Synopsis
Royal Ahold, N.V., is a large multinational company based in The Netherlands that was founded in 1877 by Albert Heijn. Three generations of the Heijn family oversaw the company’s retail grocery business. In 1989, the company hired a professional management team. The new management team expanded Royal Ahold’s operations by purchasing grocery chains around the globe, resulting in the company becoming the third largest food retailer in the world. In 2000, the company diversified into the wholesaling segment of the huge food industry when it purchased U.S. Foodservice, a large food wholesaler based in Columbia, Maryland.
Royal Ahold’s professional management team established aggressive earnings and revenue goals for the company each year and pressured their subordinates to achieve those goals. An incentive compensation plan awarded large year-end bonuses to managers of operating units that met or surpassed their financial goals. Royal Ahold’s decentralized operations when coupled with the strong incentives to achieve unrealistic earnings and revenue goals created an environment in which fraud often flourishes.
In early 2003, Royal Ahold’s independent auditors suspended their fiscal 2002 audit of the company when they discovered numerous potential irregularities in the company’s accounting records. Subsequent investigations documented that the company had improperly included the operating results of foreign joint ventures in its consolidated financial statements, had accounted improperly for initial acquisition costs related to several of those joint ventures, and had materially overstated “promotional allowances” due from company vendors. The disclosure of the massive accounting fraud resulted in criminal and civil lawsuits being filed against the company and its top executives in both Europe and the United States. Three former Royal Ahold executives, including the company’s former CEO and CFO, were found guilty by a Dutch court. The three executives were fined and given suspended prison sentences. Fraud charges filed against the company were settled by the payment of a fine of 8 million euros. Several lawsuits stemming from the Royal Ahold case are still pending.
This case examines accounting, auditing, and control issues pertinent to multinational companies. In addition, the case examines recent controversies arising between and among international regulatory agencies and rule-making bodies within the accounting and auditing disciplines. Finally, the case illustrates important risk factors commonly associated with financial statement fraud.
Royal Ahold, N.V.—Key Facts
- Royal Ahold was controlled by members of the Albert Heijn family until 1989 when a professional management team was hired.
- The new management team aggressively pursued an international expansion plan that eventually resulted in Royal Ahold owning retail grocery chains in 27 countries and a large food wholesaling operation in the United States.
- Differences in cultural norms and expectations adversely impacted Royal Ahold’s ability to manage its global business operations.
- The new management team pressured their subordinates to achieve unrealistic earnings goals and rewarded them with large year-end bonuses if they reached those goals.
- In early 2003, Royal Ahold’s Deloitte auditors suspended their fiscal 2002 audit after discovering potential irregularities in the company’s accounting records.
- Deloitte’s suspension of its 2002 audit caused significant financial problems for Royal Ahold, including sharp drops in the prices of its outstanding securities and its credit rating.
- Investigations of Royal Ahold’s accounting records revealed that the company’s previous financial statements had been materially misstated.
- The three principal sources of Royal Ahold’s financial statement misrepresentations were the improper inclusion of financial data for foreign joint ventures in its consolidated financial statements, improper accounting for purchases of foreign joint ventures, and improper accounting for “promotional allowances” by the company’s food wholesaling subsidiary.
- Among the parties blamed for the Royal Ahold scandal were the company’s top executives, the company’s Deloitte auditors, and international oversight and rule-making bodies in the accounting and auditing disciplines.
- The Royal Ahold case refocused attention on the lack of cooperation between international oversight and rule-making bodies in the accounting and auditing disciplines.
Suggested Solutions to Case Questions
1. The equity method is the proper accounting method for U.S. companies to apply to investments representing a 20–50% ownership interest in an investee company. U.S. GAAP generally does not permit full or proportional consolidation of a joint venture company in which the “parent” owns a 50 per cent interest.
In arriving at the U.S. GAAP-based net income figures shown in the reconciliations presented in Exhibit 3, Royal Ahold fully consolidated the operating results of the joint ventures in which it had a 50 per cent ownership interest. Since these entities were operating profitably, the result was to overstate the U.S. GAAP-based net income figures shown in Exhibit 3.
2. There isn’t a universally-accepted definition of “earnings quality,” but, generally, that phrase refers to the degree of correlation between a company’s reported earnings and its “true” earnings. The term “earnings quality” is also often used when referring to the degree to which a given entity’s reported earnings can be used to predict its future earnings. Because of the pervasive conservatism principle within the U.S. accounting profession, reported earnings figures that are conservative, that is, that tend to be understated, are often considered to be of high quality. However, consistently understated or overstated earnings are of low quality given the general definition of earnings quality just presented. So, in comparing the earnings produced by two competing sets of accounting principles, such as IFRS and U.S. GAAP, the key issue is which set of accounting principles produces net income figures that are more highly correlated with the given entity’s stream of actual earnings. Granted, determining “actual earnings” for purposes of this comparison is a difficult assignment.
In addressing this question, your students will likely focus on the large differences between the Dutch GAAP-based and U.S. GAAP-based net earnings figures shown in Exhibit 3. Notice that easily the most significant factor accounting for the difference in Royal Ahold’s Dutch GAAP-based
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