Ahold's accounting `irregularities' may involve rebates from vendors

Common industry practice can get out of hand

A $500 Million Mistake

February 26, 2003|By Lorraine Mirabella | Lorraine Mirabella,SUN STAFF

It came as a shock to the food retailing world when Dutch grocer and distributor Royal Ahold NV said its Columbia-based U.S. Foodservice subsidiary overstated earnings by at least $500 million in the past two years.

But few analysts yesterday were surprised that the accounting "irregularities" - which Ahold disclosed Monday - were triggered by U.S. Foodservice's practice of counting on rebates from vendors in exchange for selling high volumes of that vendor's products.

The practice, referred to as "promotional allowances" or "vendor allowances," is common throughout the food distribution industry, analysts said. Both supermarket distributors and large supermarket chains that self-distribute count on incentives from manufacturers.

"Vendor allowances have always been a pattern in the food retail sector - they're used by everybody," said Edouard Aubin, a food retail analyst with Deutsche Bank AG in New York. "But the [U.S.] Foodservice story ... clearly was a surprise to everybody."

Typically, a food distributor such as U.S. Foodservice would agree to buy a high volume of a vendor's products over a set period of time in exchange for incentives, which could come either as a discount on the cost of the goods or as a cash rebate.

Vendor allowances can reduce the cost of goods as much as 20 percent, Aubin said.

The food distributor would then be able to lower its cost of goods sold and boost its profit. But trouble can arise, analysts said yesterday, when a company is overly aggressive in accounting for the vendor allowances, then fails to meet sales goals and, as a result, never gets the incentives.

A manufacturer will say "if you buy 100 cases of tomato sauce, we'll give you a 5 percent discount," said Mark Hamstra, retail editor of Supermarket News in New York.

"What happens is the distributors then do their accounting as though they've earned the discount, even though they haven't bought that volume of tomato sauce. When they run into trouble is when the business slows down and they don't get the volume they thought they would get."

That predicament has become all too common in the shaky economy, he said.

Food distributors "base projections on preceding years, and preceding years turn out to be exceptionally good years," Hamstra said.

But another situation, Hamstra said, could be that "individual buyers are ... estimating they're going to buy high volumes from vendors knowing that they're not going to meet those goals, to make the numbers look good in the short term."

Two resignations

On Monday, Ahold, the world's third-largest retailer and owner of Giant Food Inc. of Landover, said the accounting irregularities led to an overstatement of earnings in 2001 and 2002 by more than $500 million, which the company said was about 17 percent of its 2001 operating profit.

Ahold also announced the resignations of its chief executive officer and chief financial officer. It has disclosed few details of the accounting missteps, saying only that the company has begun an investigation that will cause it to delay releasing fourth-quarter earnings.

The company reportedly suspended two U.S. Foodservice executives in the marketing and procurement department. Such a large overstatement was likely the result of intentional and overly aggressive accounting, some analysts said yesterday.

Some believe that U.S. Foodservice, which Ahold acquired in March 2000, was under intense pressure to reduce debt and maximize earnings to justify the acquisition.

"One way is to go after the vendors, and say `You can be our preferred or exclusive supplier, or we'll guarantee `x' amount of volume if you give us `x' million dollars up front,'" said Robert S. Goldin, executive vice president of Chicago-based Technomic Inc.

`Aggressive employees'

One consultant blamed Ahold's financial troubles on "aggressive employees recording revenues early" but called it an isolated event.

Even such a large restatement won't spell doom for Ahold, which has strong cash flow, and should not hurt market share or sales, said the consultant, Burt Flickinger III of Reach Marketing of New York.

"There's great institutional integrity at Ahold," he said. "It is not similar to other companies that in the retailing industry or other industries have been under investigation. It's really an isolated special situation, or a one-time transitory event that will cycle through."

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