Dollar General - Hbs

Dollar General Case

1. Consider the $13.4 million of freight costs. What is the correct (GAAP) method of accounting for these? How did Dollar General in fact originally account for these costs? (Include in your answer a table of the effects on income in any years affected, both before and after tax, of the correct accounting and the accounting they originally used.

The correct GAAP method to account for freight costs is as an expense of Cost of Goods Sold (COGS) that occur at the time services are performed and completed. This is a cost of conducting on-going operations (in-bound supplies, distribution and re-distribution). The freight costs should be expensed as occurred which will be at the time invoice is received and approved for payment. The approval of these invoices concurs that services have been performed.

Dollar General should accrue for these expenses as payables liabilities, of which, they will pay via their cash asset account at the time the payable is due. The payment will be a decrease to cash and subsequent liability.

How in fact did Dollar General handle freight charges?

Dollar General states financial results for the end of January [through and including the 28th]. The freight charges in question occurred on January 28, 2000 and should have been reported in full during this fiscal year [2000].

Dollar General handled (SEC stated) freight charges as follows:

(1) Expense $4M in the next fiscal year [2001] on a monthly basis

(2) $1.3M moved to Dollar General's Misc. Accrued Liabilities Account

(3) $2.7M to bank clearing account

Total Reduction in COGS (from 1-3 above):

The result of the above handling of freight charges would have reduced the COGS and increased Net Income. The effects of this are as follows:

YE2000

Original NI 219.4

Restated NI 186.7

Effects on the COGS, irregardless of tax, are a straight pass-through and have direct increase on NI.

ILLUSTRATIVE:

YE2000 Original Correct Freight Cost Reporting

Total Revenue -- --

Total Cost *** 8 Increase in COGS

GP

Operating Income/Loss: 8 Decrease in Operating Income

NI from Continuing Operations: 219.4 211.4

*** Total Cost / COGS less $8M from improper reporting

TAX:

With the proper reporting of Freight Costs Operating Income / Loss would decrease by $8M (mis-allocated) assuming all other operating costs remained constant. Income Before Tax would decrease, as well as, the tax exposure (Income Tax Expense) due to a lower taxable base.

2. Comparing EPS originally reported above for each year, with restated EPS. Why is the restatement for the year ended January 29, 2001 so much larger than for the other two years? Is the larger size a direct result of the restatement or a "secondary effect?"

Year 2/3/2006 1/28/2005 1/30/2004 1/31/2003 2/1/2002 2/2/2001 1/28/2000 1/31/1999 1/29/1998 1/31/1997

EPS Diluted from Cont. Operations 1.08 1.04 0.89 0.79 0.62 0.21 0.65 0.54 0.43 0.34

As Reported EPS 1.08 1.04 0.89 0.79 0.62 0.21 0.65 0.54 0.43 0.34

EPS Before Restating * 0.62 0.65 0.54

*Note: The EPS must have been restated again after 2002, since the EPS above and taken from the latest Morningstar information, do not correspond to the values given in the Dollar General handout, except for 2001.

Answer: As we see above on the 10 Yr Income Table the year 2001 had an expense in the "Other" row. This $162 million was a pre-tax expense to settle the Company's restatement-related litigation, described in the Dollar General handout. This amount significantly reduced the Operating Income. Also in the 2001 column, notice that the Income Taxes are significantly lower by approximately $80 Million than they would have been without the pre-tax expense for litigation. In addition there is an increase of the Net Int Inc & Other of approximately $40 million for 2001, similar to that of 2002 and 2003, but more than 1999 and 2000. All of these combined to decrease the EPS; however the pre-tax litigation expense (approximately $80 million, net of taxes) was the major contributor of the ESP being less in 2001 than in the other restated years.

I believe that this item was a "secondary effect" of the restatement. Had the management not tried to defer expenses into 2002 to make 2001 EPS meet analysts expectations and their own predictions and gotten caught, then there would have been no litigation. The litigation was the "direct effect" of the restatement and the pre-tax charge was a result of the litigation and thus a "secondary effect".

3. Firm's executives:

The SEC alleged that Sanderson told one of his accounting managers to expense $4 million in the next fiscal year on a monthly basis. Of the remaining $9.4 million, Sanderson allegedly told his accountant to move $1.3 million to the company's Miscellaneous Accrued Liabilities, or "rainy day," account and $2.7 million to corporate bank clearing accounts.

Turner settled for a $1 disgorgement charge and a $1 million civil penalty. Carpenter settled for a total of $143,455 comprising $33,000 disgorgement, $10,455 prejudgment interest, and a civil penalty of $100,000. Sanderson settled for a total of $270,595 comprised of $150,000 disgorgement, $45,595 prejudgment interest, and a civil penalty of $75,000. Burr finally settled on April 12, 2006, for over $1.2 million in penalties.

All officers lost their jobs. Since Turner, Carpenter, and Sanderson all settled immediately, without