During the fourth quarter of 2010 Green Mountain Coffee Roasters had some accounting irregularities become known to the public. Green Mountain’s problems all started from how they recognized income, though intercompany inventory and third party vendor. After the SEC inquiry, Green Mountain’s accounting irregularities spanned three fiscal years and three fiscal quarters. Starting with fiscal year 2007 and running through the third fiscal quarter of 2010. In total Green Mountain had five areas of their financial statements in which they did not follow GAAP. The first issue overstated $7.6 million dollars of inventory during the time period, because of an incorrect standard of cost (Dulong, 2010). Next they had a $1.4 million overstated income, because of incorrect accrual amount of incentive programs expenses. Third issue overstated income by $1 million dollars, because of timing classification of historical revenue royalties from third party vendors. Fourth issue overstated $800,000 of income, because of incorrect standards for intercompany inventory cost. Fifth is an understated income of $700,000, because of a failure to reverse accrual customer incentive program. All amounts in this report are amount of pre-income tax earnings.
Rule During this time period Green Mountain has violated three rules from the FASB accounting standards codification: inventory measurement, revenue recognition and multi element revenue recognition. Although the SEC had found more problems than just three, the issues at Green Mountain can be classified into these three areas. The SEC did conduct an 18 month inquiry only, into the financial statements of Green Mountain, costing the company about $4 million dollars (10-k form, 2011) . The first FASB code violated is 330-10-35 or Topic-inventory, Subtopic-overall, Section-subsequent measurement (FASB ASC 330-10-35). During the SEC inquiry, Green Mountain had overstated their inventory totaling $8.4 million during the fiscal years. Green Mountain had overstated its inventory two difference ways. With the net result is being an overstated net income, during the company’s record profit and double digit growth years, creating a high dividend for investors.
Second FASB code violated is 605-15-25 or Topic-revenue recognition, Subtopic-products, Section-recognition (FASB ASC 605-15-25). With this violation Green Mountain had under accrual incentive programs by $1.4 million dollars and also over accrual incentive programs by $700,000 dollars. Green Mountain had a net overstated income by $700,000 dollars during the fiscal years. Since Green Mountain has taken the “Razor and Blade” sales method, this is an important violation for their investors (Mchugh, 2012). The Razor and Blade sales method is where Gillette brand razors are sold at cost but the company makes its money when the consumer buys the blade. For Green Mountain they are selling the coffee maker at cost, while they hold the patent rights to the K-cup that fits into the coffee maker.
The last FASB rule violates is 605-25-25 or Topic-revenue recognition, Subtopic-multiple-element arrangements, Section-recognition (FASB ASC 605-25-25). This violation is from Green Mountain not having the correct cumulative revenue recognition of royalties from a third party vendor. Green Mountain had overstated their income by $1 million dollar form this error, once again overstating the net income of the company.
Analysis Green Mountain was known for being a responsible company prior to the inquiry, where they managed the production from bean to brewer. Also Green Mountain has claimed that the support only responsible farming practices, proven by their coffees being “Fair Trade Certified”. The restating of their financial records has hurt their image but only for a little while since their stock has rebounded.
“Channel Surfing” is what one blogger has accused Green Mountain of doing (Flitter, 2012). The inflation of sales and earnings is Channel Surfing; this is done to make a company seem more profitable than actual. The facts are that, yes they did go through an SEC inquiry for 18 months. There was no charges filed by the SEC and all Green Mountain did was restate their financial statement at an expense to the company’s bottom line. The company image does now have a blemish on it and they don’t have the same public support they once had. The stockholder did file a lawsuit against Green Mountain, but the judges throw the case out of court.
Green Mountain had a net profit of $79 million in 2010 and $199 million in 2011, the years affected by the SEC investigation. Between the adjustment and cost of inquiry Green Mountain had a $14.1 million dollar expense. This is a big expense to the company but it is something they have recovered from and their stock is climbing and no one has gone to jail for criminal actions.
Conclusion Green Mountain did not act like a responsible company in regards to its accounting practices, but they have straighten up there polices since the inquiry. I believe that they were trying to see how much they could get away with for revenue recognition and once caught they have followed the FASB code since then. The business model they are using for sales method is a risky game, because of patents expiring and this might be part of the motivation behind the revenue recognition policies.