I think this explains it well, bravo! One question though - the cumulative impact of the missed accruals was $132-$154M. If the accountant here is just under-accruing in the Accrued Expenses bucket, the mistake would partially reverse as the invoices are paid out fully in cash right? I don't see how this can become a ballooning mistake.
For example, if $150M of goods are shipped and $100M of invoices are issued. The accountant debts Shipping Expense and credits AP for $100M . The accountant then only accrues say $10M of the $50M in unbilled shipping costs (debit $10M shipping expense, credit Accrued Expenses $10M). So the total shipping expense that hits the P&L for the period is $110M. Then next quarter when Macy's pays the $50M balance, the accountant reverses the $10M in Accrued Expenses liability with an offsetting $10M credit to the Cash account, but then there is $40M more in cash payments that need an offsetting debit entry. Which account would the accountant debit for this leg? They would create a liability account called something like "liability estimates revision" and debit it for $40M? So this account would have a negative balance. And they would run the same scheme each year so this account would have a large negative balance.
That sounds about right to me as I'm thinking this out as I type...does that sound right to you?
Thank you very much! You're right in the challenges of this becoming a ballooning mistake in that it *shouldn't* become a compounding issue, but the correction itself can make one quarter look particularly bad.
My top line assumption was that annual delivery expenses were $4.36 billion, where $150 million would represent about 2 weeks of invoices (~80M per week), which seems pretty typical for invoice processing time. For now I'll work with your example figures, and assume that magically this business appeared from nowhere in month 1, with monthly expenses being exactly the same between months in an extremely simplified ledger system.
*Month 1*
Dr Delivery Expenses 100M
Cr Accounts Payable 100M
Description: Recognise invoices received in the month
Dr Delivery Expenses 10M
Cr Accrued Liabilities 10M
Description: Accrue for invoices not yet received
*Month 2*
Dr Accrued Liabilities 10M
Cr Delivery Expenses 10M
Description: Reverse prior month's accruals
Dr Accounts Payable 100M
Dr Delivery Expenses 50M
Cr Cash at Bank 150M
Description: Pay all invoices incurred in Month 1 including variances
Dr Delivery Expenses 100M
Cr Accounts Payable 100M
Description: Recognise invoices received in the month
Dr Delivery Expenses 10M
Cr Accrued Liabilities 10M
Description: Accrue for invoices not yet received
This leaves month 1's delivery expenses totalling $110M, and month 2's $150M. Even though they have "caught up" on last month's expenses, they have still under-accrued $40M! To actually correct, they would have had to increase their month 2 accrual to $50M, leaving the reported Delivery Expenses in month 2 as $190M - a 90% increase! If you repeat the cycle again in Month 3 it doesn't get any worse, but it doesn't get any better either (I guess it does diminish the month on month increase, but it paints a worrying trend).
Further to this and speaking to my original commentary: if the accountant wanted to "hide" month 2's result they could potentially do some *really* dodgy things like book a negative liability to reduce the costs in month 2 to match month 1's. Something like:
Dr Accrued Liabilities 40M
Cr Delivery Expenses 40M
Description: Adjust delivery expenses for suspected double billing pending investigation
This temporarily hides the previous month's screw up on the expense side while providing some cover on a balance sheet reconciliation, but how long something as blatant as a negative liability can last is hopefully "not very"!
Thanks so much for your detailed response, I just saw it. Your explanation of the 2 possible scenarios makes sense - he either completely mis-estimated the unbilled shipments OR he intentionally creative some contra-liability account (or a big debit in the accrued liabilities account) to show artificially lower delivery expenses.
The mechanics of this bookkeeping (estimating the accrued liability, then receiving the invoice, then adjusting the accruals) would suggest that it can't be a snowballing effect but rather a one-time issue that would rear its head every accounting cycle. There is also the fact that the quantity shipped would be pretty obvious for any given period so while underexpensing by $150M over a couple of years isn't a big deal, the correct comparison is really a $150M decrease in delivery expenses on a one-month basis, which would be huge.
It therefore seems to me that the only plausible explanation is intentional misreporting / fraud. If this was an innocent mistake to begin, then the month the mistake was made would show a dramatic decline in per unit delivery costs vs. prior month / prior year. This would raise red flags right away. If it didn't, then the problem would be obvious the next month when the actual invoices come in. And since this can't be a snowballing issue, he would have had to knowingly hide it until he got caught. What I don't understand is why say the logistics/shipping department would care about it at all (assuming they do) since correcting the mistake should not have much impact on the quarterly figures (only the month-over-month figures) and certainly not the annual figures.
Maybe I'm wildly extrapolating here and drawing the wrong conclusions but one inference from this if my reasoning is correct is that the logistics/shipping department at Macy's care a lot about monthly or perhaps weekly comps...
I think this explains it well, bravo! One question though - the cumulative impact of the missed accruals was $132-$154M. If the accountant here is just under-accruing in the Accrued Expenses bucket, the mistake would partially reverse as the invoices are paid out fully in cash right? I don't see how this can become a ballooning mistake.
For example, if $150M of goods are shipped and $100M of invoices are issued. The accountant debts Shipping Expense and credits AP for $100M . The accountant then only accrues say $10M of the $50M in unbilled shipping costs (debit $10M shipping expense, credit Accrued Expenses $10M). So the total shipping expense that hits the P&L for the period is $110M. Then next quarter when Macy's pays the $50M balance, the accountant reverses the $10M in Accrued Expenses liability with an offsetting $10M credit to the Cash account, but then there is $40M more in cash payments that need an offsetting debit entry. Which account would the accountant debit for this leg? They would create a liability account called something like "liability estimates revision" and debit it for $40M? So this account would have a negative balance. And they would run the same scheme each year so this account would have a large negative balance.
That sounds about right to me as I'm thinking this out as I type...does that sound right to you?
Thank you very much! You're right in the challenges of this becoming a ballooning mistake in that it *shouldn't* become a compounding issue, but the correction itself can make one quarter look particularly bad.
My top line assumption was that annual delivery expenses were $4.36 billion, where $150 million would represent about 2 weeks of invoices (~80M per week), which seems pretty typical for invoice processing time. For now I'll work with your example figures, and assume that magically this business appeared from nowhere in month 1, with monthly expenses being exactly the same between months in an extremely simplified ledger system.
*Month 1*
Dr Delivery Expenses 100M
Cr Accounts Payable 100M
Description: Recognise invoices received in the month
Dr Delivery Expenses 10M
Cr Accrued Liabilities 10M
Description: Accrue for invoices not yet received
*Month 2*
Dr Accrued Liabilities 10M
Cr Delivery Expenses 10M
Description: Reverse prior month's accruals
Dr Accounts Payable 100M
Dr Delivery Expenses 50M
Cr Cash at Bank 150M
Description: Pay all invoices incurred in Month 1 including variances
Dr Delivery Expenses 100M
Cr Accounts Payable 100M
Description: Recognise invoices received in the month
Dr Delivery Expenses 10M
Cr Accrued Liabilities 10M
Description: Accrue for invoices not yet received
This leaves month 1's delivery expenses totalling $110M, and month 2's $150M. Even though they have "caught up" on last month's expenses, they have still under-accrued $40M! To actually correct, they would have had to increase their month 2 accrual to $50M, leaving the reported Delivery Expenses in month 2 as $190M - a 90% increase! If you repeat the cycle again in Month 3 it doesn't get any worse, but it doesn't get any better either (I guess it does diminish the month on month increase, but it paints a worrying trend).
Further to this and speaking to my original commentary: if the accountant wanted to "hide" month 2's result they could potentially do some *really* dodgy things like book a negative liability to reduce the costs in month 2 to match month 1's. Something like:
Dr Accrued Liabilities 40M
Cr Delivery Expenses 40M
Description: Adjust delivery expenses for suspected double billing pending investigation
This temporarily hides the previous month's screw up on the expense side while providing some cover on a balance sheet reconciliation, but how long something as blatant as a negative liability can last is hopefully "not very"!
Thanks so much for your detailed response, I just saw it. Your explanation of the 2 possible scenarios makes sense - he either completely mis-estimated the unbilled shipments OR he intentionally creative some contra-liability account (or a big debit in the accrued liabilities account) to show artificially lower delivery expenses.
The mechanics of this bookkeeping (estimating the accrued liability, then receiving the invoice, then adjusting the accruals) would suggest that it can't be a snowballing effect but rather a one-time issue that would rear its head every accounting cycle. There is also the fact that the quantity shipped would be pretty obvious for any given period so while underexpensing by $150M over a couple of years isn't a big deal, the correct comparison is really a $150M decrease in delivery expenses on a one-month basis, which would be huge.
It therefore seems to me that the only plausible explanation is intentional misreporting / fraud. If this was an innocent mistake to begin, then the month the mistake was made would show a dramatic decline in per unit delivery costs vs. prior month / prior year. This would raise red flags right away. If it didn't, then the problem would be obvious the next month when the actual invoices come in. And since this can't be a snowballing issue, he would have had to knowingly hide it until he got caught. What I don't understand is why say the logistics/shipping department would care about it at all (assuming they do) since correcting the mistake should not have much impact on the quarterly figures (only the month-over-month figures) and certainly not the annual figures.
Maybe I'm wildly extrapolating here and drawing the wrong conclusions but one inference from this if my reasoning is correct is that the logistics/shipping department at Macy's care a lot about monthly or perhaps weekly comps...