CASE 4.8
DELL INC.
Synopsis
Dropping out of college is a decision that most people ultimately live to regret. Michael Dell is
clearly one of the exceptions to that rule. Dell left the University of Texas after his freshman year so
that he could concentrate his time and effort on a new business that he had organized. That business
would ultimately become Dell Inc. By 2001, Dell Inc. was the largest PC maker in the world.
Michael Dell’s ownership interest in his company allowed him to accumulate a net worth of nearly
$15 billion by 2012, a figure that landed him in 22nd place on the Forbes 400.
By 2002, Dell’s business model was being undermined by the intense competition among PC
makers. Between 2002 and 2007, Dell concealed its deteriorating operating results with more than
$4 billion of “exclusivity payments” from Intel Corporation, the company that supplied the all–
important microprocessors for its PCs. Intel was more than willing to make those payments to Dell
in exchange for its commitment not to purchase microprocessors from any other company. Instead
of disclosing the nature and magnitude of the exclusivity payments in its periodic financial
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Dell Inc.—Key Facts
1. Michael Dell dropped out of the University of Texas after his freshman year to focus his time
and energy on a business that he had created, a business that would eventually become Dell Inc.
2. In 1992, Michael Dell became the youngest CEO of a Fortune 500 company; by 2001, Dell Inc.
was the largest PC maker in the world.
4. The critical feature of Dell Inc’s business model was its “Dell Direct” strategy of selling custom-
designed PCs directly to consumers who placed their purchase orders over the phone or the Internet.
5. Dell Inc. invested only modest amounts in research and development and instead focused on
6. By 2002, the increasingly competitive PC industry was undercutting Dell Inc.’s business model,
7. Intel Corporation, which supplied microprocessors for Dell’s computers, offered to make up
8. From 2002 to 2007, Intel made $4.3 billion of exclusivity payments to Dell; those payments
9. Dell did not disclose the nature or magnitude of the exclusivity payments; for accounting and
10. An SEC investigation revealed the exclusivity payments made by Intel to Dell and the improper
11. In 2010, the SEC fined Dell Inc. $100 million for its improper accounting and financial
reporting; Michael Dell was fined $4 million for his role in the accounting scam.
12. A class-action lawsuit filed by Dell’s stockholders named the company’s longtime audit firm,
PricewaterhouseCoopers, as one of the defendants; the lawsuit charged PwC with turning a “blind
eye” to Dell’s improper accounting and with numerous other violations of GAAS.
258 Case 4.8 Dell Inc.
Instructional Objectives
1. To identify auditors’ responsibilities to search for evidence of “earnings management” on the
part of their clients.
2. To identify management assertions violated by improper accounting and financial reporting
treatments applied by clients.
Suggestions for Use
The major accounting “scam” in this case is an unusual one in that it did not impact Dell Inc.’s
“bottom line.” The accounting treatment that Dell applied to the exclusivity payments received from
advertising expenses) near the end of a reporting period for the purpose of reaching a predetermined
earnings forecast is “okay.” Another controversial feature of earnings management is what role
should auditors should play in limiting the window-dressing activities of clients, particularly those
earnings management tactics that are “legal.”
Students should be made aware that earnings management is an important issue for the SEC.
Generally, the SEC defines earnings management as a “material and intentional misrepresentation”
of a given entity’s reported operating results. Given this definition, you might initiate discussion of
Suggested Solutions to Case Questions
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1. As noted in the Suggestions for Use, the SEC defines earnings management as a “material and
intentional misrepresentation” of a given entity’s reported operating results. In some sense, that may
be the “best” definition of “earnings management” given the SEC’s position of authority in the
financial reporting domain, however, many parties define that phrase less restrictively. For example,
the online business encyclopedia, Investopedia, defines earnings management as “The use of
accounting techniques to produce financial reports that may paint an overly positive picture of a
company’s business activities and financial position.” This latter definition is less restrictive than
the SEC’s definition because it doesn’t include a reference to materiality. I would suggest that the
latter definition of earnings management is the more widely accepted definition. Nevertheless, the
phrase is not explicitly defined by professional accounting standards.
accountants would disagree.
Do auditors’ responsibilities include actively searching for instances of earnings management on
the part of clients? My answer would be “Definitely” if we apply the SEC’s definition of earnings
management. That is, auditors clearly have a responsibility to search for intentional and material
misrepresentations of a client’s accounting data. If we accept the less restrictive definition of
earnings management, then it becomes more problematic to define auditors’ responsibility for the
2. Under the auditing standards of the PCAOB, the “valuation” and “presentation and disclosure”
assertions would be the key management assertions violated by Dell. One could also argue that the
“completeness” assertion was violated since Dell’s operating expenses were understated. Under the
assertion “regime” of AICPA Professional Standards, Dell would have violated the classification,
completeness, and accuracy assertions for transactions and the completeness assertion for
260 Case 4.8 Dell Inc.
prompt auditors to investigate a client’s earnings history in more depth to determine whether the
client is somehow sculpting its earnings. Finally, a standard audit test for major accounts payable
items is to reconcile the client’s year-end balance for those items to the year–end statements sent to
the client by the given vendors. This reconciliation procedure should have resulted in the auditors
discovering the large “spikes” in transaction activity between Dell and Intel near the end of financial
reporting periods. [Again, refer to the second Note below.] One could argue that the discovery of
those spikes should have prompted an investigation of them.
Note: Although the term “exclusivity payments” has been used almost exclusively within the
business press and in SEC releases in referring to the Intel-Dell transactions referred to in this case,
in reality those “payments” were mostly “credits” extended by Intel to Dell. That is, in most cases,
cash was not paid by Intel to Dell. Instead, Intel simply reduced the outstanding receivable balance
at the time owed to it by Dell. I didn’t believe this technicality was important enough to point out in
3. Here’s an example of a case question that you may perceive to be too “easy.” Obviously,
auditors have a responsibility to consider the overall integrity of a client’s business model and any
major developments within the client’s industry that may impact the integrity of that business model.
For example, in performing analytical tests, the professional auditing standards repeatedly suggest
that auditors must continually revisit their “understanding” of the client and its external environment
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on the viability of the client’s business model and industry.
4. The key ethical issue raised by exclusivity payments is that they may be anticompetitive. For
example, many parties argue that the exclusivity payments made by Intel to Dell diminished the
degree of competition in the microprocessor market by limiting or denying companies like AMD
access to the massive Dell account. Ultimately, exclusivity payments may create a monopoly that is
harmful to the consumers of the given product or service. In this case, for example, the higher
quality microprocessors allegedly being produced by AMD were not incorporated in Dell’s PCs
because of the exclusivity payments made by Intel to Dell.