Holes in Krispy Kreme's Accounting

n March 4 this year, the SEC settled administrative charges against Krispy Kreme Doughnuts, Inc. the U.S. doughnut retailer. During 2003 and 2004, the SEC claimed that Krispy Kreme improperly accounted for its executive bonus plan in order to report earnings at, or one cent above, its earnings guidance. Krispy Kreme, without admitting or denying the SEC’s charges, agreed to cease-and-desist from future violations of provisions of the federal securities laws.

Bonuses were contingent upon Krispy Kreme meeting or exceeding goals for return on assets and a percentage increase in EPS.

The SEC stated that Krispy Kreme operated its bonus plan “as a de facto reserve accounting mechanism.” Rather than accruing bonuses during the year based on projected annual EPS, the SEC alleged that Krispy Kreme accrued bonus amounts equivalent to any profits over one cent above its EPS guidance in weak quarters, and in weak quarters, reversed previous accruals to meets its quarterly EPS guidance plus one cent, and accordingly trigger bonuses.

The SEC settled actions with four former Krispy Kreme executives, including the former Chairman, President and CEO, COO, CFO, and Senior Vice President of Finance. Without admitting or denying the SEC’s charges, their individual settlements included disgorgement of bonuses and fines suspensions from SEC practice.

Lawyers Push Back on Accountants

Lawyers and companies objecting to more disclosure have derailed FASB by a year on the deadline for companies to provide new disclosures about their lawsuits and other contingent liabilities. The proposals are part of a controversial rewrite of FAS 5. Companies said they could not implement the new policy for disclosing potential lawsuit liabilities in time. The FASB is still digesting 235 comment letters from lawyers, auditors, and financial statement preparers who are concerned the newly shared information would reveal confidential data and give away the store in litigation. Companies would be required to disclose "specific quantitative and qualitative information" about potential lawsuit liabilities, including maximum amounts of claims, unfiled claims, and providing in tabular format lawsuits showing various stages of probability and potential outcomes.

Investors love it--and have encouraged even more disclosure. Lawyers hate it. Must be something good about it?

Read the FASB's proposal.
A few articles:
WSJ-Law File: Merck, Pfizer, Eli Lilly, J&J, Novartis and Wyeth, the companies told FASB that that estimating the costs of continuing litigation is “highly subjective, subject to huge swings as underlying assumptions change, and unlikely to provide financial statement users with meaningful or reliable information.” Others, including GE, DuPont, Boeing and McDonalds, have also objected to the rule.
WSJ editorial from last week on the proposed rule: FASB's Lawyer Bonanza
The American Bar Association's take on it.