Monsanto’s SEC Penalty for Improper Rebate Accounting

by March 28, 2016

This is one of a series of articles focused on financial accounting disclosures and how you as a reporter can interpret and report on them. The first four articles (see related links) introduce the financial accounting concepts utilized in this and future articles. If you have a topic you are interested in, post your request in the comments or email me at steven.orpurt@asu.edu.

Monsanto Violates Rebate Accounting

On Feb. 9, 2016, the United States Securities and Exchange Commission (SEC) announced that Monsanto Co. agreed to pay an $80 million penalty for violating generally accepted accounting principles (GAAP) with regards to rebates on sales of one of its flagship products, the weed killer Roundup. Let’s learn from the situation.

Recall from our first articles (links below) that financial accounting following GAAP measures wealth created. Specifically, net income measures wealth created by an entity over a period of time (typically a year or quarter of a year for U.S. public companies). The statement of income lists gross wealth inflows (revenues and gains) less gross wealth outflows (expenses and losses). Importantly, following GAAP, financial accounting measures wealth created conservatively. Conservative accounting means that wealth outflows are recorded sooner, and with more estimates, in an entity’s wealth creation process than wealth inflows.

To measure wealth created, Monsanto needed to ask itself, ‘What is the actual selling price of Roundup to our customers?’ An alternative way to ask this question is, ‘What is the actual wealth inflow from selling Roundup to our customers?’ Apparently, Monsanto’s managers asked themselves this question, but answered incorrectly. According to the SEC’s Feb. 9, 2016 press release, Monsanto sales personnel received approval from two Monsanto accounting executives (both CPAs) to “begin 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.”

Given the above statement, Monsanto effectively started the rebate program in 2009. As a reporter and user of financial statement information, you can reasonably assume that Monsanto’s customers bought Roundup in 2009 because they expected to receive, and Monsanto expected to pay them, a rebate. A detailed reading of the SEC Order confirms this idea. Therefore, the wealth inflow from Roundup sales in 2009 was the gross selling price, less expected rebate amounts. Monsanto failed to record the expected rebate amounts as a wealth outflow in 2009, instead recording them in 2010. They then repeated this accounting approach in ensuing years. Sales revenue and thus net income were then overstated for 2009 (and 2010 and 2011 according to the SEC Order).

As a reporter learning about this situation, either from Monsanto sales personnel or perhaps retailers, you can immediately start asking questions from the perspective of wealth creation. Note that understanding formal and complicated GAAP standards isn’t necessary. Here, you could follow your intuition.

Potential questions you might ask include:

  • Learning that customers bought Roundup anticipating a rebate, you might ask, “How did Monsanto account for the rebate program in 2009?”
  • Upon learning that Roundup sales were up in the 2009 fourth quarter, “Why offer a rebate program in 2010?”
  • “What does a rebate program indicate about near-term and long-term sales of Roundup?”
  • “What was the cause of the increase in Roundup sales during the fourth quarter of 2009 if it wasn’t customers anticipating a rebate?”

Managers are always motivated to bend their interpretations of GAAP. In the case of Monsanto, ignoring the rebates in 2009 allowed it to show higher net earnings than otherwise, and the difference just happened to allow it to meet security analysts’ consensus earnings forecasts for fiscal year 2009. Bonuses, promotions and other awards are often tied to meeting security analysts’ expectations.

More generally, an entity manipulating sales revenue near year end to reach annual financial targets is, as SEC Chair Mary Jo White stated in the Monsanto SEC press release, “the latest page from a well-worn playbook of accounting misstatements.” As a reporter and user of financial information, always look for exceptional sales revenue increases near an entity’s year end, and/or look for new, accommodating behavior shortly after year end. Then, ask why that unusual behavior might occur. In Monsanto’s case, one-third of its U.S. sales of Roundup occurred in the fourth quarter of 2009, an unusually high amount, particularly since Monsanto has an Aug. 31 fiscal year end coinciding with the end-of-summer weed growing season. One would reasonably expect fewer sales of weed killer at this time of year.

You could also reasonably ask why the external auditors were unaware of Monsanto’s improper accounting for rebates. The detailed SEC Order indicates that Deloitte & Touche, LLP did ask Monsanto’s accounting management about the rebates, but management told customers of the rebate just before year end. The auditors then assumed that Monsanto’s customers’ purchases of Roundup in 2009 were not incentivized by the rebate program. Had they communicated with customers, or further investigated the increase in Roundup sales near the 2009 year end, perhaps communicating directly with Monsanto’s sales force, they might have discovered Monsanto’s improper accounting.

The technical details of Monsanto’s rebate accounting are well described in the SEC Order. Even if you are inexperienced with accounting and financial statement analysis, reading the SEC Order will likely be educational.

The SEC press release, and having all SEC press announcements emailed to you, provide another rich source of potential financial stories.