Companies have incentives to recognize revenues but not the costs associated with generating those revenues because doing so allows them to report inflated income for the current period. Under US GAAP, companies are required to “match” revenues with costs in the same period so that current earnings are an accurate predictor of economic income. Monsanto, a large multinational agricultural public company, did exactly what it was not supposed to do. It violated the most fundamental accounting rule—the matching principle. The company was eager to recognize revenues but not the costs associated with generating revenues.
The Securities and Exchange Commission (SEC), the Robocop patrolling Wall Street and the guardian angel of the average investor, charged Monsanto of misstating earnings because the company failed to properly account for the costs of sales associated with its flagship herbicide product “Roundup.” Monsanto agreed to pay $80 million in penalties. It is one of the largest accounting-related settlements by the SEC since Mary Jo White took over as the Chair of the Commission in 2013.
One of Monsanto’s flagship and highly profitable products is a weed-killer herbicide named Roundup. Because of intense competition from generic products, and possibly facing the prospect of a sharp decline in profits, Monsanto introduced an aggressive rebate program from 2009. Under the program, the company would offer steep price reductions on the product, or pay a rebate on the product in subsequent years, if retailers and distributors met certain sales goals. In 2010 alone, Monsanto paid $44.5 million to its two largest distributors as a rebate for meeting the sales goals of Roundup for its past rebate programs.
The accounting problem was that Monsanto was recognizing revenues from the sale of Roundup but it failed to include an estimate of the cost of the rebate that would be paid to its retailers/distributors in future periods. Because the rebate contributed to the sale of Roundup for the current period, the company is required to include rebate estimates in the current period. The company possibly deferred recognizing the rebate costs to future periods when cash was being paid which violated the matching principle and the fundamental “accrual” notion of accounting.
In addition to the company fine of $80 million, three Monsanto accounting and sales executives agreed to pay penalties to settle individual charges against them. The SEC found that two certified public accountants (CPAs) at Monsanto either knew or should have known that Monsanto was improperly documenting costs tied to the program and were suspended from practicing as accountants of public companies.
Monsanto neither admitting nor denied any wrongdoing but agreed to hire a consultant to review its financial reporting of the rebate programs. Based on the review, the company disclosed that it was going to restate its earnings from 2009 to 2011.
Monsanto’s CEO, Hugh Grant, reimbursed the company $3,165,852 for cash bonuses and stock awards received during the period. It is not surprising or unusual for CEOs to pay back their incentive compensation if the company has accounting related misreporting. Under the “clawback” provision of the Sarbanes-Oxley Act of 2002, executives are required to pay back compensation during periods when accounting misstatements occurred, even if the executive was not directly engaged in the misconduct.
Ms. White said “Corporations must be truthful in their earnings releases to investors and have sufficient internal accounting controls in place to prevent misleading statements…. Failing to recognize expenses related to rebates is the latest page from a well-worn playbook of accounting misstatements,” she said.
Costs of Accounting Manipulations
The stock price of Monsanto has gone down from a high of $120 to a current price of around $90 which is a 25% decline. With total shares outstanding at 536 million, the magnitude of the total loss to shareholders is a staggering $16 billion in just one year. As always, ultimately, investors and shareholders lose from accounting abuses.
February 27, 2016; 3.55Pby