Understanding claims through UCC, FASB and GAAP

Hastings, Richard D


Attempts by Financial Accounting Standards Board (FASB) and other contributors to Generally Accepted Accounting Principles (GAAP) to improve private industry practitioners’ adherence to best practices in accounting seems to have mixed results. Recent attempts by the Securities and Exchange Commission (SEC) to enforce FASB advisories have led to well publicized investigations, including the investigations at Aurora and more recently at Lucent Technologies.

There is much concern within mercantile trading partners about the unusually difficult situation for trade claims (also referred to as charge backs, or as disputes). It appears that certain procedural loopholes exist between GAAP, Uniform Commercial Code and contract law that encourage an excessive number of expense disputes to occur. The following article attempts to explore the relationships between expenses, GAAP, FASB advisories and contract law to see if the excessive number of trade claims is possibly the result of inadequate coordination between practitioners and the advisors to FASB, UCC revisions and GAAP. It appears that private industry adherence to better practices would exist if more questions were raised regarding the origins of claims in the foundations of UCC and GAAP.

The Search for Root Causes

Simplification of the methods used to recognize, classify and resolve claims (also known as deductions and/or chargebacks but hereinafter referred to as claims), may improve the resolution of claims. Much attention is given to claims due to their impact upon earnings. There is, however, insufficient investigation into the root causes of claims. A deeper reading is needed into the concepts in Uniform Commercial Code (UCC); Financial Accounting Standards Board (FASB); Accounting Principles Board (APB); The Securities and Exchange Commission (SEC); and other contributors to Generally Accepted Accounting Principles, (GAAP). Their concepts guide best practices, but more needs to be done to find out why these continue to allow for so many poor business practices, excessive amounts of unwarranted claims, and unreasonably prolonged disputes.

Especially important is the fact that regulatory interventions into noteworthy cases of alleged malpractice occur often years after management practiced what turned out later to be unlawful or irregular practices. In the case of Aurora Foods, Inc., four former officers were recently indicted for allegedly concealing promotional expenses that inflated earnings in 1998 and 1999i. What we do not immediately consider is the sad fact that the business practices in place at Aurora that led to the alleged earnings irregularity in 1998 were very likely in place long before 1998, meaning that regulators are probably years behind the curve in understanding what happened. Looking back through recollections of nervous defendants is not an optimal way to learn about allegedly irregular practices. There exists a serious gap in expectations and knowledge between regulators and daily practitioners. This gap may contribute to a worsening of the already extraordinary problem of claims in commercial trade. This article asserts that efforts spent on resolving claims must be complemented by a new and rigorous investigation into the root causes of claims. These causes seem to exist in the legitimate and credible worlds of accounting principles and contract law.

The Impact of Time

Existing methods used at many commercial sellers (especially those selling to retailing firms) often do not consider the role of interpretation of the concepts conveyed by UCC Article 2 — Sales. Nor is there an adequate understanding of how buyers (especially retailing firms) typically record disputed items in their accounts (buyer and seller refer to institutions exchanging title and possession of goods and services). Misunderstandings occur often at the level of daily practitioners more so than of their supervisors. This knowledge gap is a critical point that requires further investigation.

It is likely that time has affected the usefulness of many ideas within GAAP and UCC due to continuing evolution of globalization, electronic automation and disintermediation in trade supply chains. Time has certainly affected some of the adequacy of the applicability of many concepts in UCC and GAAP to modern commercial conditions. Some of the governing accounting concepts date back to Accounting Research Bulletins published in the 1950s. Revisions are today being made to UCC articles 9 and 2 especially in regards to innovations in electronic information; however, the bulk of the concepts in UCC-2 and UCC-9 remain substantially the same as the original UCC articulations dating’ back to the 1952 provisions. Rebates, promotions, advertising and vendor responsibilities are greater in number and more complex than they were only thirty or forty years ago.

Financial reports are relatively inadequate in their disclosure of the impact of claims upon ending balances – the stuff that financial reports are made of. This fact reduces the accuracy of external reporting and analysis while it reduces the precision of external financial reports themselves – to the detriment of many trading partners relying upon such information. Recent suggestions by FASB recommend that management should voluntarily disclose more information about “critical success factors and trends surrounding those factors(ii)” is indicative of just how out of touch regulators are with the brutal realities of private industry accounting. Revenue growth, profits, EPS, market cap and analyst conference calls are the crushing priorities on the minds of many managers in American commerce today. Expenses that can be handled in legitimate ways to reduce any dilution of profit or revenue growth will be fully explored. From this urgency – as much as from other reasons – do we find root causes for excessive claims in trade today.

The Securities and Exchange Commission leans on the Financial Accounting Standards Board concerning the work of professional auditors. It is not clear if FASB is providing helpful guidance for industry bookkeeping practices or if it sometimes tries to catch up with changing business practices. Auditors who visit firms only occasionally often are behind the curve in their ability to interpret what occurred for months and sometimes years at their clients. Financial reports used to make substantial trade and investment decisions point back to this “curve.” This is similar to the problem we observed in the lag time between SEC indictments of management at Aurora and the reality of how much earlier daily practices became routine and then, years later, allegedly fraudulent. In the case of Aurora, the issue was promotional expenses typical of consumer products vendors selling to retail firms. The details of the Aurora case are not required to conclude that whatever happened there is happening often under the guise of legitimately argued claims. A promotional trade expense must be paid by at least one party to the contract; however, UCC inadequacies quickly invite certain parties to the contract to dispute not only the rightful ownership of a given expense but the outright origin in contract discussions of the intentions and agreements that were the foundation for future transfers of title and possession.

These problems require new questions and better answers to existing questions.

FASB, Rebates and Handling Fees

A recent FASB Emerging Issues Task Force (EITF #00-14), Accounting for Certain Sales Incentives, refers to the disputes between buyers and sellers of packaged consumer products, especially when rebates are offered. Generally, this process involves the following. A manufacturer creates a rebate that is sometimes matched by rebates offered by the retailer (the customer of the manufacturer) to help stimulate unit turnover (retail sales). The ultimate customer, the consumer, is also involved in this process making it more complex. According to FASB Statement of Financial Accounting Concepts 5, Recognition and Measurement in Financial Statements of Business Enterprises) a sale is not considered revenue until the price of the transaction is absolutely fixed. The consumer’s choice of whether to send in the rebate makes the pricing of the unit sale not fixed until the consumer sends in the rebate. FASB is concerned that the recording of this expense is not occurring in a standardized, uniform manner.

It is possible that some retailers and their vendors are sending rebate expenses back and forth as claims depending upon previously contracted agreements regarding sales incentives (i.e., rebates) that are ultimately nothing other than an expense. Without sufficient guidance in place long before business practices become daily routine, it is likely that rebates result in a new round of claims. Rebates may be understood as a variable to price and, therefore, as a reduction to revenue. Alternatively, rebates could be viewed as separate marketing expenses to be recorded as an increase to SG&A expenses later in the accounting cycle. The lack of clear direction on rebates suggests that FASB’s opinions in EITF 00-14 are years behind ordinary practices. Furthermore, EITF 00-14 could promote new forms of poor practices as firms desperately try to catch up with FASB and take illegitimate claims in other areas of trade to compensate for weakening financial positions caused by compliance with sudden rulings by regulators.

At the bedrock level of concern is the fact that looking at sales incentive expenses as an irregularity to price and therefore voiding the recognition of revenue turns everything back to the concepts of consignment selling. Executive officers should be given much better options if regulators expect improvements to compliance.

In FASB 00-10 (Accounting for Shipping and Handling Fees and Costs), FASB offered an opinion on handling fees and shipping expenses – some of the most frequent causes of claims. It was noted that inconsistencies exist in how firms record these items. Some record them as a component of cost of goods sold while others record these as an item embedded within SG&A expenses. In other instances, a fee is monetized into a receivable and enjoyed as revenue – as a net inflow of cash to offset an open debit in receivables (when collected). In the case of Aurora Foods, the SEC alleged that certain defendants “discussed putting known trade promotion expenses in accounts receivable, rather than simply recording them on the books of the Company.”(iii) FASB seems to have a gentle approach to the inconsistency of accounting for shipping and handling fees. The SEC, in their reading of the Aurora Foods case, seems to have found either reason to suspect criminal intentions or simply believes that poor handling of certain expenses is usually caused by criminal intentions. The SEC litigation against Aurora’s former managers leaves the reader wondering what were the exact sequences of bookkeeping entries that took the promotional expenses from one account to another.

This lapse in regulatory thoroughness suggests that the SEC and FASB should begin to consult with private industry auditors and accountants more than they do today.

From Ambiguity to Invention: More Root Causes of Claims

FASB #00-10 is indicative of the underlying ambiguities in regulatory guidance that often contribute to a worsening of claims. In the most egregious cases of malpractice, buyers incorrectly record offsets to both accounts payable and to cost of goods sold. In these situations management sometimes hopes that time will allow for a current enjoyment of better financial reports while providing later opportunities to correct any previous “misinterpretation” of GAAP. Uncertainties exist regarding how something should be recorded and the claims investigator will be challenged to figure out how to classify the claim.

Two different perspectives influence the movement of goods and services from transferor to transferee: 1) the practical business of entering debits and credits; and 2) a conceptual approach that affects business practices from an end-loaded conceptual perspective. The latter consists of the application of contract law and accounting principles after routine practices occur. Unfortunately, after a claim turns into a more serious dispute is sufficient attention given to contract law and what its terms mean. Accounting principles also are compromised often before auditors come to visit. The urge to report profit often causes management to support inappropriate interpretations of contract law when P/O’s are formed and performance begins. Where there is a contract, there is an agreement. Where is an agreement, however, there is a disagreement and, therefore, a loophole.

Contracts and Sales

The UCC Article 2 definition of “contracts” differs significantly from its definition of “sales.” “Contracts” refers to present or future sales (UCC Article 2, sec 2-106, 1). “Sales” refers to present and future exchanges of title and property. “A ‘sale’ consists in the passing of title from the seller to the buyer for a price (sec 2-401). ” A contract is required, therefore, to make sales in both present and future time-periods. Without a contract, however, a sale loses its significance and loses its legal foundation. The idea refers to time and sequences. If a contract is required in concept for a sale, then a contract precedes a sale.

When a sale occurs, certain bookkeeping entries occur. Expenses inevitably accrue in coordination with revenue. When a disagreement exists regarding an expense, there are various ways of treating the expense. When an unexpected expense occurs in conjunction with revenue, a claim is often the result. The claim may be treated as an adjustment (offset) to a monetary asset or monetary liability (a/r or a/p) but the claim may also be viewed as an amount due by counterparty. The latter of these involves a monetization of an expense, something that is controversial, sometimes unlawful and sometimes quite common in practice.

The difference between monetary and offsetting items has relevance to UCC concepts about contracts.

1. Is the claim monetized or is it recorded as an offsetting entry?

2. Is the dispute about the original contract (agreement)?

3. Is the claim about performance (sale)?

It will be seen that the gradual transition from contract to sales and the shift from monetary items to offsetting items bear noteworthy relevance to major concepts in UCC and GAAP.

SAB 101, Revenue and Agreements

According to SEC Staff Accounting Bulletin No. 101 (SAB 101), Revenue Recognition in Financial Statements, from December 1999, recognition of revenue occurs when “all” of the following take place:

“Persuasive evidence of an agreement exists.”

“Delivery has occurred or services have been rendered”

“The seller’s price to the buyer is fixed or determinable” – and– “Collection is reasonably assured.”

The four items from SAB 101 govern a flow of events from contractual (agreement) to performance (sales) to conclusion (collection). There is the need to show evidence of an agreement (a contract); there must be performance of said contract; there must be consideration given by each party for consideration received; and said consideration must be collectable. Within the four items in SAB 101, each offers its own unique and attractive option for the accounting of claims. In item #1, it can be argued that the agreement included or excluded things other than contracted. In item #2, it can be argued that the transfer was flawed and that, therefore, no delivery was rendered according to contract. In item #3, the price is easily argued as being in flux. And finally, in item #4, it can be argued that the contract was void since collection did not occur. Each of these concepts finds a comfortable and legitimate foundation in SAB 101, which is, in turn, founded on more fundamental statements of accounting concepts. The legitimate and excessive natures of claims are founded partly in the lawful world of GAAP.

“A Meeting of the Minds,” Sales and GAAP

It is said in contract law that a “meeting of the minds” must occur for a contract to exist. This notion governs, therefore, the creation of contracts and contracts, in turn, govern the subsequent exchanges of goods, services and payments. The written contract, however, points back to a non-written understanding between parties to the contract. According to SAB 101, if the agreement is not final, then revenue recognition is not appropriate. The buyer (counterparty) can create significant difficulties for the seller when it makes a major claim because, if revenue recognition is not appropriate under some conditions, then a claim sets in motion attempts by the seller to figure out how to recognize revenue. The need to recognize revenue becomes the emergency from which occur, unfortunately, many new claims.

When counterparties orally discuss the creation of a P/O, certain information is sometimes exchanged in written form before the P/O is approved. Some questions should arise at this stage. Is the pre-contractual discussion an adequate and accurate record of the concepts in the minds of the parties? Were there oral agreements that implicitly contradicted the written discussions? When sales management approves the P/O, are there outstanding issues that were never exchanged in either written or oral form during the pre-contractual periods? Failure to establish such adequacy leads directly to inadequate defenses and inadequate responses to claims. The time to establish an adequate understanding of what was intended by the nonverbal and unwritten aspects of a contract is at the approval stage of the PIO. The credit department is often not involved at this stage because of the pressure to create new revenues. Under optimal conditions, however, the contract should be fully adequate before any sales (transfers) occur.

It is recommended that regulatory agencies begin to explore the connection between contract law and GAAP before making new, major pronouncements on accounting standards.

From Purchase Orders to GAAP

The creation of a P/O causes certain bookkeeping entries to occur. For the seller of goods, this often requires allocation of inventory (changing that portion of book inventory to cost inventory) to the buyer for packing and delivery purposes. At this point, the buyer does not record anything because the buyer will not recognize receipt of goods (title and property) until after the seller physically transfers the goods. Inventory is credited (-), cost of goods sold is debited (+) and the sale is ready to occur. (For larger firms using integrated software like SAP, much of this occurs automatically.) Physical transfer of title and property require appropriate documentation in the form of bill of lading and invoice. After the transfer, A/R is debited (+) and revenue is credited (+). The buyer records an increase in assets (debit) and an increase in payables (credit) – assuming the buyer is granted credit terms of sale. Equity is changed for buyer and seller. Assets decrease at the seller resulting in a decrease in equity (debit); assets increase at the buyer resulting in an increase in equity (credit).

It is easy for buyers and sellers to conform to bookkeeping norms at this stage. Breakdowns occur after these initial conventions take place. Conditions become complex after performance (delivery) occurs. The buyer decides what to do with what is received, how it was received, when it was received and why it was received. All of this points back to the four items in SAB 101. This is where different ideas about recognition of expenses occur, including the huge range of ideas governing sales incentives, shipping and handling fees, coupons, rebates and promotional expenses.

Is it possible, therefore, that the claims process is really the phase of investigation into finding a common idea between seller and buyer regarding how an item should be recognized? Is it possible that an unknown amount of claims result from a lack of clear process regarding why and how any operating event between seller and buyer should be recognized? Is the investigation of a claim a time to argue back and forth why an item “is mine” or “yours”; or, is this a time to find a reason to record an item one as an expense or as a cost?

Maybe the world of claims is a vastly complex conversation between mercantile participants regarding questions that neither party can answer.

Monetary Items and Offsetting Items

The recognition of cost relative to sales (in GAAP) is sometimes not properly addressed by the parties to the contract (P/O). A hypothetical case follows.

A vendor sells $25,000 of product to its customer. Payment is received on April 6, 2001 for an amount less than invoiced. The buyer makes a claim for freight for $1,150, and for quality, $2,000. The collector learns that the buyer already paid the shipping company by check under a disputed claim for freight. The buyer records these claims in the following manner.

Firstly, a claim for freight should immediately be recognized by the seller as a contract idea and not related to performance. Freight occurs in every delivery of goods because it is how all goods are delivered. The contract stipulated the transfer of goods; therefore, there will be freight.

Secondly, the deduction for quality is something that was not stipulated in the first “meeting of the minds” because nobody is going to create a contract that stipulates a future sale with poor quality! The quality problem must be isolated to this individual delivery since it was not stipulated to occur in every delivery. The buyer sends a bill to the seller for freight in the amount of the claim. This action monetizes the claim for freight. If the seller “charges back” the claim to the buyer, then the seller’s A/R is debited and the claim is monetized again. The claim for quality is, however, not monetized. It exists only as an offsetting entry to accounts payable. A credit in accounts payable is a monetary liability. An offsetting entry is not a monetary item.

Many larger retailers have detailed rules governing additional penalties for non-performance of contracts. If quality is the problem, there might occur penalties in addition to a deduction for defective quality. These can include estimated pecuniary costs for processing the claim. There is the estimated value of shipping to return possibly defective goods. Lost revenue due to lack of goods available for sale is another source of penalties. So much is expected from the performance of vendors especially in the retail sector supply chain that the opportunities are endless to say that something went wrong. Bookkeeping entries are not always uniform for all of these penalties because of the number of parties involved and because of the many types of claims.

It should be the job of the claims professional to find out whether the claim is pointing back to the contract or directly at the sale. This information leads the investigation in the direction of the personnel who either created the original contract or who were involved in packing and loading the goods sold. This is a first step back towards the foundation of the problem.

The Benefits are Many

It usually seems that the buyer (especially the retailer) enjoys all of the benefits resulting from claims. The situation, ironically, may have certain benefits to the seller (vendor). Above all, the creation of a claim creates time. During the claims investigation process, the seller continues to record the amounts receivable from its customer at book value because the seller often expects full cash settlement on all goods sold and services rendered. This is justified by the seller in their financial accounting by pointing back to the collection phase referred to in SAB 101; and by pointing back to the idea that the price asked by the seller is fixed. Interim financial reports continue to show many receivables at book value and there is no immediate need to credit the contra accounts to receivables for doubtful accounts or to build reserves against uncollected amounts. Reserves for certain uncollected expenses sometimes occur automatically.iv

Claims result in immediate cash flow insufficiencies while resulting in almost no immediate impact upon working capital (partly because AIR is still recorded at book value). Later, however, AIR and equity are unfavorably impacted when reserves and higher costs of funding erode the enterprise’s financial position. For the analyst, deteriorations in working capital are indicative of long run systematic problems that can include excessive claims. Increases in short-term and long-term borrowings are sometimes caused by cash flow shortages that are caused by excessive claims (that, in turn, reduce cash inflows). Decreases in cash basis revenue causes earnings shortfalls that decrease equity and require concurrent decreases to certain assets in order to balance the books at the end of major reporting periods. Claims, in their systemic disease form, cause massive irregularities across supply chain boundaries and impede the accuracy of analysis and risk management.

Claims for freight are especially ambiguous. Sometimes it is not known if freight is structured into the price asked by the seller or if freight is something that can be collected later under separate billing. If the seller pays for freight (according to the original agreements), then the cost of selling will be slightly higher. Gross profit, therefore, is slightly lower. The claims process initiated by the buyer of the products creates, ironically, an opportunity to figure out how the seller will treat this amount. Will the seller enjoy higher gross profit if the buyer pays the claim? Will the seller have to cut a check? Or, will the freight dispute be settled in favor of the seller along with the dispute about quality? Claims create time for all parties to the contract to see which option is more attractive. In the most sophisticated firms, formulas are generated that price the value of the outcome of disputes. It is possible that claims is something that sometimes benefits both parties to a contract.

It is unknown how many external users of financial statements are aware of the impact of claims upon external financial reports. Periodic ending account balances tell the external analyst almost nothing about the inner workings of claims and how these affect, much later on, the financial conditions of many firms. It is likely that some companies that suddenly report unfavorable results were sitting upon a mountain of high hopes from many claims that unfortunately did not work out the way management thought they would. In addition to many other issues, it is recommended that regulators give some consideration to the gap caused by the current impact of claims on cash flows and future deteriorations in ending account balances especially in working capital accounts.

If an expense is a cost with expired benefits, then a claim is an expense waiting for an agreement. GAAP meets UCC and another claim is disputed.

Proof and Other Opportunistic Failures

Requests for proof of delivery and taking unearned discounts create especially attractive reporting opportunities. If goods are received and work their way into distribution and finally into manufacture or retail sale, then a claim for proof of delivery is the most audacious way to keep things operating while dramatically reducing cost of goods sold.

If nothing else, the buyer of the goods can change the timing of the matching principles of revenue and cost to a more desirable outcome. It only takes a few large claims of this type to make a material difference in earnings and financial position. In the retail supply chain, unearned discounts and requests for proof of delivery are a vast problem.

It is Systemic, not Specific

That claims exist to the extent that they do (especially in the retail merchandising sector) points to a rising level of unexamined systemic risk for a large portion of the economy over time. An open debit, like a claim, is an example of specific risk. There is exposure to the uncertainty that the claim against an invoice will reduce net cash inflow for an amount less than budgeted. Lower borrowing rates initiated by the Federal Reserve system during the last decade helps promote the issuance of bank and trade credit to distressed firms; however, the funding of distressed firms can indirectly subsidize unhealthy, systemic defects in our financial infrastructure. Innovations in information technologies are not ready to correct what appears to be a serious malfunction of contract law and GAAP. One claim against one invoice must be multiplied by millions of occurrences. The cost in terms of labor and time and lost productivity is something that possibly exceeds many billion of dollars. The aggregate impact of claims in trade is potentially an unexamined systemic risk with chronic, debilitating symptoms that we barely understand.

Idiosyncratic Risk and Generic Integrated Software

The development of methods to classify claims can be helpful especially if these methods derive from root causes. There are widespread complaints that existing integrated software packages (used especially at many larger firms) do not provide sufficient claims information systems. There exists in particular an inability to provide an idiosyncratic approach to claims information for the users of such software. Institutions are looking for improvements to pre-tax earnings. This is the primary force behind the energy put into claims resolution and the vast amount of education directed at this problem. Everybody in the enterprise is involved in this objective, including outsource firms helping to resolve claims. The software package may or may not provide efficient help towards this goal.

Improvements to the claims process can also improve certain personnel issues in staff development (more job satisfaction; the feeling that the systems used are uniquely pertinent to the users’ personal and departmental goals). Each institution is unique; each worker is unique. If firms are unique, then claims will be idiosyncratic and unique to that firm. The resolution of problems becomes more idiosyncratic as more details emerge regarding what went wrong, or what was misunderstood.

With this in mind, the development of classification methods must reflect the dynamics of the seller to the fullest degree possible. Customization of integrated software applications often leads to excessive hours of time spent to improve the generic nature of the software. If these systems are generic during the initial phases of contractual agreements, it is likely that such software will be more inadequate to the unique methods of servicing, billing and recording the transfers of title and property that occur after the contracts are created. The process of endlessly adding more names to the family tree of dispute types does not go to the roots of the causes of claims.

There is an intimate connection between idiosyncratic risk factors and claims. The kind of claims a seller incurs is reflective of its portfolio mix of customers, types of customers, types of products and services sold including terms, amounts and number of transactions in any given period of time. Claims resolution is intimately connected to each firm’s (each sellers’) idiosyncratic approach to doing business. Claims resolution is, therefore, a productivity issue with idiosyncratic risk factors.

More, Better Questions Needed

It is arguable that many major fraud cases could have been stopped earlier on by better investigations into root causes of trade claims. There is, however, little incentive to probe into process dysfunction when the primary goal is to reduce expenses. Adding to the problem is the ambiguous terminology used by collectors, credit managers and claims personnel to talk about claims. We hear discussions about “chargebacks” but not much about bookkeeping conventions. We observe that an invoice is a debit in A/R and whatever remains of it after a deduction is still a debit. In the end, when a claim has been monetized into a receivable, we are still talking about an open debit. A debit is a debit is a debit: this would be a good starting point for a better dialogue about claims.

The concepts communicated especially by SAB 101 raise questions about the ability of firms to comply with such regulations. It also raises questions about the direction of research and enforcement work being done at FASB and the SEC. Management will not cease to recognize revenues simply because a coupon is being tendered in a few weeks by a consumer somewhere on line in a small grocery store.

Expenses seem to search for a safe landing on firm, legally stable ground. It is clear that conceptual work done at FASB and at the SEC do not sufficiently consider the underlying safe ground provided by UCC and contract law. If a disputed expense should not be monetized, and if both parties reject such claim, then the final resting place for a disputed expense is often in the form of a claim resting on the generalities of contract law. When claims are not quickly processed, major questions arise regarding whether the disputants know what to do with the expense. If there is insufficient knowledge about expectations from the SEC, FASB, UCC and GAAP to daily practitioners (especially in claims and collections), then what can we expect between two firms using potentially different accounting methods and idiosyncratic processes to recognize revenue and expenses?

Further investigation into these lapses in common knowledge is a better next step for regulators. This should be the subject of a major conference held by advisory members to UCC revisions, to FASB, AICPA representatives, SEC officials and leading members to Financial Executives International (FEI). A conference on the foundations of claims in regulatory concepts and in accounting standards would benefit many parties more than issuing a naive proclamations like that of FASB on January 29, 2001 recommending more voluntary disclosure. “Voluntary disclosure should cover not only good news but also disappointments. Disclosures are most useful if they report on previously disclosed plans and goals and the results achieved in meeting those plans and goals. “These comments will find little pause from profit-driven executive directives implemented into daily practice at thousands of companies in the U.S. Additional compliance challenges emerge from recent SEC initiatives into information disclosure, SEC Fair Disclosure (“Reg FD”). The SEC is increasing pressure upon firms to ensure fair disclosure of information to an undefinable, unreachable, non-verifiable audience. Energy spent on such initiatives would be better used to find the root causes of claims in mercantile trade.

The world of claims is our window into a growing realm of systemic risk. Knowledge of exposure to risk is diminished by our growing reliance upon real-time, online B2B exchanges and by Federal Reserve System monetary adjustments. Portfolio risk theory during the last ten years has been greatly influenced by theories on the use of short-term liquidity sources from distressed loan portfolio classes. Systematic risk in these portfolio classes is aggravated by a larger amount of claims occurring at distressed firms in certain loan classes. Firms that have a rising number of claims – more importantly than the quantitative size of any claim – are excellent resources for research and investigation into the root causes of claims. If pressure increases from the SEC regarding enforcement of FASB announcements, then we can expect a worsening of the existing lack of knowledge about poor business practices that lead to the use of claims as a method for finding out how to handle ordinary expenses. What is required are more questions and better questions. Additionally, it would be optimal for GAAP and UCC to cooperate in their conceptual processes while advisors make suggestions to revisions of UCC. In the same way, advisors to FASB and law enforcement authorities at the SEC must begin to address the inherent weaknesses in the knowledge of accounting principles that is a major cause for the worsening situation of claims in mercantile trade today.

In the same way that Enterprise Risk Management (ERM) views risk from an integrated perspective, it would be optimal for advisors, regulators and practitioners to begin integrating their perspectives on claims to arrive at a thorough improvement to a situation currently out of control.

Classification: Where to Begin

The following is a set of recommendations to create a better foundation for resolving claims.

1) Train existing staff on debit and credit conventions so they each completely understand the most basic rules of the accounting equation (assets=liabilities+capital).

2) Ask the accounts payable personnel or accounting officers at your customers if the item described as a claim in their remittance to you is recorded in their accounts as an offset to payables or as a receivable. They do not have to tell you, but it will be interesting to see if they tell you to not ask

3) Build a claims information tree with two columns, one for contracts and one for sales. All personnel in the enterprise should understand they are going to look for this difference when working on claims.


The Securities and Exchange Commission at www.sec.gov.

SEC Concept and Interpretative Releases at www.sec.gov/rules/conc indx.htm

SEC Staff Accounting Bulletin: No. 101 – Revenue Recognition in Financial Statements at www.sec..gov/rules/acctreps/sab 101.htm

Financial Accounting Standards Board at www.fasb.org. Emerging Issues Task Force (EITF) at http://www.rutgers.edu/Accounting/raw/fasb/tech/index.html

Uniform Commercial Code at www.law.cornell.edu UCC Article 2 – Sales at http://www.law.cornell.edu/ucc/ucc.table.html


i See SEC Litigation Release #16866 dated January 23, 2001 “SEC CHARGES MULTI-MILLION DOLLAR FINANCIAL REPORTING FRAUD AGAINST FORMER CHAIRMAN AND OTHER FORMER SENIOR OFFICERS AND EMPLOYEES OF AURORA FOODS INC.” It was not made precisely clear by the SEC in their complaint exactly what bookkeeping entries were made, in what sequence, that resulted in the criminal outcome.

ii From FASB News Release dated January 29, 2001, “FASB Issues Report on Voluntary Disclosures, Improving Business Reporting: Insights into Enhancing Voluntary Disclosures.”

iii Idem.

iv In the case against the Aurora Foods officers, the SEC alleged that an officer bypassed the computer software’s automatic debiting of the reserve for promotional expense and began making entries on a manual basis.

Richard D. Hastings is the Director of Communications and Research at Global Credit Services, Inc., a B2B information provider and credit clearing house for supply chain risk management. Richard is a contributor to the Credit Research Foundation where he is a Research Fellow. His special interests include retail sector dynamics, risk theory, economics and mercantile claims.

Copyright Credit Research Foundation First Quarter 2001

Provided by ProQuest Information and Learning Company. All rights Reserved

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