Capsim Mini-Case

Mini Case Studies 1

Finance Why the rules are the rules

Mini Case Studies 2

Finance: Why the rules are the rules

According to the Organic Trade Association, sales of organic

food steadily growing since 2012. Americans spent $43.3

billion on organic products in 2015.

One company riding that wave is Hains Celestial Group

which sells organic food and personal care products through

distributors to thousands of retailers. For the first half of

2016, Hains Celestial saw its share price increase 32%. Then,

in August, it lost $1.3 billion from its market value overnight,

after announcing profit targets would not be met for the fiscal

year to June 30th and year-end results would be delayed.

All because of accounting.

Is it the market, or the reporting? Some commentators speculated Hains’ problems may flag a softening in the market for

consumer organics. Others said the loss of value was a temporary setback, making it a good

time to buy Hains Celestial shares. Whatever the final fallout, a company growing strongly

and selling some of the hottest products in the food industry hit a roadblock because of

accounting anomalies -- and it is far from the first.

The problem stemmed from the timing of Hains’ revenue reporting. When the company ships

product to a distributor, it books the revenue. Distributors receive concessions that Hains

applies according to a formula, rewarding them for high volumes sold in shorter periods.

“Since Hain recognizes revenue before the goods are sold, it needs to make an estimate of

how big those concessions will be,” said Fortune Magazine. According to the Wall St Journal:

“It is reviewing whether revenue associated with the concessions should continue to be

reported when products are shipped to distributors or recorded when the distributors sell

them to retailers.” Perhaps more worrying is the company’s admission that it needs “to assess

its internal controls over financial reporting.”

Some scope for flexibility Forbes pointed to another organic food company, Annie’s, that faced similar problems due to

accounting irregularities in 2014 but recovered quickly, and was bought by General Mills soon

after.

While there is some scope for individual companies and industries to incorporate unique

aspects of their businesses in their financial reporting, the rules of accounting – laid out in the

Generally Accepted Accounting Principles (GAAP) – are very strict. Clear rules means that

stakeholders – including shareholders, potential buyers and even governments – can make

consistent evaluations over time and between different companies.

“It is no longer sufficient merely to comply with accounting rules so that there is no technical breach;

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Investors require valid information “Investors do not like to be misled by fraudulent or dishonest managers who are economical

with the truth or bend it to their advantage,” warns Jenny Rayner, in Managing Reputational

Risk: Curbing Threats, Leveraging Opportunities (Wiley, September 11, 2003). “It is no longer

sufficient merely to comply with accounting rules so that there is no technical breach; to

restore confidence in the markets, investors also want companies to respect the spirit of the

standards.”

After the accounting and audit scandals that bankrupted Enron and WorldCom in the early

2000’s, new legislation in the U.S., the Sarbanes-Oxley Act, increased penalties for destroying,

altering, or fabricating records in federal investigations or for attempting to defraud

shareholders. The act also increased the accountability of auditing firms to remain unbiased

and independent of their clients. That makes it more difficult for fraud to go unpunished, but

as Hains Celestial discovered (to its detriment) any accounting irregularities can have serious

implications in the marketplace.

to restore confidence in the markets, investors also want companies to respect the spirit of the standards.”