Summary of the CaseThe company was started in 1887 as Heijn purchased “a small grocery store from his father, which “was located in Oostzaan,” found on “the Dutch peninsula known as North Holland, also one of The Netherlands provinces” (Knapp & Knapp, 2007). Heijn was known as being “frugal and hard-working,” allowing him to own “two dozen grocery stores scattered throughout the small country” (Knapp & Knapp, 2007). Early success was attained through the design by Heijn “to meet the specific interests and needs of the community in which it was located” (Knapp & Knapp, 2007). During the 1900s, Heijn began launching unique products, “marketed under the Albert Heijn brand” (Knapp & Knapp, 2007).. Within 10 years, by 2000, the company was registered on different stock exchanges, including the NYSE.
It is noted that “until the late 1980s, members of the Heijn family had occupied the key management positions within the firm” (Knapp & Knapp, 2007). Market shares were increased through purchasing “existing grocery chains in foreign countries” (Knapp & Knapp, 2007). This allowed for a “growth-by-acquisition policy,” requiring increased capital, obtained by raising “large amounts of debt and equity capital during the 1990s” (Knapp & Knapp, 2007). The chains purchased were located in “Asia, Eastern Europe, Latin America, Portugal, Scandinavia, South America, and the United States” (Knapp & Knapp, 2007). This led the company to be “the third-largest grocery retailer worldwide by the turn of the century” (Knapp & Knapp, 2007). The largest U.S. company acquired was “Foodservice, a large food wholesaler headquartered in Columbia, Maryland, a suburb of Washington, D.C.” (Knapp & Knapp, 2007). In 2003, after purchasing two smaller U.S.-based food distributors, Royal Ahold ranked as the second largest food wholesaler in the United States” (Knapp & Knapp, 2007). These acquisitions “caused food wholesaling to be the company’s largest source of revenue, accounting for slightly more than one-half of its annual sales” (Knapp & Knapp, 2007).
The company’s reputation was affected by “a financial scandal shortly after the turn on the century” (Knapp & Knapp, 2007). This resulted in a consumer boycott and immense criticism. During 2003, the scandal was named as “Europe’s Enron” (Knapp & Knapp, 2007). It was found that when the company decided to become a wholesaler, management was “largely unfamiliar with that segment of the industry,” resulting in a “hands-off policy” (Knapp & Knapp, 2007). However, all operations were to “be held to the same rigorous performance standards that were imposed on the company’s domestic operations” (Knapp & Knapp, 2007). Management was pressured to meet unrealistic annual earnings targets in order to earn “significant year-end bonuses” (Knapp & Knapp, 2007). Due to the unrealistic earning targets, many of the company’s employees engaged “in self-serving behavior that materially distorted the company’s periodic financial statements” (Knapp & Knapp, 2007).
Since 1973, Deloitte was known as the ‘group auditor’ for the company, meaning that Deloitte “oversaw the audits of the company’s annual consolidated financial statements, although accounting firms in other countries, such as the United States, participated in those audits” (Knapp & Knapp, 2007). In 2003, Deloitte announced that “it was suspending its fiscal year 2002 audit of the company,” because auditors “had uncovered questionable accounting and financial reporting practices that had to be thoroughly investigated before the audit could be completed” (Knapp & Knapp, 2007). During this time, the stock price decreased “by approximately 70%,” and the company’s credit rating was decreased, causing the “market price of the company’s outstanding debt securities” to decrease, making it difficult to “raise additional capital in either the debt or equity markets” (Knapp & Knapp, 2007). Initial actions to resolve the issues involved firing the CEO and CFO, rising capital through “selling several foreign subsidiaries,” and cooperating “with all law enforcement and regulatory agencies investigating the company’s financial affairs and take the appropriate measures to ensure that the sources of the accounting problems were identified and eliminated” (Knapp & Knapp, 2007). The three sources of material misrepresentations were the improper inclusion of “financial data of certain foreign joint ventures in its consolidated financial statements, which resulted in large overstatements of its consolidated revenues and assets” (Knapp & Knapp, 2007). Second, the overstatements led to “aggressive accounting decisions that the company made in recording the initial investments in foreign joint venture companies” (Knapp & Knapp, 2007). Third, fraud was detected in Foodservice. Accounting financial statements were filed with the SEC and contained Form 20-F containing “a schedule that reconciled its net income determined under Dutch-based GAAP to the net income that would have been produced by the application of U.S. GAAP” (Knapp & Knapp, 2007). Foodservice overstated promotional allowances through inflation or frontloaded promotional allowances. In other cases, Foodservice recorded “fictitious promotional allowances near the end of an accounting period to ensure that their operating unit reached that period’s earnings goal” (Knapp & Knapp, 2007). It was found that “the improper accounting for promotional allowances at U.S. Foodservice easily had the most dramatic impact on the company’s reported profits” (Knapp & Knapp, 2007).
Originally, the net income was overstated through a full consolidation of the companies that Ahold acquired although it only owned 50%. Under ASC 323 discussing investments, the equity method should have been used, resulting in only 50% of the information from acquired companies to be used in Ahold’s financial statements (US GAAP Plus, 2015). Therefore, the net income would not have increased as much as stated in the financial statements (Accounting Tools, 2015).
Earnings quality refers to the rate that earnings adhere to GAAP. Under GAAP, earnings need “to accurately represent current operating performance and to aid in accurately forecasting future operating performance. These requirements for high-quality earnings mean that the reported earnings amounts for a particular period should: represent the underlying economics of the business [and] be both persistent and predictable (the metric should be stable over time)” (Keefe, 2015). It has been found that even if a company’s financial data produces a higher net income under IFRS than under GAAP, the “US GAAP and IFRS are not distinguishable using these earnings attributes with the exception of Relevance, which is significantly higher under US GAAP than under IFRS” (Gordon, Jorgensen, & Linthicum, 2010). Thus, relevance was a significant issue in this particular case because of the inflation of promotional allowances due to fraud by Foodservice and the full consolidation of acquired companies, rather than the 50% owned.
It was found that according to EITF 01-09, “sales incentives and points earned in point-loyalty programs [must] be recorded as a reduction of revenue. The Company recognizes incentives related to gaming play and points earned in point-loyalty programs as a direct reduction of gaming revenue” (FASB, 2010). The same concept occurs for promotional allowances. Thus, under EITF 01-09, promotional allowances are deducted from revenue. However, Foodservice inflated the amount of promotional allowances received, adding it to revenue, rather than subtracting it.
There are numerous complications that exist within an independent audit of a multinational company. For example, it is not always clear as to what standards are used: GAAP, IFRS, and/or GAAS. It is also not always clear as to the home country of the company, which influences audit methods due to the differences in accounting standards. Significantly, it is found that “auditing and accounting standards vary from country to country largely because of differing business practices, fiscal systems and company law. Worldwide uniformity of auditing and accounting standards is an objective of the International Federation of Accountants (IFAC) and the International Accounting Standards Committee (IASC). In this case, the independent audit was complicated due to the standards used. For instance, Dutch GAAP was used in conjunction with U.S. GAAP. This influenced the results due to the different rules for each accounting standard.
The three elements of the fraud triangle include: “perceived unshareable financial need, perceived opportunities, and rationalization” (Association of Certified Fraud Examiners, 2015). Therefore, Deloitte faced the element of perceived opportunity. The risk factors should have affected the audit by considering the hands-off policy enacted by the company, which affected management of Foodservice.
Audit tests involve testing different variables, such as revenue and rate of allowances. These should then be compared to previous values in order to determine the significance of differences. This can assist in determining the possibility of fraud.
Differences would revolve around promotional allowances, returns, and waste. For instance, there may be more waste (due to lack of sales) in retrial grocery chains than food wholesaling. Furthermore, chains are more likely to have returns due to customer satisfaction issues. Finally, most chains offer customer loyalty through rewards programs, causing promotional allowances to be a major contributor to sales increases. Therefore, the promotional allowances need to be focused on, which should have been deducted rather than added to the revenue of Foodservice.
- Accounting Tools. (2015). Equity Method. Retrieved from http://www.accountingtools.com/equity-method
- Association of Certified Fraud Examiners. (2015). The Fraud Triangle. Retrieved from http://www.acfe.com/fraud-triangle.aspx
- FASB. (2010). EITF 01-9. Retrieved from http://www.fasb.org/jsp/FASB/Document_C/DocumentPage?cid=1218220142394&acceptedDisclaimer=true
- Gordon, E. A., Jorgensen, B. N., & Linthicum, C. L. (2010). Could IFRS Replace GAAP? A Comparison of Earnings Attributes and Informativeness in the US Market. Retrieved from http://www.insead.edu/facultyresearch/areas/accounting/events/documents/CouldifrsReplaceUSGAAP-JORGENSEN.pdf
- Keefe, T. (2015). Earnings Quality: Defining “Good Quality.” Retrieved from http://www.investopedia.com/university/accounting-earnings-quality/earnings2.asp
- Knapp, M. C., & Knapp, C. A. (2007). Europe’s Enron: Royal Ahold, N.V. Issues in Accounting Education, 22(4), 641–660.
- McCallister, J. P., Orsini, L. L., & Gould, J. P. (1997). Global Auditing and Accounting Confusion. Retrieved from http://www.journalofaccountancy.com/issues/1997/sep/global.html
- US GAAP Plus. (2015). ASC 323 — Investments — Equity Method and Joint Ventures. Retrieved from http://www.iasplus.com/en-us/standards/fasb/assets/asc323