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Case 5-9 Royal Ahold N.V. (Ahold)
Ahold is a publicly held company organized in the Netherlands with securities registered with
the SEC pursuant to Section 12(B) of the Exchange Act. Ahold’s securities trade on the NYSE
and are evidenced by American Depositary Receipts (ADRs). Today its common shares are sold
on NYSE Euronext.
Summary of the Charges against Ahold
On October 13, 2004, the SEC charged Royal Ahold N.V. (Ahold) with multiple violations of
Section 17(A) of the Securities Act, Section 10(B) of the Exchange Act, and Exchange Act Rule
10(B-5). Charges were also filed against three former top executives: Cees van der Hoeven, the
former CEO and chair of the executive board; A. Michael Meurs, the former CFO and executive
board member; and Jan Andreae, the former executive vice president and executive board
member. The commission also filed a related administrative action charging Roland Fahlin, a
former member of Ahold’s supervisory board and audit committee, with causing violations of the
reporting, books and records, and internal control provisions of the securities laws.
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Statement of Facts
The following summarizes the main facts of the case with respect to transactions between Ahold
and USF.
Budgeted Earnings Goals
From the time that it acquired USF in April 2000, Ahold and USF budgeted annual earnings
goals for USF. Compensation for USF executives was based on, among other things, USF’s
meeting or exceeding budgeted earnings targets. USF executives each received a substantial
Promotional Allowances
A significant portion of USF’s operating income was based on payments by its vendors, referred
to in various ways such as “promotional allowances,” “rebates,” “discounts,” and “program
money” (referred to below only as “promotional allowances”). During at least FY2001 and
FY2002, USF made no significant profit on most of its end sales to its customers. Instead, the
majority of USF’s operating income was derived from promotional allowances.
False Confirmations and Statements
USF executives engaged in or substantially participated in a scheme whereby USF reported
earnings equal to or greater than its earnings targets, regardless of the company’s true
INTERACTION WITH DELOITTE AUDITORS
Because USF lacked an internal auditing department, Ahold hired Deloitte to perform internal
auditing services at USF, a practice permitted for the same external audit firm prior to SOX.
Deloitte reported to the internal audit director of the company. In auditing the promotional
allowances and internal control processes, a number of documents were requested from USF
management, including the vendor contracts. Management refused to produce many of the
requested documents. Several members of management refused to meet with the internal
auditors, making the completion of internal audit objectives virtually impossible.
Deloitte conducted confirmations of the promotional allowances to verify income. Management
had already induced vendors to falsely report promotional allowances to income amounts and
receivables to the auditors and had concealed the existence of written contracts with USF
Fraudulent Acts by Management
As previously noted, USF executives contacted or directed subordinates to contact vendors to
alert them that they would receive confirmation letters and to ask them to sign and return the
letters without objection. If a vendor balked at signing the fraudulent confirmation, USF
executives pressed the vendor by, for example, falsely representing that the confirmation was
just “an internal number” and that USF did not consider the receivable reflected in the
confirmation to be an actual debt that it would seek to collect. USF executives sent, or directed
subordinates to send, side letters to vendors who continued to object to the fraudulent
confirmations. The side letters assured the vendors that they did not, in fact, owe USF amounts
reflected as outstanding in the confirmation letters.
USF executives attempted to prevent the discovery of the fraudulent scheme by making
accounting entries that unilaterally deducted material amounts from the balances that USF owed
to certain vendors for the products USF had purchased, and simultaneously credited the
promotional allowance receivable balance for the amount of such deductions. These
Financial Statement Misstatements and Restatements
As a result of the schemes already described, USF materially overstated its operating income
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Questions
1. Evaluate the facts and circumstances of the case using the Fraud Triangle. Discuss
how auditors perform an audit and assess risk when red flags exist that the financial
statements may be materially misstated.
Incentives/Pressures (Environment-related issues)
• Compensation for USF executives was based on, among other things, on USF’s meeting
or exceeding budgeted earnings targets. USF executives each received a substantial bonus
in early 2002 because USF purportedly satisfied earnings goals for FY2001. USF
executives were each eligible for a substantial bonus if USF met earnings targets for
FY2002.
Opportunity
The opportunity to commit fraud existed because there were no checks and balances
against management fraud. Management took the opportunity to engage in several
transactions where internal controls were nonexistent or overridden. A summary follow.
• USF, a wholly owned subsidiary of Royal Ahold, lacked an internal auditing department,
a very unusual failing given the need for strong internal controls. Deloitte conducted the
internal auditing for Ahold and served as the external auditor. Ahold is a Dutch company
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• USF executives attempted to prevent the discovery of the fraudulent scheme by making
accounting entries that unilaterally deducted material amounts from the balances that
USF owed to certain vendors for the products USF had purchased, and simultaneously
credited the promotional allowance receivable balance for the amount of such deductions.
Rationalizations
While not explicitly addressed in the case, it is safe to assume that management of Ahold
and USF became accustomed to manipulating earnings to meet earnings targets and
maximize bonus payments. It appears to have become standard practice at the companies.
2. Evaluate the role of Deloitte from the perspective of professional judgment by
referring to the discussions in Chapters 4 and 5. Do you think Deloitte compromised
its professional responsibilities in accepting evidence and explanations provided by
the client for the joint venture and promotional allowance transactions? Explain.
It appears Deloitte did not meet its professional responsibilities by accepting management
provided evidence without adequately vetting it. The following describes some of the
more glaring failings focusing on a lack of professional judgment.
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• USF had no comprehensive, automated system for tracking the amounts owed by the
vendors pursuant to the promotional allowance agreements. Instead, USF, for purposes of
interim reporting, purported to estimate an overall “promotional allowance rate” as a
percentage of sales and recorded periodic accruals based on that rate. Information
provided by USF executives caused the estimated rate to be inflated. The intended and
actual result of inflating USF’s promotional allowance income was that USF, and Ahold,
materially overstated their operating incomes. Deloitte did not detect this in its audit.
3. The court ruled that Deloitte was not responsible for the fraud at Ahold because its
management deceived the auditors and hid information from the firm. Do you think
Deloitte compromised its ethical responsibilities in this case? Identify any such
deficiencies and why you believe compromises existed.
The Deloitte auditors had an obligation to plan and perform the audit to detect material
misstatements. As part of that obligation, the auditors need to assess the risk of fraud,
gather and assess evidence, and perform the audit with a healthy dose of skepticism. For
instance, the external auditors received confirmation letters from vendors which
overstated promotional allowances to USF by more than 100 percent. USF was able to
pressure the vendors into signing the fraudulent confirmations or gave side letters
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assuring the vendors that the amounts reflected as outstanding in the confirmation letters
was actually owed. The auditors did not maintain control over the confirmation process.
The auditors must not have done analytical procedures on the promotional allowance
amounts, trends over several years, or compared to the industry averages. Where was the
skepticism? Did they question the high response rate of confirmation, that none had
exceptions, that there was no trend or history of what the promotional allowances had
been? Did they examine a promotional allowance contract to see if the amounts were for