Two Years Later, Dell Stays Mum on Accounting Probe

By Michelle Kessler

SAN FRANCISCO — A Securities and Exchange Commission probe into Dell’s accounting is more than 2 years old — and the PC giant won’t say when it might be over.

Dell (DELL) has revealed very little about its accounting problem, which first piqued the SEC’s interest in August 2005. An internal investigation is “moving into its final stages,” Dell spokesman David Frink says. “We’re doing a rigorous and thorough review. We’re not going to say anything beyond that.”

That leaves investors and customers wondering how big the problem is, says tech analyst Martin Reynolds at researcher Gartner. “We really don’t know what’s going on,” he says.

Most have taken the investigation in stride so far. Dell’s shares have risen 16% since the investigation was announced a year ago. But the accounting woes could be a big distraction if they continue — or prove to be bigger than thought, Reynolds says. Dell doesn’t need that. It is already struggling, losing market share to Hewlett-Packard and seeing its once-cushy profit margins decline, he says.

Kenneth Goldmann, a partner at accounting firm J.H. Cohn, and other accounting experts say it’s possible to make an educated guess about what’s wrong at Dell, based on the little bit of information it has released. Dell has put out statements saying accounting issues are related to “revenue recognition” and “accruals, reserves and other balance-sheet items.”

That likely means Dell has uncovered problems with the way it saved up for a rainy day, says Tracy Coenen of Sequence Inc. Forensic Accounting. (Forensic accountants review corporate financials to uncover problems.) Potential issues:

Sales. Deciding when to record a sale is harder than it sounds. Let’s say a company buys 100 Dell PCs, to be delivered in 30 days. Is the sale recorded when the order is placed? When the computers are delivered? Or when the company pays for them

In accounting, such questions are governed under revenue-recognition rules. These rules are complex and sometimes misunderstood — or fudged, Goldmann says.

That’s because public companies usually make predictions to Wall Street about how much money they’ll make in a quarter. If a company is having trouble meeting those numbers, it might recognize some revenue early to influence the results, Goldmann says. Sometimes that’s allowed under accounting rules, but other times it’s not, he says.

One such area where Dell may have run into trouble is its partnership with chipmaker Intel, Reynolds says. Intel often strikes partnerships with the computer makers who buy its chips. In a typical deal, Intel will pay a PC maker to feature information about its chips in their advertisements, Reynolds says. (That’s why many PC ads feature the “Intel inside” logo.) A shareholder lawsuit filed in January alleges that Dell improperly accounted for as much $1 billion a year from Intel. Dell declined to comment on the case.

Warranties. When customers buy extended warranties, they usually pay upfront. The PC maker typically sets aside some of that money to pay for warranty repairs in years to come, Coenen says.

Since nobody knows for sure how many repairs will be needed, the amount set aside is a guess. That’s called a reserve. Sometimes reserves become too big or small, so accounting rules allow companies to take money in or out, she says.

Problems emerge when a reserve becomes a “cookie jar” used to prop up a bad quarter or downplay a good one, Coenen says. “You can use those accounts to manipulate your results,” she says.

Whatever the problem at Dell, it remains unclear who is to blame. Dell has said it uncovered “evidence of misconduct,” but provided no details. CEO Kevin Rollins resigned in January; founder Michael Dell returned to run the company.

The company stopped filing quarterly reports with the SEC in June 2006. Since then it has released limited sales information via press release each quarter, but has stopped holding normal conference calls with analysts.

The silence puts Dell at risk of being delisted from the Nasdaq stock exchange. The Nasdaq must review any company that’s not making its SEC filings at least once every 90 days. So far, it has only given Dell warnings. That’s likely to continue, says Therese Pritchard, a securities lawyer at Bryan Cave who formerly worked for the SEC.

Wall Street and the SEC both understand that complicated accounting problems can take a long time to unravel, she says. Dell is likely reviewing years of transactions — perhaps tens of thousands of individual sales — to uncover what went wrong, she says.

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