Financial Statement Restatement and Ethics

Introduction

Hertz, the international car rental company, recently restated their financial report for the period 2012 – 2013. In 2014, after announcing the intention to restate, the company’s shares declined from a peak in July 2007. According to Hertz, (2015), the misstatements in 2013, showed a $349 million reduction in pre-tax profit in the period up to December 31, 2013.

Factors that contributed to the financial statement restatement

In November, 2014, the Audit Committee and Hertz management found adjustments of the 2012-2013 reports to be material and therefore be restated. The main cause of the misstatements was control deficiencies, especially in its Brazilian operations. The company made some misstatements worth $46 million during the last quarter of 2013 relating to its previous consolidated statements for the period ending 2012. Overall consolidated financial statements misstatement was worth $35 million. Pre-tax adjustments on vendor incentives cost $2 million, which had been entered as reduced marketing expenses instead of decreased earnings on equipment. In Brazil, Hertz had not charged some assets and allowances in doubtful accounts, which reduced pre-tax income by $4 million. Immaterial misstatements cost $3 million. The problem of control deficiencies would have been avoided if the company had deployed competent personnel and used standard and correct formulae in all its branches.

The company’s report was misstated on capitalization and timing of depreciation for non-fleet assets and allowances. The Brazil operations included misstatements on allowances, obligations without invoice, fleet depreciation, non-fleet vendors, information technology, non-fleet capital expenditures, and vehicle salvage, amortization period of vehicle registration and licenses, and inaccurate reserve estimates. Other misstatements included litigation, intercompany accounts, accrued travel vouchers, unbilled revenues and restoration of rental properties at the end of a lease, refurbishment costs and probable charge back on credit cards. Hertz should have had tighter monitoring of it Brazilian operations, approach to billing systems, asset valuation and depreciation methods.

Report by Hertz stated that misstatements were partly because the top management was unresponsive to accounting queries, and inconsistent with company accounting policies. The CEO was abrasive in style, demanding unrealistic targets from employees like meeting internal budgets, adjusting estimates and making potentially risky business plans. They in turn made misleading entries, and failed to disclose necessary information for effective review of account entries and transactions.

Legacy accounting environments such as unclear reporting lines, unqualified personnel, and lack of decisional authority impended initiatives and created conflict, leading to inefficient systems. Hertz should have engaged competent managers and given them free space to articulate their ideas (Hertz, 2015). When they instituted an internal, forensic investigation, using external and independent counsels. The company then reviewed its financial records and identified some control deficiencies.  These included risk assessment, information, monitoring and communication. Specific restatement adjustments included the following;

In the car rental division, Doubtful Accounts/Credit Memos used historical methods that led to inaccurate rates of write-off for receivables, different credit risk assessments, wrongly assumed reserve levels for credit memos, and managerial bullying, leading to a cumulative misstatement of $7 million in US and $12 million in Brazil. In equipment rental division, Doubtful Accounts/Credit memos used historical methods with unsupported assumptions, formula errors, and harsh managerial style that contributed to misstatement of $8 million.

When assessing damage receivables from third parties the company used estimated unbilled balances, unsupported assumptions like write-offs instead of collecting history, wrong formulae to calculate claims, and abrasive management tone, which led to restatement of $48 million in US and $8 million globally.

Impact on Stock Price

As published in Google Finance, (2015), the company’s stock price was $26.7 in July 2007, $1.55 in November 2008, gradually rose to $17.21 in April 2011 and to $27.4 in July 2013, and eventually to a record $30.6 in August 2014. When the company announced intentions to restate in July 2014, there was a sharp decline immediately, but a steady rise over the last quarter.  Before and after the restated report was released in July 2015, the value declined, and is still low but gradually rising. One may therefore conclude that the company’s restatement, a change in top management in the company branches, and a $300 million cost-saving measure outlined in the financial report of July 2015, have led to a sustained investor confidence in the management.

Evaluation of Restatement on Management Ethical Violations According Sarbanes-Oxley Act

Sox Online, (2015), states that in section 13(a) and 15(d), the principal financial officer takes responsibility for any entries in the financial report. In the restatement, the company admits to “inappropriate management tone” or bullying of junior officers, leading them to make misleading entries, as highlighted in the Brazilian operations.

In section 302, the Sarbanes-Oxley rules include US companies’ international operations for example where the CEO was held accountable for the misstatements in the Brazilian operations.

The company should comply with accounting standards and updates by harmonizing its accounting policies in all territories with national accounting regulations. The company should also update its standards to acceptable norms. Hertz’s problem involved use of legacy standards and wrong formulae that led to wrong conclusions on depreciation, and outdated assumptions in its forecasting of future earnings.

References

Google Finance, (2015). Hertz Global Holdings Inc: NYSE:HTZ quotes & news – Google Finance. Google.com. Retrieved 13 October 2015, from https://www.google.com/finance?q=NYSE:HTZ

Hertz, (2015). Hertz.com Investor Room  – Financials. Ir.hertz.com. Retrieved 13 October 2015, from http://ir.hertz.com/financials

SOX Online, (2015). The Act Table of Contents. Sox-online.com. Retrieved 13 October 2015, from http://www.sox-online.com/act_toc.html