Macy’s Missed Expenses Spark More Internal Control Concerns
But that repair job is just a first step to rebuild confidence of investors as auditors, and likely regulators, will be on the look-out for signs of other problems at the struggling retailer.
The recently reported control failures raise concerns over whether the company’s other financial statement guardrails, known as internal controls over financial reporting, are similarly at risk, likely triggering deeper scrutiny from auditors ahead of the retailer’s annual report next year.
“You are now saying that you can no longer rely on our internal controls report. That goes beyond small parcel delivery cost accounting—that speaks to the entirety of the financial environment,” said Jesse Silvertown, principal at forensic accounting firm The Ledge Company.
Internal controls serve as the foundation of a company’s financial reporting and are meant to ensure that investors can rely on their corporate accounting. Auditors also lean heavily on those controls and for large clients like Macy’s they test those financial reporting guardrails each year to make sure they provide an effective backstop.
The retailer and its auditor
Company officials have said that there was no theft and that the former employee, who masked delivery expenses, acted alone and sought no personal gain. Macy’s has declined to answer questions about its internal financial reporting safeguards.
“Integrity is paramount at Macy’s Inc., and we promote a culture of ethical conduct. When discovered, we move quickly to investigate and address the issue,” Tony Spring, chairman and CEO of Macy’s, said during an earnings call with analysts on Wednesday. “We’ve also identified and begun to implement additional controls to be a stronger and more disciplined organization so that an action like this could not happen again.”
A Material Weakness
Macy’s financial reporting guardrails didn’t account for employees that would falsify documents or make erroneous accounting entries, the company said.
To combat that risk recurring, the retailer is putting in place new safeguards that address the reliability and completeness of information used for accounting and manual adjustments related to delivery expenses and non-merchandise expenses. The company also took extra steps to ensure its accounting complies with US standards.
Macy’s hasn’t said whether other staff signed off on the ex-employee’s work—a redundant layer of review that serves as a common form of protection at US companies.
“But it does raise questions and issues of tone at the top. Was this person under so much duress that they needed to protect their division?” said Stacey Ritter, assistant accounting professor at Santa Clara University. “Does it seem like the type of place where people might look the other way because you’re trying to do what’s right for the company?”
Macy’s internal controls are likely to receive extra attention from its auditors at KPMG who will be tasked with ensuring that there aren’t other faults in the retailer’s safeguards and that the just-announced fixes work as intended.
The audit will likely require more work and could pressure the company to meet deadlines for it’s annual financial report, Silvertown said.
KPMG, meanwhile, will also face scrutiny from the US audit regulator, which will check whether the firm should have caught the accounting error and what steps it took to spot such a problem, Ritter said.
KPMG declined to comment.
SEC Scrutiny
“A sufficient investment in internal accounting controls is really important,” said Ryan Wolfe, chief accountant of the Securities and Exchange Commission’s enforcement division, in remarks Wednesday to an American Institute of Certified Public Accountants’ financial reporting conference in Washington. “If more companies are making the necessary investments in their internal accounting controls, more errors are going to be prevented and detected before they make it to investors.”
Wolfe declined to comment on Macy’s accounting woes, but he told the conference that commission staff look at every restatement. Promptly fixed errors are less likely to trigger an investigation, he noted.
The SEC also keeps a close eye on how companies report accounting restatements and whether they issue informal fixes or whether they reissue entire financial statements because investors could no longer rely on them. The agency’s top accountant has issued written guidance countering corporate justifications for relying on revisions to fix errors.
Macy’s described its delivery expense error as immaterial to past reporting periods and so the company didn’t need to reissue three years of financial statements to correct the misstatement. Instead, the company revised certain line items on the income statement and balance sheet disclosing the adjustments in a press release on Wednesday and its quarterly SEC filing issued on Thursday.
The errors didn’t affect the company’s debt covenant compliance, vendor payments, or cash flows, the company said.
“In one sense it’s a rounding error,” said Michelle Leder, editor of Footnoted.com. “But on the other hand, it’s a significant amount of money.”
Such a prominent correction stands apart from typical revisions. Known as “Little R” restatements, revisions are normally tucked quietly into the financial statement footnotes of an SEC filing with little fanfare or notice.
The company could just as easily have told investors not to rely on its past financial statements, what is known as a “Big R” restatement, with a very similar release, said Rachel Thompson, an assistant accounting professor at North Dakota State University.
Macy’s restatement choice could eventually trigger a comment letter from SEC staff asking how the retailer determined the error was ultimately immaterial, Thompson said.
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