In June 2014, car rental company Hertz announced that it needed to restate its financial results for 2011, as well as re-examine financial results for 2012 and 2013. The company is experiencing accounting problems, and it is not the only large company to admit to accounting problems in the past few years. Why do big companies develop accounting problems? Often, it's because accounting systems rely on both objective numbers and subjective interpretation.
When large companies announce that the company is experiencing accounting problems, it is often code for a deliberate or accidental error somewhere within the accounting system. Sometimes, these errors are costly; when drugstore company CVS Caremark experienced accounting problems in May 2014, the company received a $20 million fine from the U.S. Securities and Exchange Commission.
CVS was required to pay the $20 million fine because the SEC alleged that CVS had deliberately omitted details about its business losses, choosing to present an interpretation of its accounting records that gave a more positive picture.
Accounting is a system of many rules, but each of those rules comes with its own opportunity for interpretation. It is this interpretation that leads big companies towards accounting problems. Sometimes, as with CVS, the interpretation is a deliberate error of omission. Sometimes it is simply an interpretation that presents the company in a more favorable light.
In 2012, for example, online coupon company Groupon revised its financial results after its auditor, Ernst & Young, determined that Groupon had underestimated the potential cost of customer refunds. This was an interpretive choice that made the company look like it was doing better financially, but the auditing company considered it an accounting problem that needed to be fixed.
In the case of Hertz, the company is currently correcting accounting errors related to "capitalization and timing of depreciation for non-fleet assets," among other errors. The company has also delayed filing its first quarter results for 2014 until it has the opportunity to re-examine its 2011, 2012 and 2013 financial results.
The revised Hertz financial results are likely to show losses, and Hertz stock has already dropped in anticipation of these losses. Of course, nothing about Hertz's business model has actually changed; the company is simply clarifying its accounting and adjusting for errors of calculation and interpretation.
Accounting systems rely on objective numbers, but companies often choose to interpret or present those numbers in specific ways. These accounting errors sometimes lead to deliberate omissions, as in the case of CVS, or accounting problems uncovered by auditors, as in the case of Groupon. It is yet to be seen how Hertz's accounting issues will affect the company long term, but Hertz is just one of many large companies that experience accounting problems.
(Photo courtesy of Jomphong at FreeDigitalPhotos.net)