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Monday, September 11, 2006

Dell Distributing a delayed Quarterly Report

Dell Inc became nothing less than famous for its direct to consumer distribution model.  However, today it anounced a delay in its quarterly reporting spurred on by what originally started as an informal SEC investigation.  That investigation has expanded and now the State of New York is investigating accounting issues dating back to 2002.  Some reports even indicate that the Department of Justice is getting involved.

According to CNBC reports, the questions raised may relate to concerns over methods used in balance sheet reporting relating to reserves accrued by Dell.

Balance sheet reporting is a growing area of concern for many large companies.  Unlike problems at Apple relating to the expensing of Stock Options, most balance sheet reporting problems are created when reserves for potential future charges are set up.  The valuation of these potential future charges hit the bottom line when the reserve is taken normally.  However, problems and discrepancies can become uncontrollable when methods of valuation or impractical or tediously out of control due to large volumes of transactions. 

This is no excuse, but in an age of cut backs, downsizing and extreme outsourcing, proper valuations are even harder to assess when there is no area of the company that has a solid grasp on the issues at hand.

Many retailers, who also sell directly to consumers, have run into issue with Balance Sheet accounting relating to chargebacks, and warranty or returns issues. 

A reserve may be set up for an expected expense down the road.  If the accrual is not large enough for the future expense that will come due, unexpected one time charges must be assessed to catch up the books.  So if accruals from years past are too light, then not only will a catch up charge need to be executed to literally pay the bill, however a restatement in earnings and all the related transactions such as income tax reporting may be required.

So profits in the past may be rosier than they really were, when their late to catch up expense finally come home to roost,

On the flip side, if a company over accrues, they will increase their expenses and have a big profit hit at some time in the future.  This can result in situations that might not help a stock valuation out much, but that can significantly reduce a tax bill.  After all lower profits translate to lower taxes and lower overall expenses.  Cagie officers can always find some place to park that extra reserve later on down the road.

Unfortunately, there are the books disclosed to the public and then there is someone behind the seens that translates what those books really mean.  Balance Sheet Accounting is one aspect of the Rosetta stone of the real set of accounting books.  Don't ever let your due dilligence team stop at the Profit and Loss or income statement, always make sure there is nothing hidden in the balance sheet.

Think the third party auditors are going to catch this?  Maybe in a perfect world, a world where Enron's don't happen, but again the devil's in the details and auditors don't always dig far enough into the details either.  They get a few weeks a quarter to figure out what is going on, even less than their counterparts that are actually within the company.

Not to be cynical, but Sarbanes Oxley doesn't carry much weight off shore either.  The loop holes for this legislation start just a few miles off the coast and cover most of the world.  Yes, many US companies are trying to get up to standards, but if you look to companies outside of the US, they rarely have any requirements to meet this level of standards, even when they operate in the US.

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