorrectly, according the the legal indictment against Kmart, because they were “subject to a pay-back provision and should have been amortized over the life of the contract” (findarticles.com, Feds Indict). However, by recording them as earnings in a single quarter, Kmart was able to inflate its profit by almost 10%. That was very attractive to the new CEO and others in management who wanted to see Kmart's stock prices raise or at least quit falling.

The fraud is fairly straightforward in this case because of the way the transaction was treated. Although the revenue was received in the quarter it was reported, according to GAAP (Burman & Knight, pg 59), if the company will receive benefit for the revenue for an extended time, it must be recognized over time in the form of amortization. Now that I have a slightly better understanding of the bias and estimates in accounting I will assume that the accountants were able to have some sort of rationalization for booking the revenue as it did. This is were the problems began where the fraud is concerned. I believe it was the bias of the accountants who approved this rationalization to show profit for the company. It was this bias that likely persuaded the company to allow a less than adequate rationalization to be used on their financial statements.

This scandal was identified after the company was forced to file bankruptcy, so it cannot be contributed to financial collapse, but it delayed the inevitable and likely increased the losses of Kmart investors. The investigations that resulted in this scandal targeted eight individuals. Surprisingly, only three of them were Kmart employees. Kmart vendor employees were in the sights as well. According to cfo.com,
“The individuals are accused of helping Kmart recognize the allowances prematurely on the basis of false information provided to the company's accounting department.
The SEC asserts that a number of vendor representatives co-signed false and misleading accounting documents, executed side agreements, and, in some instances, provided false or misleading third-party confirmations to Kmart's independent auditor, PricewaterhouseCoopers LLP.”
This Securities and Exchange Commission (SEC) allegation was for representatives of Kodak, Pepsi, Frito-Lay and Coke. This lawsuit was finally dismissed from federal court because the evidence was not strong enough to convict any individual of wrongdoing (findarticles.com, Case Dismissed).

Kmart was able to come out of Bankruptcy in May 2003 as Kmart Holdings Corporation after securing financing for more than $2 Billion (fundinguniverse.com). In November 2003 the Detroit Free Press reported that the bankruptcy caused 67,000 people to loose their jobs and Kmart was forced to sell off or close 600 stores (smartpros.com). Cut down to size Kmart was able to become profitable once again and late in 2004 merged with Sears Roebuck to become Sears Holdings.

The major players in this scandal turned out to be the buyers who were looking for creative ways to improves revenue. They were accustom to getting these “promotional allowances” from vendors, but the problem came when they were allegedly trying to deceive the accountants within Kmart of what the payments were actually for. As I look at my position I find it difficult to see a situation where I would try to “hide” important aspects of information to deceive. I had an opportunity to “cover-up” a monumental problem that was discovered with one of our products. It cost our company $500,000 to perform the recall, which is nearly 10% of our annual revenue, what is worse is that it was during the worst economic period since the great depression. Fortunately, my organization is focused on long term growth and what is best for the customers, so there was support internally for fixing the problem.

If I had been the account representative for Kmart with the purchasing authority, I would have made sure all the critical information was passed onto the accounting department. The more difficult job to do in an “upright” manner would be the sales representative of Kmart's vendors. They were asked, by Kmart reps, to sign false documents. In that situation you need a customer service mindset, that means doing what the customer needs. Even if I were in this position I would have refused to falsify any documentation, but it may have cost me my job.




Resources:

Burman & Knight (2006). Financial intelligence: A Managers guide to knowing what the numbers really mean. Boston, Mass: Harvard Business School Press.
(cfo.com) Kmart Vendors Hit with Fraud Charges. Retrieved January 15, 2010 from: http://www.cfo.com/article.cfm/3464986

(findarticles.com) Feds indict former Kmart execs: alleged accounting errors could put merchants behind bars. Retrieved January 15, 2010 from: http://findarticles.com/p/articles/mi_m0FNP/is_5_42/ai_98998090/

(findarticles.com) Case dismissed: former Kmart execs cleared. Retrieved January 15, 2010 from: http://findarticles.com/p/articles/mi_m0FNP/is_22_42/ai_110805535/

(fundinguinverse.com) Kmart Corporation, History. Retrieved January 15, 2010 from: http://www.fundinguniverse.com/company-histories/Kmart-Corporation-Company-History.html

(nytimes.com) S.E.C. Names 8 in Kmart Accounting Case. Retrieved January 15, 2010 from: http://www.nytimes.com/2004/12/03/business/03kmart.html

(smartpros.com) Fired From Kmart, Ex-CFO Is Key Figure in Lawsuits. Retrieved January 15, 2010 from: http://accounting.smartpros.com/x41496.xml

(sptimes.com) SEC says 8 took part in accounting fraud at Kmart. Retrieved January 15, 2010 from: http://www.sptimes.com/2004/12/03/Business/SEC_says_8_took_part_.shtml