Dell\'s, Inc. Accounting Fraud

DELL INC. FRAUD

Business practices came under fire when America's seventh largest firm Enron collapsed due to unethical accounting strategies. This case triggered a series of unwelcome events where one after the other, large organizations in the U.S. collapsed or run for bankruptcy cover with one case even implicated the infamous Martha Stewart for insider trading. The various deceitful activities of some larger companies resulted in widespread public mistrust of business practices and values. Companies as big as Adelphia, ENRON, Global Crossing, Kmart, Qwest communications, WorldCom and Xerox are all under thorough investigation by one of the few reliable authorities, Securities and Exchange Commission (Royal Bank of Scotland). All the aforementioned names were business of international repute that were charged with the unethical act of projecting inflated profits to trick stakeholders and earn higher profits and generate greater revenue from expensive stocks (Royal Bank of Scotland). WorldCom ran for insolvency in July 2002, making it one of the biggest bankruptcies of all times (Royal Bank of Scotland). Both World Com and ENRON hugely overstated their profits and hence committed the major crime of misleading stockholders.

Latest in this group has been Dell Inc. otherwise one of the most non-controversial large corporations. Accounting fraud refers to fraud made when declaring revenues made during one business year. This can multiply over time or may simply be a one-time incident but it is now happening more often than we ever knew before. Dell in 2010 failed to inform the SEC of exclusivity payments it received from the chip giant Intel in exchange of the agreement not to use chips made by rival AMD. The reason not many people would ever learn about Dell incident is because Dell kept it all very quiet and quickly resolved the issue by agreeing to pay $100 million as settlement fee for payments not disclosed. It neither agreed nor disagreed to the charges but simply agreed to pay a hefty amount to hush the entire matter.

This was not the first time though that Dell faced problems. An audit in 2003 also confirmed accounting irregularities which had been adjusted by 2007 but it was now in 2010 that government auditor found major irregularity in the form of failure to disclose payments which SEC asserts were the reason Dell was able to meet its earnings target. (Goldman, 2010)

The financial information presented to the users of account must adhere to certain standards and guidelines and should be a free of biasness or any inconsistency. The guidelines are stated in General Accepted Accounting Principles and every entity must adhere to them when issuing financial statements.

These include the principle of regularity or consistency, principle of non-compensation, principle of prudence, principle of continuity, principle of periodicity, representation in good faith and comparability over time and with other entities. The standard also requires the auditor to consider the effectiveness of the company's audit committee in evaluating the effectiveness of the company's internal control. As part of their internal control responsibilities, a company's principal executive and financial officers are responsible for designing (or overseeing the design of) the process for providing reasonable assurance of the reliability of the company's financial reporting and that the company's financial statements for external purposes are prepared in accordance with GAAP. A management must adopt procedures suited to the needs of a company to evaluate the design of internal control over financial reporting and test its effectiveness. A management must decide on a framework to evaluate the effectiveness of internal control over financial reporting. SEC rules require that the framework be "a suitable, recognized control framework" that has been "established by a body or group that has followed due-process procedures, including the broad distribution of the framework for public comment." Although other frameworks may comply with SEC criteria, the SEC has specifically stated that the framework in the 1992 report of the Committee of Sponsoring Organizations of the Treadway Commission satisfies the criteria. Dell failed to meet the GAAP standards on some occasions and in 2010, it had to face serious charges which were quickly settled for $100 million.

Now that we know the background it is important to understand why it happened and why it has been happening every so often with large corporations. The intense focus and stringent rules of Wall Street for companies to remain profitable consistently each and every year are something that needs serious revision. A company that doesn't get involved in some accounting irregularities might now be an exception and not a rule; since it is not possible to meet earnings targets each quarter without fail. What Dell did could be easily understood and in the long run even forgiven because this kind of fraud would keep happening if Wall Street continues to demand certain targets each quarter. (Hess 2010)

Dell's Michael Dell had been telling investors that his company's ability to meet earnings targets for 20 quarters was due to "superior operations" but it was later found that Dell's failure to disclose the magnitude of exclusivity payments were the main reason it was able to meet investor expectations for 20 quarters. It had nothing to do with strategy or superior operations management.

We need to pay closer attention to how this accounting fraud took place. In 2010 SEC accused Dell of presenting false information to its investors about how it was meeting earnings targets. The company had used the money made from its contract with Intel to pad its quarterly earnings, something that investors were never told. This was how Dell was able to surpass everyone's expectations. Any rebates issued to a company must be included in the financial statements and Dell was receiving rebates from Intel for not using any chips other than Intel's chips in its computers. These rebates can come under fire for violating anti-trust laws and hence were never disclosed. In order not to come under fire, Dell finally allowed AMD to become its second supplier, this led to a drastic decreased in rebates earned from Intel and Dell's financial health suffered. But investors or SEC never came to know about the magnitude of these payments or how they were being used. "Dell manipulated its accounting over an extended period to project financial results that the company wished it had achieved but could not…Dell was only able to meet Wall Street targets consistently during this period by breaking the rules." said Christopher Conte, associate director of the S.E.C.'s enforcement division, in a statement announcing the settlement.

It was said that without these payments, Dell's performance would not have been what it appeared to be during the past one decade. These exclusivity payments were an important part of company's earnings per share. They were only 10% of the total earnings in 2003 but then went up to 76% in 2007 which shows just how massive was the part played by exclusivity payments. In the period from 2003 and 2007, the payments amounted to $4.3 billion and while Dell and Intel developed a complex pricing system between them to show that these payments were meant to be something other than exclusivity payments.