SEC Investigating Green Mountain Coffee – Are Revenue Recognition Disclosures to Blame?

MarketWatch posted an article titled Green Mountain’s accounting creates a stir.  The article strongly suggests that Green Mountain (NASDAQ:GMCR) “has a history of changing the way it reports revenue…” It goes on to say …”its bookkeeping is being investigated by the Securities and Exchange Commission.”

Another article I found quotes the following from today’s Form 8-K filing (which I haven’t found yet):

On September 20, 2010, the staff of the SEC’s Division of Enforcement informed the Company that it was conducting an inquiry and made a request for a voluntary production of documents and information. Based on the request, the Company believes the focus of the inquiry concerns certain revenue recognition practices and the Company’s relationship with one of its fulfillment vendors. The Company, at the direction of the audit committee of the Company’s board of directors, is cooperating fully with the SEC staff’s inquiry.

First of all, there is a difference between an inquiry and an investigation.

I just attended a day and a half long seminar on revenue recognition.  To say it is a complex subject is an understatement.  It is also a huge focus area right now for the SEC.

One key lesson I learned in that class is that, in terms of revenue recognition disclosure, more is better.  Put it out there and tell people what you are doing.  MarketWatch on the other hand is taking Green Mountain to task for doing so:

Whereas Green Mountain’s revenue recognition was once described in a single sentence, it now fills three paragraphs in its securities filings. But the enhanced disclosures are raising questions. Regulators might be wondering why Green Mountain has tweaked its accounting policies for booking revenue for the last three years running.

In my view, enhanced disclosures are a good thing.  The SEC is asking companies for more information in this area, and the differences in revenue recognition policies for different sales channels.   It is quite possible the inquiry is on these changes, and it is quite possible that this will resolve without any changes for Green Mountain.  The slant in this article though seems quite unwarranted at this point, and only serves to discourage reporting companies from continuing to improve their disclosures.

Congratulations to Michael Ansley – Crain’s Detroit Business 40 Under 40 2010

A quick shot out to congratulate my client Michael Ansley, Founder and CEO of Diversified Restaurant Holdings, on being named to Crain’s Detroit Business 40 Under 40 for 2010.  The Company’s press release pretty much says it all.

My Firm, Silberstein Ungar, PLLC,  became the Company’s SEC auditors in 2009 after helping them comply with their Sarbanes-Oxley 404(a) responsibilities.  Michael has built a great company and delivers a great product.  We look forward to working with Michael and has team for a long time.

A View on the Proposed FASB Changes in Lease Accounting and Lease vs. Buy

I ran across an interesting blog today by Jim Duport of Lucernex Technologies.  His posting “The proposed FASB changes and the impact on the lease vs. buy decision” covers a lot of the anxiety 0ut there right now on the proposed new standard for lease accounting.  Jim isn’t a CPA but has a lot of experience in the leasing industry; not sure all of his debits and credits are right (and I admit I haven’t yet read the proposed standard) but I think he’s got a good grasp of the issues.

My restaurant group clients are especially nervous about this proposed statement.  Generally, they sign a 10 year lease that has anywhere from two to four optional renewal periods of five years.  Imagine putting all of that on your balance sheet right from the start and then maybe have to do a present value calculation with a judgmental internal rate of return.  Jim Duport suggests that many businesses that enter into long-term leases may become building owners.  I think he’s right.  And using Jim’s term, I think there will be unintended consequences.

I understand the conceptual guts of this statement, but this rush to convergence with international standards is going to have a big impact.  Just like people say “the tax tail shouldn’t wag the investment dog” I don’t think the accounting tail should wag the business decision dog.

Observations: The PCAOB’s Report on Auditing During the Economic Crisis

On September 29, 2010, the PCAOB issued Report On Observations Of PCAOB Inspectors Related To Audit Risk Areas Affected By The Economic Crisis. The 26 page report discusses in-depth what they have found during inspections over the last three years, a period during which the financial markets nearly collapsed and valuations were all over the place.

As to be expected, the PCAOB hits on audits of the financial industry pretty hard, but they covered other industries and problems they note.  Deficiencies observed in audits of both financial services and non-financial services industry issuers are as follows:

  • Fair Value Measurements for Financial Instruments – no surprise here.  This is one of the most difficult areas to audit, as the concepts are hard to grasp.  Primary deficiencies included the failure to (1) evaluate, or evaluate sufficiency whether fair value measurements were determined using appropriate valuation methods or adequately test controls over issuers’ valuation processes; (2) evaluate, or evaluate sufficiently, the reasonableness of management’s significant assumptions, including performing tests beyond inquiries of management; and (3) evaluate available evidence that was inconsistent with issuers’ fair value estimates.
  • Fair Value Measurements for Non-Financial Assets – again, no surprise here.  Weaknesses were observed especially as it related to fair values in business combinations and testing for goodwill impairment.   Specific conditions are similar to those in the previous paragraph.  PCAOB also noted that auditors “sometimes failed to challenge issuers’ conclusions that goodwill did not need to be tested for impairment more frequently than annually despite the existence of impairment indicators…”
  • Revenue recognition – PCAOB noted that fraudulent financial reporting often involves inappropriate revenue recognition.  Special weaknesses were cited in testing fair value of certain elements in multiple element arrangements.
  • Valuation of Inventories – the reduction in consumer and business spending in some instances resulted in increased inventory in relation to sales, decreases in inventory turnover, etc.  Specific weaknesses cited were auditor failures to sufficiently evaluate the reasonableness of reserves for excess and obsolete inventory, failure to adequately test whether all impaired inventory has been identified, and failure to consider whether markdowns were recorded when necessary when the issuer is using the retail method.
  • Income Taxes – deficiencies were primarily cited in testing valuation of deferred tax assets and tax contingency reserves.

I have to admit to being a little surprised by the focus on valuation of inventories, but none of the other areas is all that surprising.  As I was reading this report (I admit to skipping the pages on the financial industry as we don’t do financial industry audits) the following thoughts kept coming to mind:

  • The areas cited, especially fair value measurements and revenue recognition, have been major hot buttons for a while.  Personally, I just attended a day and a half seminar on revenue recognition alone, and I’d like to go to a fair value session before the upcoming audit season.  These are very complex areas, especially fair value.
  • The PCAOB inspectors have the benefit of 20/20 hindsight to say this is where you should look and what you should have done.  In the crunch of an audit, you are trying to get a lot done in a compressed time period, and it is easy to criticize after the fact.

One thing I can guarantee you – my audit planning for calendar year audits starts tomorrow.