Deciphering Financial Statements (Cendant Corporation)
Cendant Corporation was created through the merger of CUC International, Inc. and HFS Incorporated. The company provides travel service, real estate services, and membership basedconsumer services. In April 1998, Cendant discovered several accounting irregularitiesrelating to the CUC segment. Widespread fraud had been occurring in that segment.The 1997, 1996, and 1995 financial statements were restated as shown below. Review theinformation presented and answer the questions that follow.
3. RESTATEMENT (Partial)
As publicly announced on April 15, 1998, the Company discovered accounting irregularities in certain business units of CUC. The Audit Committee of the Company’s Board of Directors initiated an investigation into such matters (See Note 17). As a result of the findings of the Audit Committee investigation and Company investigation, the Company has restated previously reported annual results including the 1997, 1996, and 1995 financial information set forth herein. The 1997 annual results have also been restated for a change in accounting, effective January 1, 1997, related to revenue and expense recognition for memberships. While management has made all adjustments considered necessary as a result of the investigation into accounting irregularities and the preparation and audit of the restated financial statements for 1997, 1996, and 1995, there can be no assurances that additional adjustments will not be required as a result of the SEC investigation. The following statements of operations and balance sheets reconcile previously reported and restated financial information.
Year Ended December 31, 1997
for Errors, Irregularities,
and Accounting Change
Marketing and reservation
General and administrative
Depreciation and amortization
Merger-related costs and other unusual charges
Income from continuing operations before income taxes,
extraordinary gain and cumulative effect of
Provision for income taxes
Income from continuing operations before extraordinary
gain and cumulative effect of accounting change
Loss from discontinued operations, net of taxes
Income before extraordinary gain and cumulative effect
of accounting change
Extraordinary gain, net of tax
Income before cumulative effect of accounting change
Cumulative effect of accounting change, net of tax
Net income (loss)
IMPROPER REVENUE RECOGNITION
The Company made adjustments to correct the misapplication of generally accepted accounting principles resulting in improper revenue recognition. These errors include: the understatement of estimated membership fees to be refunded to members; the immediate recognition of revenue which should have been deferred and recognized over the membership term; the recording of fictitious revenue; other accounting errors.
IMPROPER REVERSAL OF MERGER LIABILITIES
The Company recorded adjustments to correct the reduction of liabilities previously established primarily for merger transactions and a corresponding inappropriate entry to record revenue.
REVENUE ASSOCIATED WITH POOLED ENTITIES—NOT PREVIOUSLY RECORDED
The Company recorded adjustments to consolidate the financial statements of acquired entities which were accounted for as poolings of interest as required by generally accepted accounting principles. Previous consolidated financial statements did not reflect certain acquired company financial statements for periods required.
ELIMINATION OF INTERCOMPANY TRANSACTIONS AND CONTRA-REVENUE
The Company made adjustments to eliminate intercompany revenue not previously eliminated and properly classify certain expenses as contra-revenue resulting in reductions to revenue.
1. Under the heading “Improper Revenue Recognition,” the company identifies three ways in which revenue was overstated. What would have been the journal entries that were made (or weren’t made) to overstate revenues?
2. Determine the amount that should have been reported as “Income from continuing operations before income taxes, extraordinary gain and cumulative effect of accounting change.” How did this result differ from what was initially reported? Why was net income so much less than income from continuing operations?
3. From the information given here, can you tell what the accounting change was? How does the accounting change relate to Cendant’s accounting errors?