Chapter 21

In July 2013, retail book giant Barnes & Noble created some headlines in the business press that were less than welcome. Earlier in the month, the company’s CEO resigned. By late July, the company released its annual report for the year ended April 27, 2013, and reported that financial statements for the previous two fiscal years were to be restated due to material errors resulting from inadequate controls over the accrual reconciliation process at its distribution centres. The audit report stated that the company had not maintained effective internal control over financial reporting. When the financial statements were released, the company’s share price immediately dropped by 5% to $17.51.

While the admission of internal control problems is certainly worrying to investors, the restatements made in the prior years actually improved the reported results. Cost of sales was reduced by $8.5 million in 2011 and by $6.7 million in 2012, which improved the reported profit and earnings per share amounts. However, more interesting was the adjustment to previously reported retained earnings. The company increased retained earnings by almost $95 million at the start of the 2011 fiscal year and reduced accounts payable by a similar amount. This had a significant positive effect on the company’s net equity position. However, despite the adjustments, the company was still experiencing current losses.

While an improvement in the balance sheet is generally viewed positively, in this case shareholders and regulators were not impressed. On December 6, 2013, the Securities and Exchange Commission (SEC) announced it would be investigating Barnes & Noble’s accounting practices, causing an immediate 11% drop in the share price. Then, on December 19, 2013, a shareholder launched a lawsuit against the company, claiming that the company had not properly exercised its fiduciary duties to its shareholders. By the end of December 2013, the share price had dropped by 25% from the price in July when the financial results were first reported.

Accounting is no different than any other activity that involves human judgment: errors can occur. And when errors in reported financial results come to light the effects can be profound. As seen in the example of Barnes & Noble, readers of financial statements can react negatively to the news of errors in previously reported results. As such, accountants need to be acutely aware of their responsibility to correct such errors and of their requirements to fully disclose such information. Changes in reported financial results, even if positive, can still cause a loss of confidence by the readers, and those readers may begin to doubt the integrity of other disclosures.

(Sources: Barnes & Noble, 2014; Dolmetsch, 2013; Solomon, 2013)