Dell explains "inappropriate accounting"

Though Dell has finished an internal investigation into its accounting practices, there are still plenty of questions about the company, which not long ago could do no wrong in the minds of investors and customers.

What we know now, is that Dell's finance department was apparently willing to fudge numbers to ensure it would hit or surpass its quarterly profits forecasts. They seem to have done that with the knowledge of, or sometimes at the request of, senior executives. And they did it because Dell's accounting department didn't strictly follow generally accepted accounting principles, or GAAP, chief financial officer Donald Carty said in a conference call. Carty became chief financial officer after Jim Schneider stepped down in January.

The department used "inappropriate accounting decisions and entries that appear to have been largely motivated to achieve desired accounting results", Carty said during the call with investors, apparently reading from a document filed with the Securities and Exchange Commission explaining the results of the company's investigation.

The company felt so pressured to meet Wall Street expectations that its finance department bent accounting rules to make up for shortfalls in certain quarters and under-reported results in others, each time ensuring that Dell did in fact hit profits targets that financial analysts were expecting. Carty didn't go into detail but it appears much of the accounting manipulation involved the timing of expenses and payments recognised on Dell's balance sheets.

So who knew about the financial shenanigans, and when? Carty said executives knew and even encouraged it but he won't say exactly who those executives were, and is so far refusing to single anyone out for responsibility. "I'm not going to talk about any individual by name," Carty said. "We've taken what we believe to be appropriate actions with respect to personnel involved in this, up to and including terminations."

More importantly, how did this happen at a company widely considered to be conservative and, above all, trustworthy? Dell's explanation is that not only did it not maintain a culture that emphasised strict adherence to GAAP rules, it didn't have enough employees with the proper accounting training or experience to know better.

In addition, Dell says inadequate resources in its accounting department is partly to blame, and - in a remarkable acknowledgment for a company that pioneered selling computers on the internet - that much of its accounting is done manually, with very few electronic trails.

Carty acknowledged that Dell is "underinvested in IT resource in the financial area". He also told investors "financial systems can't be blamed for irregularities but they can occasionally be blamed for errors".

Overall, the financial impact to Dell's bottom line is limited. Between the fiscal years 2003 and 2006, Dell's net income was more than $12bn. The audit committee now says that the actual net income Dell earned during that period is $50m to $150m less. Profits per share for that time frame are likely to be 2 cents to 7 cents per share lower.

The main problem was in the way Dell was keeping track of its reserve and accrued liability accounts, which is money set aside, for example, when the company sells a warranty on one of its computers. It's up to Dell to estimate how much will be necessary to set aside should someone call in a repair on their computer. The difference between, say, $50 and $100 isn't much for one computer but when multiplied by one million warranties, it adds up quickly.

The problem with reserve accounts is that they're quite easily manipulated because there's no absolute rule on how much money to set aside, said Tracy Coenen, founder of forensic accountant firm Sequence.

She said: "You can play games with it. It's one of those gray areas in accounting."

To make sure this doesn't happen again, Dell says it is reorganising its finance department. Accounting and financial reporting duties will be kept separate from the people responsible for planning and forecasting future quarters. The position of chief accounting officer has also been "strengthened" and will be responsible for all accounting and financial reporting responsibilities for the entire company.

Dell executives continue to co-operate with the government's probe, Carty said. But the biggest concern for Dell, which is dealing with shrinking market share, exploding laptop batteries and an increasing perception that its products are decidedly bland (despite a new effort to sell laptops in snazzy, new colours), is how this will play out with customers.

Samir Bhavnani, an analyst with Current Analysis West, said: "You don't want any questions. They've been doing a bunch of things good to get back on their feet a bit and this is a pretty big speed bump. Hopefully they're able to get over it."

Erica Ogg writes for CNET News.com