Scrutinizing Accounting in the Retail Industry

The ever-changing world of vendor accounting is particularly susceptible to abuse. It is no surprise that under the increased scrutiny of the Sarbanes-Oxley era, problems with vendor accounting are affecting the retail industry as demonstrated by a probe by the Securities and Exchange Commission (SEC) into retail giant Saks, Inc.

Saks announced in March that the SEC was probing vendor markdown allowances and the adequacy of Saks internal investigation into the matter at one of six merchandising divisions of it Saks Fifth Avenue stores. Based on a preliminary estimate made during the investigation in 2002, Saks improperly collected as much as $21.5 million in markdown allowances between 1999 and 2003. The company said it would reimburse or compensate vendors and restate its annual earnings. Before Sarbanes-Oxley, it might have ended there.

The implementation of Sarbanes-Oxley Section 404 Rules requires companies to document controls over processes like the markdown allowances at issue in the Saks case. Markdown allowances allow retailers to demand more money from their suppliers if an item is sold for less than anticipated. In the past, such common arrangements were not documented or part of contractual agreements.

The Financial Accounting Standards Board (FASB) issued additional rules two years ago in an attempt to standardize how companies account for vendor money, especially markdown allowances. The SEC is interested because the income owed by vendors to retailers is significant within the industry.

Some worry that if the markdown allowance practice is widespread, other retailers could be affected by the Saks probe.

“This is how the scandal started in food,” Howard Davidowitz, chairman of Davidowitz & Associates Inc., a retail investment banking boutiques in New York, told the Investment Dealers’ Digest. “It started with one company, but pretty soon almost every food company was making massive adjustments, and, by the way, a bunch of people went to jail.”

Unlike the scandal in the food industry, which revolved around fictitious rebates of promotional allowances, the Saks probe revolves around markdown allowances. Markdown allowances are unique because they occur after an item is sold to a store. If the store doesn’t realize the anticipated profit, it goes back to the vendor and demands the difference.

Market experts say that markdown allowances are a major issue within the industry and that it is unlikely the probes will end with Saks.

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