Macy's: How this is possible for any company big or small

When Macy's is in the news right before the Thanksgiving holiday, most would expect the coverage to center around their Black Friday sales, or for the financially savvy readers, consumer-spending trends leading into up or down financial results for the company. This year, the accounting department said, "hold me beer" 154 million times.

Macy's was headquartered in Cincinnati, OH (not NYC as many would assume) from 1945 to 2020. With Cincinnati being my hometown, of course I am going to have an opinion, especially when the issue is in my realm of understanding.

The bright white building on the backside of every Cincinnati skyline picture will forever be in my mind "Macy's".

What Happened

Macy's found itself in the spotlight for all the wrong reasons. The company's accounting department made a whopping $132 mm error ($154 mm over three years) in a small package delivery accrued expense account. This misstep has sent shockwaves through the financial world and raised serious questions about internal controls, auditor responsibility, and the reliability of financial statements as a mechanism of investor confidence. 

Macy's $132 million mystery has auditing experts scratching their heads.

Macy's has the finger of fault pointed squarely at KPMG for not identifying the issue.

KPMG has the finger pointed right back at Macy's for not establishing a proper internal control environment

Investors are pointing fingers at both Macy's and KPMG asking them to get their s**t together and figure it out.

According to Macy's, it fired an individual who "intentionally made erroneous accounting accrual entries" and launched an investigation.

How I Think It Happened: SALY

Anyone who has been in an accounting role has heard the "SALY" acronym, "Same as Last Year". For as much money that has spent by firms and professional associations to challenge the moniker of the stereotypical accountant, accountants are creatures of habit. Many, albeit not all, lower-level staff accountants, audit staff, tax associates, and every intern in-between only know accounting as debits and credits. College accounting curriculums are boring . . . more boring than you are even imagining. Accounting students simply survive with no real-life knowledge of what they are supposed to do on their first day without the aid of an internship. So how do they learn? They look at what happened previously, try to understand why, ask some questions if they have the courage to do so, then regurgitate.

While I may be proven wrong, I take issue with the use of "intentionally", especially when it comes to an accrual entry. For the non-accountants, accrual means an estimate, but some estimates are better than others. 

• Most companies have payroll accruals, which if you know what everyone is paid and/or how many hours everyone works, that is an easy calculation. 

• Large equipment retailers may have warranty accruals which try to estimate the amount of warranty claims that its customers may present. These are more or less an educated guess because who really knows?

When I see "intentional" I interpret that as being a "fraudulent" activity, which has significant consequences in our world *cough cough* Enron *cough cough*.

Therefore, I would not be surprised if this turned out to be a staff accountant making an estimated entry for these shipping expenses. This type of entry should have been reviewed and signed off by a superior each time the entry was made. This is where we start to establish a control environment where individuals are reviewing other people's work to prevent lone individuals from unilaterally impacting the financial statement. 

Everyone is at fault, the company, the auditors, and the investing public:

• Macy's is at fault for not providing the appropriate training mechanisms to their teams, as well as not providing an environment for review and verification of reviews. 

• The auditors are at fault for not validating appropriate review controls. The auditors tend to work off the "SALY" approach just like company accountants. While I realize auditors cannot review every piece of detail within a company's accounting department, the "materiality" excuse has run its course. 

• The general investing public is also at fault for getting mad in the first place. Nobody was clamoring to burn people at the stake when such accrual entries were helping EPS. But the minute it turns south, everyone complains about their loss. The investing public needs to know this happens within every public company, and if they are relying on "accurate financial statements" as a mechanism of determining investment options, keep the blanket over your head. The best you are going to get is "directionally correct".

Implications To Your Business

This is the great debate of many small businesses whether to use the cash method of accounting or the accrual method of accounting. While many sole proprietors will opt for the cash method for simplicity’s sake, and the IRS has rules as to when companies must begin using the accrual method, many of the articles around this debacle have indicated there was no misappropriation of cash. Therefore, under a cash method of accounting, such an issue would never have existed.

It comes down to a comparison of economic income versus cash income. An easy way to think about it is a utility bill. The utility bill may run through the end of a calendar month (e.g. June 30th), but the payment may not be due until two weeks later (e.g. July 14th).  Under the accrual method, the expense is recognized as of June 30th because economically that expense has been incurred and the utility consumed by that date. Under the cash method, the expense is recognized when the bill is paid as that is when the cash leaves the business. Under this example, if the accountants of a business need to know what the profitability is at the end of June (i.e. the close of a month, quarter, or year), they may not necessarily have the invoice yet to know what the expense should be.  Therefore, they may use the previous month's expense as an estimate or look back and see what the monthly expense was in the previous year if there is significant volatility month-over-month. Either way, it becomes an educated guess and "directionally correct". In Macy's example, extrapolate this over the company's nearly 750 locations and you can imagine where a small error can lead to a significant error.

Absolutely, but companies trade off accuracy with timeliness. In this example, you would need to wait until the utility invoice comes in until they are able to report on the profitability of June. For one location that may not be significant, but for 750 locations that may be more burdensome. There are undoubtedly different billing cycles amongst their locations, and many of the expenses may be running through their landlord's CAM. For Macy's sake, they also have C-suite officers clamoring for numbers as quickly as possible so they can plan how they want to spin the results to Wall Street. Small business owners want to know what profitability looks like to determine how to plan out the rest of their year for purchases and hiring.

In a Macy's scenario, what if their sales have a 30-day or 60-day return policy? Accountants would need to wait until that time period has passed to fully understand what the return rate looks like on the sales for the month you are trying to close. Then there are scenarios/policies on how Macy's treats returns without receipts. If the company accepts such returns, even waiting until after the return policy may not give you 100% accuracy.

Conclusion: Learn To Live With It

The number of accountants in both the public and private spheres is shrinking year-by-year. Therefore, those who choose to move into the profession will be asked to handle more with less resources and less time.  Mistakes are undoubtedly going to happen, and in this current market, it is likely to happen more often. The only thing companies, auditors, and the general investing public can do to tamp it down is to remove the benefits of financial results. In doing so, we can remove the "intent" factor in providing inaccurate estimates. However, companies and investors want to see profitability as profitability turns into bonuses, raises, dividends, and higher yields. Until we prioritize accuracy over financial gains, the public will need to learn to take each occurrence with a grain of salt and hope that accountants maintain their morals and auditors can identify issues prior to results going to Wall Street.