The Ahold case

in #vincentb6 years ago

Ahold was founded in 1887 by Albert Heijn, who purchased a small grocery store from his father. He let the company grow from a small grocery store to an internationally operating concern by fulfilling specific interests and needs of the public. The company changed its name to Ahold in 1973 and got the title ‘Royal’ in 1987. In 2000, the company had shares on several stock exchanges around the world. However, in the beginning of 2003, a financial scandal was discovered, which lead to several effects within the company, but also externally in the form of new regulations and standards.

The company wanted to grow internationally by taking over existing grocery stores in other countries over the world (de Jong, DeJong, Mertens, & Roosenboom, 2007; Knapp & Knapp, 2007). Therefore, money was needed, which was gained by raising large amounts of debt and equity capital. In 2003, Royal Ahold was the second largest food wholesaler in the United States (US) through several take-overs. However, this expansion drift, including the acquisition of U.S. Foodservice in 2000 (Broekstra, Sornette, & Zhou, 2005) also lead to problems, because the company had to deal with different cultural norms, laws and regulations which affected the management of the several foreign grocery stores. The company made use of a hands-off policy, which indicated that the management of the groceries which were taken over, hold their position and managed the store for Royal Ahold. However, these managers had to reach the same financial targets as managers of stores in the Netherlands, which was quite unrealistic. When managers met these targets, they were rewarded with large bonuses. This led managers to behave opportunistically in order to get the bonus. They showed self-serving behavior in a way that materially distorted the company’s financial statements, which was discovered by independent auditors from Deloitte at the beginning of 2003 (Knapp & Knapp, 2007). This discovery led to financial problems, which threatened the company’s ability to continue as a going concern.
The distortion of Royal Ahold’s financial statements are a result of three causes, which all were a result of self-serving behavior (de Jong, DeJong, Mertens, & Roosenboom, 2007; Knapp & Knapp, 2007) and the use of holes in the financial reporting standards (Bahram, 2014). Firstly, the company incorrectly included financial data of foreign joint ventures in its consolidated financial statements, which lead to overstated revenues and assets. The data was included incorrectly, because Royal Ahold consolidated financial data of these foreign joint ventures in their financial statements while they had no effective control (minimal 50% ownership) over these companies. They betrayed the auditors of Deloitte by providing letters which were forcibly signed by the managers of the joint venture companies in which they stated that Royal Ahold effectively controlled the joint venture companies. This resulted in material misstatements. Furthermore, the company failed to reveal that it was obliged to purchase the ownership interests of certain investors in the joint venture companies.

Secondly, Royal Ahold made aggressive accounting decisions when they recorded the initial purchase transactions used to acquire foreign joint venture companies, which inflated the company’s net income. The company inflated the amount of goodwill, which has to be reported when an acquisition does take place. Furthermore, the company did not charge off several expenses related to the acquisitions in the proper way (de Jong, DeJong, Mertens, & Roosenboom, 2007). All this, in order to achieve the set financial targets.

Lastly, a large subsidiary of Royal Ahold, U.S. Foodservice, fraudulent extensively in its accounting records, which had a material impact on the profit the U.S. Foodservice and overstated the consolidated net income of Royal Ahold materially. This fraud did not only take place after the acquisition by Royal Ahold, but also before that acquisition, and involved promotional allowances (which were not accounted systematically as a result of missing internal controls), which were overstated by inflating the promotional allowance percentages or frontloading (record allowance as a reduction of the cost of sales in the beginning while whole allowance is not received yet). Furthermore, managers of U.S. Foodservice sometimes recorded fictitious promotional allowances in order to reach the financial targets. After the acquisition of U.S. Foodservice, this bad accounting for promotional allowances went even further in order to achieve the financial targets. This badly reporting of promotional allowances had the worst impact on the reported results of Royal Ahold. Furthermore, it indicates the lack of diligence of the auditors of U.S. Foodservice (Bahram, 2014).
Another important problem were the weak internal controls in Royal Ahold which resulted in accounting irregularities (Bahram, 2014; de Jong, DeJong, Mertens, & Roosenboom, 2007). This issue turned out of the forensic audit of PriceWaterhouseCoopers. An example of a poor internal control is the fact that managers monitored subsidiaries which they previously managed. When Deloitte discovered these questionable accounting practices, which needed further investigation, the audit firm suspended its audit over the fiscal year 2000. The stock price of Royal Ahold deteriorated and its credit rating went down, which made it difficult to gather new capital. The board of directors responded by firing the chief executive officer (CEO) and chief financial officer (CFO) of the company. Moreover, the board promised to cooperate during the investigation and to take the required measures to solve the problems in order to get some confidence from investors back.

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