homes was the sixth largest U.S. home builder during the 1998-2006 housing
boom. Like other major home builders,
Beazer’s market value grew by a factor of 8-10 during that period. However, the new home market slowed in 2006
and then collapsed in 2007.
SEC alleged that Michael T. Rand, Beazer’s chief accounting officer,
understated Beazer’s reported profits in every quarter but one from 2000
through 2005 by understating Beazer’s “land inventory” account and by
overstating its “cost to complete” reserve.
The SEC further alleged that during each of the four quarters in 2006,
and in the first quarter of 2007, Mr. Rand increased Beazer’s reported profits
by increasing the “land inventory” account, decreasing the “cost to complete”
reserve, and fraudulently recording sale-and-leaseback transactions for model
case provides an excellent overview of the U.S. housing boom and collapse. It can be used prior to New Century Financial
Corp (Chapter 3), which covers the collapse of a sub-prime and Alt A mortgage
lender. The case is also excellent for
covering the practical issues of accrual accounting in uncertain environments.
SEC charges imply that it is relatively simple to estimate the value of the firm’s
“land inventory” and “cost to complete” accounts. When a home builder acquires land for a new
housing development, some land is set aside for streets and sidewalks, some for
parks or lakes, and some for open space near busy roads. The builder then subdivides the remaining
land into lots it hopes to sell. Lots
near a park or lake are more desirable, while lots near the entrance to a
subdivision are typically less desirable.
Someone assigned a cost of the land to individual lots, and that
assignment process is clearly arbitrary.
In addition, as the property becomes more or less desirable, the
remaining land becomes more or less valuable than when the firm first estimated
the value of each lot. The SEC’s
complaint made the valuation process seem far more objective than it is in
cost-to-complete reserve covers the cost to complete sold homes. That includes, for example, cracked driveways
or basement floors, leaking faucets, roofs, or windows, or faulty painting or
landscaping. The average cost per home
might be $5,000 or $10,000, depending on the home cost and the history of the
development. After 6-12 months, the
allowance for a particular home might be reduced to zero as the warranty
expired or as the likelihood of claims declined. The SEC complaint made that valuation process
seem far more objective than it is in practice, particularly for a rapidly
growing firm that almost certainly was relying on less experienced managers and
workers, and less experienced accountants.
case also covers a sale-and-leaseback transaction. Those accounting rules are complex, so again,
it might not be clear that Mr. Rand engaged in fraud.
the cumulative alleged profit understatement for 2000-2005 was about $72
million for a firm that had about $2 billion of operating profits. In addition, during nine quarters from
2007-2009, Beazer recorded about $1 billion of impairment charges. Given the implicit subjectivity in those nine
impairment charges, it seems highly likely that the “land inventory” and “cost
to complete” accounts were also highly subjective numbers.
use this case to consider the subjectivity of various accrual accounts. I also use it to consider who would make the
accrual calculations. Beazer constructed
housing developments throughout the nation.
Michael T. Rand almost certainly was not personally responsible for
preparing accrual estimates at the operating level.
each of the accounting issues discussed in the body of Case 9:
- Discuss whether it
seems likely that Dell recorded the transaction improperly to manipulate
results or whether it was more likely an honest mistake (e.g., Dell did
not know about the rule; the implementation relied on judgment and the
investigators had the benefit of hindsight; or the sheer volume of
low-value orders Dell ships each day makes it very difficult to properly
implement these detailed rules).
- Discuss whether the
error addressed in Part 1 of this discussion is material and should have
been disclosed. Review the accounting changes and internal control
procedures that Dell proposed, and evaluate those changes in terms of
their probable costs and benefits
make sure that the bullet point and solution is together and that the solution
is at least a paragraph long