Professional Documents
Culture Documents
KEYWORDS
Royal Ahold, U.S. Foodservice, Vendor Allowance Receivables, Accounting, Securities and Exchange
Commission, Conservatism, Corporate Governance, Market capitalization, Price-to-Sales ratio
1. INTRODUCTION
In light of the fundamental Accounting concepts, this paper will analyze Royal Ahold, a food retailer
in The Netherlands, that had to deal with a serious scandal when they admitted they had overstated
their profits by half a billion dollars [1]. In reaction to this news, the stock of Ahold on the
Amsterdam Stock Exchange plummeted 55 per cent on Monday the 24th of February [23]. This
scandal is known as the “Ahold Accounting Scandal”. In the US they even called Ahold “Europe’s
Enron” [3]. This is an interesting case, with many interesting options for analysis . Next to this, I still
remember this event vividly, as many friends and acquaintances had invested their assets in Ahold
stock.
The first step was to delve into Ahold’s 2002 annual report [2] to find out if any irregularities
related to the accounting scandal could be found. As it turned out, at the time that Ahold announced
that it had to restate its financial results, the annual report had not yet been published yet [4].
Therefore, the annual report that Ahold published is actually the audited version. In this version
corrections are made based on the various investigations and audits performed within Ahold
internally and all of its subsidiaries. The 2002 annual report was finally published on October 2nd
2003 [13]. In order to be able to delay the publication of its annual report this long, on May 13th of
2003, Ahold got approval from its shareholders to do so [14].
This does make the 2002 annual report very interesting, as it describes in detail what went wrong,
and how profits could be overstated by such an excessive amount. After analysis of the annual
report it becomes clear that the primary cause of Ahold’s overstatement of income, stems from
accounting fraud within one of Ahold’s subsidiaries in the USA. This company, U.S. Foodservice
(USF) committed accounting fraud by stating fictitious and overstated vendor allowance receivables
over a period of several years. Next to this, these vendor allowances were improperly or
prematurely recognized. This had been a practice of USF even before it was acquired by Ahold [5] in
2000 [10]. To put this in other words, the United States Securities and Exchange Commission (SEC)
stated that: “USF artificially inflated its operating income by recording promotional allowances that
were not earned in the period recorded, and in many cases were entirely fictitious." [8]
Now that the main cause of the accounting scandal has been identified, the remainder of this paper
will be concerned with USF vendor allowance and Ahold stock analysis, as well as relating the fraud
to core accounting concepts.
2. ANALYSIS
In this section, we will clarify the concept of vendor allowances within USF (paragraph 2.1), look at
historic Ahold stock development (paragraph 2.2) and analyze the effects of the scandal on the
Ahold stock using two distinct financial measures (paragraph 2.3 & 2.4).
This is still somewhat vague, but from other sources [6, 7, 8], it becomes clear the vendor allowance
is synonymous for supplier rebates or promotional allowances. Examples of these vendor allowances
are for instance achieving sales targets or granting better shelf positioning of products [7]. Next to
this it can be money granted due to promoting a new product from the supplier [6], or for other
marketing efforts [9]. Also, for instance if an order from a supplier exceeds 100 million dollars, 5
percent of this amount is refunded as a vendor allowance. And in general, the bigger the orders
from USF, the higher the promotional allowances granted to them [3].
As can be seen, the concept of vendor allowances is quite broad. The vendor allowances can be
seen as a way for a vendor to receive a certain counter-performance from the distributor [6]. A
veteran in the retail industry, Mark van Stekelenburg, states in an interview that this system of
vendor allowances is extremely complex. Next to this, the desired counter-performance of the
distributor is vague [6]. And this is where a big part of the problem lies, according to him. This
allowed the bookkeepers at USF to have several options as how to put “cost of goods sold” in the
books. He describes two variants: the conservative and the aggressive [6].
As we are dealing in this term paper with the Ahold accounting scandal, you can imagine that at
USF, with respect to these vendor allowances, they chose the aggressive variant in justifying the
vendor allowances. So what would happen, was that they already booked purchase discounts for
sales target agreements made with suppliers, even though the required volumes for these discounts
were never actually achieved [6]. Even after not being able to live up to these targets for one
quarter, they remained optimistic and again added them up to their operating income for the next
quarter. The bookkeepers kept repeating this, in order to cover up their optimism. This strategy
was successful on the short-term to fool the auditor, but eventually led to the auditor (Deloitte &
Touche in this case) discovering the fraud [3]. To make things worse, it has been shown that USF
immediately booked these vendor allowance receivables, but refrained from actually paying their
suppliers for the products ordered [8]. It even came to the point where top management asked
their regional managers to buy large quantities of product from their suppliers, in order to meet the
sales targets [8]. Anyone can imagine that these kind of practices are not sustainable.
Next to these intentional fraudulent practices, the SEC underpinned that things got even more out
of hand due to the fact that USF had no support from IT systems to keep track of these complex
vendor allowance arrangements and the associated amounts owed by the suppliers [3]. Also
fraudulent behavior was made easy by the lack of internal controls over vendor allowances.
Therefore employees could simply overstate allowances [3]. Finally, the vendor allowance
arrangements made with suppliers, were not formalized in a contract, but merely minutes were
made of meetings, and then after reviewing them signed by both parties [6].
Figure 1: Royal Ahold stock price development on NYSE Euronext over 2003
By looking at Figure 1, one can see the enormous impact that the overstated earnings had on
Ahold’s stock price (indicated in the figure by event B). In response to the release of the Q1 and Q2
figures (event C and D), the stock price did not change much, even though consolidated sales
dropped over 10 per cent compared to the previous year. When Ahold announced a shareholder
meeting to explain why the publication of the 2002 annual report was taking so long (event E),
investors responded positively. Finally, one more interesting observation to be made looking at the
historic stock price, is that after publication of the Q3 figures the stock price suffered somewhat.
Ahold had just regained some trust with its shareholders, when they had to rectify their Q3 figures
that same day, due to currency exchange translation errors [22]. This naturally did not go down
very well, especially after just having released the audited annual report of 2002 (event F).
The market capitalization is the total market value of a company, expressed in a currency, of all the
company's common outstanding shares [15]. This measurement is used by the investment
community to determine a company’s size. Also it allows comparison of one company’s market cap
to another [16]. The NYSE Euronext stock exchange for instance uses a three-tier categorization, of
small cap, medium cap and large cap [17].
Market capitalization is calculated by multiplying the amount of common stocks outstanding with
the current stock price [16]. In the case of Ahold, three calculations of market cap were made to
demonstrate the impact of the accounting scandal, and are shown below. The number of
outstanding stock were taken from its 2002 annual report and represent slightly over 1 billion
stocks [2].
The NYSE Euronext classifies a company in the large cap compartment if it has a market cap of 1
billion euro’s or more (=€1 000 000 000+). Therefore comparing these values between February
21st and March 13th, one can see that due to the scandal, Ahold is close to being classified from a
large cap company to a medium cap company. In other words; the scandal had a dramatic effect on
Ahold’s total market value.
The Price-to-Sales ratio (P/S) is used as a: “Stock valuation tool to compare the market
capitalization of a company to its sales” [18]. To put it differently, it reveals the market value
assigned to each euro of sales generated. A low P/S ratio indicates a profitable investment, while a
high P/S ratio indicates a lower profit [18].
For this calculation we again take three distinct measurements in order to value the Ahold stock
relative to its own past performance. In this case we will compare P/S ratios for Q1, Q2 and Q3 of
2003 and will use the stock price on the final day of each quarter for market cap determination. Just
like before we take the figure of the weighted average number of common stock outstanding of
roughly 1 billion during 2003 [2]. The ratios for each quarter are shown below:
As mentioned before, a low P/S ratio indicates a profitable investment. Therefore looking at the P/S
ratio of the Ahold stock during Q1 of 2003, it becomes apparent that the market has undervalued
Ahold’s sales (as sales remain practically stable over the course of these three measurements).
So, does this make Ahold a safe and profitable investment just looking at the P/S ratio? The answer
to that is NO, as we also need to take into account that a low P/S ratio might indicate problems
within a company [18]. In this case it is clear why the P/S ratio has taken a nose-dive. Due to the
accounting irregularities that arose on the 24th of February a lot of investors got rid of their Ahold
stock during Q1.
Next to this, the P/S ratios reveal that during Q2 and Q3 the market is increasingly starting to value
Ahold’s sales again for what they are. This is reflected in the trend of the growing P/S values.
Therefore, from P/S calculation we can conclude that the Ahold stock was severely underpriced
during Q1 of 2003 with respect to their sales.
Secondly, regarding the concept of disclosure, it becomes obvious that investors would like to know
about fraudulent practices before deciding to invest in the Ahold stock. This is related to disclosure,
as it is the: “act of releasing all relevant information about a company that may influence an
investment decision” [11]. At USF selective disclosure was a reoccurring phenomenon. This
selective disclosure could have allowed insiders to take advantage of information, at the expense of
the general public.
Thirdly, conservatism plays an important role in the Ahold case. As was mentioned earlier, the
booking of vendor allowances was done on a much too optimistic and aggressive way. If Ahold
would have been conservative about vendor allowance receivables, then perhaps they would have
been able to restate their earning to a higher level instead of a lower level, subsequently hurting the
stock price.
Finally, also the matching principle comes into play here. As defined by our Accounting professor at
UCSD, George Haloulakos, the matching principle states that revenues and expenses should be
recognized in the period in which they occur. Also from what we saw, we can conclude that
sometimes vendor allowance receivables were already booked, even though the products had not
even been paid for by USF. This is a violation of the matching principle.
4. CONCLUSION
After having discussed the main causes that led to the Ahold stock plummet , and also the related
accounting concepts that were violated in the process, the crash comes as no surprise. In hindsight,
the variables that led to stock crash seem pretty straightforward. Also, there was the problem of
having to dig deeper and deeper holes in order to fill up the previous ones. A situation that is hardly
sustainable.
The Ahold accounting scandal was such an eye-opener, that the SEC tightened accounting rules with
respect to vendor allowances in response to the Ahold case. The new rules require organizations to
be much more conservative with respect to vendor allowance receivables [9]. Therefore, let us
hope that the changes in regulations, in response to the Ahold case, will prevent this kind of
behavior from being displayed again in the future.
REFERENCES
[1] CNN, “Accounting scandal hits Ahold”,
http://money.cnn.com/2003/02/24/news/companies/ahold_grocers/
[3] M. C. Knapp, “Europe’s Enron: Royal Ahold, N.V.”, University of Oklahoma, American
Accounting Association, 2007,
http://aaahq.org/audit/midyear/07midyear/papers/knapp_europesenron.pdf
[4] Ahold, “Ahold files Annual Report 2002 on Form 20-F with SEC”,
http://www.ahold.com/en/node/863
[5] All Business, “Ahold Set To Acquire U.S. Foodservice; National FoodService Distributor With
Sales Of $7 Billion...”, http://www.allbusiness.com/company-activities-management/financial-
performance/6402460-1.html
[6] V. Frölke, “US Foodservice heel agressief met kortingen”, NRC Handelsblad,2003,
http://www.nrc.nl/dossiers/ahold/nieuwsarchief_tm_2003/article1610668.ece/US_Foodservi
ce_heel_agressief_met_kortingen
[8] IBS Center for Management Research, “Royal Ahold NV - The US Foodservice Accounting
Fraud”, 2007,
http://www.icmrindia.org/casestudies/catalogue/Finance/Royal%20Ahold%20NV-
US%20Foodservice%20Accounting%20Fraud-
Finance%20Case%20Studies.htm#Accounting_Fraud_at_US_Foodservice
[11] Marshall, McManus, Viele, “Accounting: What the numbers mean”, McGraw-Hill, Eighth
Edition, 2008
[12] NYSE Euronext, “Company Profile Royal Ahold”, NYSE Euronext, 2010,
http://www.euronext.com/trader/companyprofile/companyprofilev2-18661-NL-
NL0006033250.html
[13] Ahold, “Ahold files Annual Report 2002 on Form 20-F with SEC”,
http://www.ahold.com/en/node/863
[14] Ahold, “Ahold shareholders meeting extends deadline for completion annual accounts
2002”, http://www.ahold.com/en/node/472
[21] Ahold, “CORRECTED PRESS RELEASE: Ahold announces results for first three quarters of
2003”, http://www.ahold.com/en/node/2786
[22] Ahold, “Ahold publishes corrected figures for the first three quarters of 2003 and a
correction to the disclosure included in the outlook”, http://www.ahold.com/en/node/2782