Will your rebate accounting come back to haunt you? Settle down around our campfire, and we’ll share some cautionary tales…
It’s a chilly October evening. You’re sitting alone in your kitchen, reading your favorite industry blog. Then, with a startling suddenness, your phone begins to ring.
You answer and a stranger’s voice says your name. Then, they tell you where they’re calling from. Your blood runs cold.
It’s not a masked killer, hiding inside your cupboard. It’s much worse.
It’s Martha calling from the Securities and Exchange Commission (SEC). She wants to talk about the profits your company posted in the last quarter. Specifically, she wants to know how you accounted for your rebates.
Horror stories like this one are all too common. And to celebrate Halloween, we’ve gathered together a few to chill the spine of distributors and vendors alike…
Heads roll at Target
Department store Target Australia was on track for $53m in earnings before interest and tax for the first half of FY2016—some $17m down on the same period in FY2015.
In an apparent attempt to address the shortfall, senior managers at Target decided to use rebate agreements to artificially boost its earnings. It arranged rebates with over 30 different suppliers for the first half of FY2016, promising that, in return, it would pay higher prices during the second half.
By March, Target’s parent group, Wesfarmers, had begun an investigation. By mid-April, three of target’s senior managers had quit, and Wesfarmers’ Managing Director had described their actions as “mind-blowingly stupid”.
Monsanto gets haunted by its ghost rebate programs
A few months earlier, U.S. agribusiness Monsanto Company—best known for its flagship product, Roundup—had experienced its own rebate nightmare.
According to the SEC, “Monsanto’s sales force began telling U.S. retailers in 2009 that if they “maximized” their Roundup purchases in the fourth quarter they could participate in a new rebate program in 2010.”
The problem? If you use a rebate scheme to incentivize sales in one financial year, you need to record a proportion of the costs a related to the program in the same year—unless you want to find yourself in breach of U.S. Generally Accepted Accounting Principles (GAAP).
Instead of recording the cost of this program in 2009, Monsanto delayed until 2010, materially misstating its consolidated earnings in corporate filings.
In the words of Scott W. Friestad, Associate Director in the SEC’s Division of Enforcement, “Monsanto devised rebate programs that elevated form over substance.” These ‘ghost’ programs would ultimately lead to an $80 million penalty for violating accounting rules.
Tesco commits “market abuse”—and a regulatory nightmare ensues
In 2018, the UK’s Financial Conduct Authority said that Tesco plc and Tesco Stores Ltd had “committed market abuse” in relation to a trading update published in 2014.
The update stated an expected six-month trading profit for Tesco plc of £1.1bn. A matter of weeks later, the multinational retailer published a further update announcing it had “identified an overstatement of its expected profit”. According to the Financial Times, this overstatement was due to was inflated estimates of rebate income owed.
When you combine the company’s agreed compensation package for investors with its plea deal with the Serious Fraud Office, the cost of Tesco’s mistake totals £214m.
The gruesome death of Dick Smith Holdings
Branches of Dick Smith Electronics were, until recently, a common sight on the streets of Australia and New Zealand.
But when Dick Smith Holdings (DSH) collapsed in 2016—leaving creditors more than $260m short—receivers Ferrier Hodgson made some shocking allegations. “By reason of DSH’s treatment of rebates,” their letter claimed, “DSH was able, in effect, to “borrow” profit from a subsequent year.”
Liquidator McGrathNicol subsequently found that the retailer's buying decisions were driven by supplier rebates rather than customer demand—sacrificing product mix for short-term profit.
A grim tale from the archives—Royal Ahold
At the turn of the millennium, U.S. Foodservice (now U.S. Foods) was already a major distributor of food to restaurants, hotels, schools and hospitals. When it was acquired by Dutch company Royal Ahold in 2000, its vendor rebate activities came under the purview of Ahold’s independent auditors Deloitte & Touche.
Initially, all seemed well. Then, in 2002, D&T discovered problems which caused them to not only suspend their current audit, but withdraw their audit opinions for the previous two years.
On February 24 2003, Ahold announced it would restate earnings for FY2000, FY2001, and the first three quarters of FY2002—reducing them by a total of over $500 million. It also announced a forensic accounting investigation, largely due to irregularities at U.S. Foodservice.
That same day, company’s stock price lost almost two-thirds of its value, and its Chief Executive and Chief Financial Officer resigned.
What had happened? According to testimonies from U.S. Foodservice insiders, its upper management had suggested bonuses were at risk unless sales increased in the last quarter of 2002.
The company’s chief operating officer had proposed a solution—order large amounts of inventory, immediately recognizing the vendor rebates. The strategy would not only pave the way for the company’s costly restatement of its earnings, but for a massive excess of inventory which, in some cases, had to be sold at a loss.
Don’t have (rebate) nightmares…
As we’ve seen, inaccurate rebate accounting can lead to some very unwelcome consequences. And it isn’t always the result of a deliberate attempt to mislead the market.
Often, the sheer number and complexity of a company’s rebate agreements can cause it to stray from the safe, bright path of financial compliance, into the shadowy woods where GAAP is contravened, profits misstated, and dire prices paid.
That’s one reason why robust rebate management solutions, like our own DealTrack, are so vital. They help provide a single, auditable source of truth for rebate agreement—so you can protect your business against rebate accounting nightmares, and sleep a little easier.