Question

Monsanto Rounds Up $80 Million in Accounting Violations

ST. LOUIS (FEBRUARY 9, 2016)

BY MICHAEL COHN, Accounting today

The Securities and Exchange Commission said Tuesday that St. Louis-based agribusiness Monsanto Company has agreed to pay an $80 million penalty ….. to settle charges that it violated accounting rules and misstated company earnings pertaining to its flagship product Roundup.

An SEC investigation found Monsanto had insufficient internal accounting controls to properly account for millions of dollars in rebates offered to retailers and distributors of its herbicide Roundup after generic competition had undercut Monsanto’s prices and resulted in a significant loss of market share for Roundup. Monsanto booked substantial amounts of revenue resulting from sales incentivized by the rebate programs, but failed to recognize all of the related program costs at the same time. Therefore, Monsanto materially misstated its consolidated earnings in corporate filings during a three-year period….

The agribusiness giant has attracted controversy over the years for pressuring farms to buy its Roundup-resistant seeds every year and suing them if they re-use the seeds. The company has even sued farms where Roundup-resistant crops were found to be growing because the genetically modified seeds had blown over from neighboring farms. Monsanto has also faced lawsuits of its own for hiding the carcinogenic effects of a key ingredient in Roundup. Accounting violations are a relatively new area for Monsanto, however…

According to the SEC’s order instituting a settled administrative proceeding against Monsanto, accounting executives … and sales executives…began telling U.S. retailers in 2009 that if they “maximized” their Roundup purchases in the fourth quarter they could participate in a new rebate program in 2010. Executives developed talking points for Monsanto’s sales force to use when encouraging retailers to take advantage of the new rebate program and purchase significant amounts of Roundup in the fourth quarter of the company’s 2009 fiscal year….Approximately one-third of Monsanto’s U.S. sales of Roundup for the year occurred during that quarter.

The SEC contended that … U.S. GAAP required the company to record in 2009 a portion of Monsanto’s costs related to the rebate program, but Monsanto improperly delayed recording these costs until 2010.

Monsanto also offered rebates to distributors who met agreed-upon volume targets. However, late in the fiscal year, Monsanto reversed approximately $57.3 million of rebate costs that had been accrued under these agreements because certain distributors did not achieve their volume targets (at the urging of Monsanto). Monsanto then created a new rebate program to allow distributors to “earn back” the rebates they failed to attain in 2009 by meeting new targets in 2010. Under this new program, Monsanto paid $44.5 million in rebates to its two largest distributors as part of side agreements arranged by management, in which they were promised late in fiscal year 2009 that they would be paid the maximum rebate amounts regardless of target performance. Because the side agreements were reached in 2009, Monsanto was required under GAAP to record these rebates in 2009. But the company improperly deferred recording the rebate costs until 2010.

Monsanto repeated the program the following year and improperly accounted for $48 million in rebate costs in 2011 that should have been recorded in 2010, according to the SEC. Monsanto also improperly accounted for more than $56 million in rebates in 2010 and 2011 in Canada, France and Germany. They were booked as selling, general and administrative expenses rather than rebates, which boosted gross profits from Roundup in those countries…..

Monsanto said it cooperated with the SEC settlement…” (It) neither admitted nor denied the SEC’s allegations. Today’s announced settlement does not require any changes to the company’s historical financial statements due to our proactive efforts to restate our financials for the period at the center of the SEC’s investigation.”

She pointed out that that the $80 million civil penalty was fully reserved for and previously disclosed in the company’s financial statements for fiscal year 2015.

Miller also objected to how Monsanto has been characterized. “We do not pressure farmers into buying our products. Farmers have lots of choices and we must earn their business every year….. Additionally, Monsanto has never sued a farmer when trace amounts of our patented seeds or traits were present in the farmer’s field as an accident or as a result of inadvertent means. …

Despite lawsuits against Monsanto over its ingredients, Miller contended that glyphosate (a key ingredient in Roundup) does not cause cancer. “Glyphosate is a vital tool for agriculture with a more than 40-year history of safe use,” she said. “Glyphosate has been the subject of hundreds of detailed health and safety studies – making it one of the most thoroughly studied herbicides on the market….”

…(Executives) agreed to pay penalties of $55,000, $50,000 and $30,000 respectively, and agreed to be suspended from appearing and practicing before the SEC as an accountant (for a period of time)….

The SEC’s investigation found no personal misconduct by Monsanto CEO …who reimbursed the company $3,165,852 and $728,843, respectively, for cash bonuses and certain stock awards they received during the period when the company committed accounting violations. Therefore, it wasn’t necessary for the SEC to pursue a clawback action under Section 304 of the Sarbanes-Oxley Act.

1)     Audit theory says that the risk of material misstatement is a component of inherent risk and control risk. Assume you are the auditor for Monsanto for 2009. Discuss ways in which the auditors could have been become aware of inherent risks of material misstatement during the planning stage. Identify key inherent risks as evidenced in the reading.

2)     What accounts (based on what is described in the narrative) are over or understated? Where do the accounts fit within the scope of these accounting elements – current assets, long-term assets, current liabilities, long-term liabilities, contributed capital, accumulated other comprehensive income and retained earnings?   Indicate the account, its position in the elements, whether or not it is over or understated, and discuss the specific financial statement assertion violated.

3)     Discuss what happened in terms of the fraud triangle.

4)     What do you think about the PCAOB’s role in this matter?

Answer 1

1. The key inherent risks evident through the reading are:

• Insufficient internal accounting controls to properly account for millions of dollars in rebates offered to retailers and distributors of its herbicide Roundup.
• Failed to recognize all of the related program costs at the same time, despite generating great sales revenue.
• Misstating consolidated earnings in the three-year report
• Attracting controversies and facing different lawsuits every now and then because of ample matters.
• Degraded quality products and therefore consumer trust.
• Failure of reaching volume targets and bad management and managerial practices in the system.

Ways in which the auditors could have become aware of the inherent risks of material misstatement during the planning stage:

• Breakdown of capital and revenue expenditure and further seeing that they are recorded properly in financial statements too.
• Proper inventory and cost management
• Review the level of expectations and discuss it with the management.
• Detailed testing of all book values to ensure that they are properly recorded.
• Detailed study of cost and net realizable value of the inventory.
• Maintain professional skepticism and carefully review judgemental decisions to make the company's image same as before
• Monitor and control activities.

2. Revenues from Roundup in 2009-2010 were 3,527mn and impact of costs attributed to revenue programmes were 44.5 mn and 4 mn. It overstated its revenues by 44.5 million in 2009 and didn't record the cost and recorded it as a deduction in 2010.

In 2010, it overstated its revenues by 48mn, and again repeated the same procedure of not recording cost and claiming the deduction in 2011. Also, it understated its revenue by 44 mn as it had accounted for the round-off cost of 2009 in 2010 which should be ideally recorded in 2009. The net effect is an overstatement of 4 mn.

Financial statement assertions in the case are:

• Accuracy
• Completeness
• Cut-off
• Rights and obligations
• Valuation
• Understandability

3. Fraud triangle is a framework designed to explain the decision to commit the ultimate fraud.

The three stages are pressure, opportunity and, rationalization.

Pressure: In this case, the pressure arose because of the costs climbing up soon and debt and many financial issues.

Opportunity: The opportunity arose because of not so stringent rules and regulations and also the way of settling the losses.

Rationalization: Internal and external factors affecting them such as devaluation the products and firm, piling of suits and this they thought may justify or mitigate or minimize their losses and reputation too.

4. The PCAOB has four primary functions in overseeing these auditors: registration, inspection, standard setting, and enforcement.

To promote federal securities laws and to see if the auditors are complying with it and for investor protection

Inspection of books of accounts of the firm.

Communication of critical audit matters

Clarifying auditors role

Matters communicated or required to be communicated to the audit committee and that: (1) relate to accounts or disclosures that are material to the financial statements; and (2) involved especially challenging, subjective, or complex auditor judgment.