Financial reporting at Kraft Heinz – we cook it all!

SEC Charges The Kraft Heinz Company and Two Former Executives for Engaging in Years-Long Accounting Scheme, announces a recent news release

Here are some extracts:

  • The Securities and Exchange Commission today charged The Kraft Heinz Company with engaging in a long-running expense management scheme that resulted in the restatement of several years of financial reporting. The SEC also charged Kraft’s former Chief Operating Officer Eduardo Pelleissone and its former Chief Procurement Officer Klaus Hofmann for their misconduct related to the scheme.
  • According to the SEC’s order, from the last quarter of 2015 to the end of 2018, Kraft engaged in various types of accounting misconduct, including recognizing unearned discounts from suppliers and maintaining false and misleading supplier contracts, which improperly reduced the company’s cost of goods sold and allegedly achieved “cost savings.” Kraft, in turn, touted these purported savings to the market, which were widely covered by financial analysts. The accounting improprieties resulted in Kraft reporting inflated adjusted “EBITDA,” a key earnings performance metric for investors. In June 2019, after the SEC investigation commenced, Kraft restated its financials, correcting a total of $208 million in improperly-recognized cost savings arising out of nearly 300 transactions.
  • As alleged in the SEC’s order and in its complaint against Hofmann, Kraft failed to design and maintain effective internal accounting controls for its procurement division. As a result, finance and gatekeeping personnel repeatedly overlooked indications that expenses were being improperly accounted for. In addition, Pelleissone was presented with numerous warning signs that expenses were being managed through manipulated agreements with Kraft’s suppliers, but rather than addressing these risks, he pressured the procurement division to deliver unrealistic savings targets. Hofmann approved several improper supplier contracts used to further the misconduct despite numerous warning signs that procurement division employees were circumventing internal controls, and certified the accuracy and completeness of the procurement division’s financial statements when the misconduct was occurring. As a member of Kraft’s disclosure committee, Pelleissone then improperly approved the company’s financial statements.

The underlying order contains some interesting detail. For example, it describes a $3.5 million upfront payment made to KHC by a supplier, in exchange for it entering into a new three-year contract in 2015. The company recognized the amount in 2015, but, the SEC states: “this accounting treatment was improper because the final contract, (as) approved and signed, mischaracterized the true nature of the supplier payment by concealing the fact that the $3.5 million prebate payment remained linked to a three-year contract.” It’s a shame that the description of the issue isn’t a little clearer, but it’s an interesting reminder of how the introduction of IFRS 15 ended the legitimate up-front recognition of some such up-front payments (and of the detailed analysis that might now be required to identify the appropriate treatment for such a “prebate.”)

Here’s another variation on that theme:

  • …in 2017, for example, procurement division employees negotiated a $2 million prebate to KHC from a sugar supplier in exchange for a three-year contract extension and future sugar purchases. In addition, the agreement called for KHC to return the $2 million back to the supplier, in the form of paying higher prices for sugar over the three-year period. Thus, the agreement did not produce any actual cost savings. (Management) should have known the true structure of the transaction, including through their participation in monthly performance reviews, during which it was disclosed that the $2 million was tied to a contract extension and future volume purchases, but that KHC planned to recognize the full cost savings in August 2017.

The order contains yet more examples along the same lines. Overall, we’re told: “Out of the 295 transactions that KHC ultimately corrected in connection with the restatement, approximately 59 were part of the procurement division’s expense management misconduct.” No doubt this entailed any number of internal communications that (in classic ethics training manner) appear damning when exposed to the light of day, such as:

  • In one internal communication, for example, a member of KHC’s controller group acknowledged a procurement buyer’s effort to “jam [a] rebate in to help [KHC’s] results in 2017.” That member of the controller group took no steps to report this conduct to legal or compliance, nor to determine whether it was part of a larger practice within procurement.

The penalties imposed in response to all of this might prompt some lively debate – is the civil penalty of $62 million to be paid by Kraft a major sanction or (as one commentator termed it) a slap on the wrist; is it appropriate that while Hofmann was (subject to court approval of the settlement) barred from serving as an officer or director of a public company for five years, Pelleissone avoided such a consequence, while consenting to cease and desist from future violations and pay a civil penalty of $300,000 (which might also seem like, well, not very much). Anyway, it all makes for interesting, and of course cautionary, reading…

The opinions expressed are solely those of the author

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