On HP's Debacle: "The Numbers Don't Make Sense"

Tyler Durden's picture

HP said that more than $5bn of yesterday's gargantuan write-down was due to "serious accounting improprieties" but as Bloomberg's Jonathan Weil states "the numbers don't make sense". With only $3.5bn of total assets on their balance sheet as Q2 2011, a $5bn 'fraud' would seem tough to swallow - and HP has far from forthcoming on any details. Perhaps the fault lies within (as opposed to without) as Weil notes HP recorded $6.6bn of goodwill (the plug between market price and the above-market price HP paid) - which was later revised to $6.9bn; now HP is writing down that goodwill - and blaming it on financial fraud from Autonomy. "HP didn't record the goodwill because it was lied to by Autonomy. HP recorded the goodwill because it knew Autonomy's identifiable assets were worth much less than it paid." It seems to Weil (and to us) that HP's management want the 'obvious-to-the-world write-downs required for goodwill and intangibles' post such a huge 'over-pay' to appear to be someone else's fault.

 

Via Bloomberg's Jonathan Weil:

HP didn’t record the goodwill because it was lied to by Autonomy. HP recorded the goodwill because it knew Autonomy’s identifiable assets were worth much less than it paid.

 

Here’s the problem with Hewlett- Packard Co.’s explanation today for why it took an $8.8 billion writedown related to its purchase of Autonomy Corp.: The numbers don’t make sense.

 

HP said “more than $5 billion” of the writedown “is linked to serious accounting improprieties, misrepresentation and disclosure failures discovered by an internal investigation by HP and forensic review into Autonomy’s accounting practices prior to its acquisition by HP.”

 

One reason the previous number seems odd is that Autonomy showed only $3.5 billion of total assets as of June 30, 2011. That was the date of the last balance sheet Autonomy publicly disclosed before it was bought by HP in November 2011.

 

Perhaps it’s true that Autonomy somehow committed more than $5 billion of financial-reporting improprieties with only a $3.5 billion balance sheet. I’m not sure how this is possible. But if it is, HP should explain. So far the company hasn’t.

 

HP said in its 2011 annual report that it paid $11 billion for Autonomy, a software company based in Cambridge, England. In connection with the acquisition, HP initially recorded $6.6 billion of goodwill and $4.6 billion of other intangible assets. HP later revised the goodwill to $6.9 billion and reduced other intangibles by about $300 million, according to its most recent quarterly report.

 

The goodwill figure is especially telling. Goodwill is the bookkeeping entry that a company records when it pays a premium to buy another company. More precisely, it’s the difference between the purchase price and the fair market value of the acquired company’s net assets. Goodwill can’t be sold by itself. The goodwill in this instance tells you that HP paid $6.9 billion more than it believed Autonomy’s net assets were worth.

 

Now HP is writing down some of that goodwill and blaming it on supposed financial-reporting improprieties by Autonomy. This also doesn’t make sense. HP didn’t record the goodwill because it was lied to by Autonomy. HP recorded the goodwill because it knew Autonomy’s identifiable assets were worth much less than it paid.

 

HP provided few details today to back up its allegations, which Autonomy’s former top executives are denying. HP put no hard numbers on the actual accounting errors it alleged. During a conference call with investors, HP Chief Executive Officer Meg Whitman said: “The board relied on audited financials -- audited by Deloitte -- not Brand X accounting firm but Deloitte.”

 

That doesn’t explain why HP paid $11 billion for Autonomy. As I wrote in a Ticker post on Oct. 4, it was obvious well before today’s news that HP needed to book more huge losses to write down goodwill and other intangibles. HP’s leaders just want investors to think the debacle is other people’s fault. What a shock.

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GetZeeGold's picture

 

 

When GAAP is outlawed things will start making more sense.

idea_hamster's picture

How do you commit accounting fraud for more than the assets on your balance sheet?

Easy:  defraud your liability side as well -- which is unlimited.

Why did Enron implode so spectacularly?  Not because its assets were zero, but because its liabilies were entire factors of magnitude greater than anyone realized.

They had $3.5 B in assets?  Fine -- all they need is $1.5 B in hidden debt exposure.  These guys have to think outside the box a bit.

Richard Chesler's picture

It's a big club, and not friends of Obama are not in it.

Joe Sixpack's picture

The Hidden Liability = Meg Whitman's failure to take California, thus no leverage for extortion?

AldousHuxley's picture

meg whitman is republican version of hillary.

 

ebay was fluke.

kliguy38's picture

Yeh sure.....of course it will make sense and it will be replaced with GARP and then GOPP and then GGOP blah blah blah......the sheep will keep falling for the same game....and WHY?? Because they WANT to.

Zero Govt's picture

replaced by CoCo the Clown

ParkAveFlasher's picture

Replaced by IFRS, which has the singular distinction of defining nothing in any intelligible language.

Zero Govt's picture

CoCo the Clown is an act, like the entire accountancy profession. The more script (rules) they add the more chaotic and completely incompetent the act becomes

it's like the Law/Judiciary, Regulation and Govt itself, it's a sack full of shit (rules)

formadesika3's picture

The Auditing model at present is flawed. It involves a basic conflict of interest. This is what brought Arthur Anderson down. Auditing firms should work for an insurer. That insurer would sell a policy to publicly-traded companies for a clean bill of health. This would eliminate the pressure auditing firms are subject to by company management.

ParkAveFlasher's picture

Just what the world needs, more insurance. /s

Fiat currency is the ultimate insurance policy.  All roads lead to evaporation of value in the largest reservoirs, considered TBTF, which are then refilled with printed paper.  And like insurance policies, you have to have it by law, yet you know that you are paying for nothing.

It's physics.  Once the object of labor, the value of time well spent, is lost, it can not be replaced because you can not go back in time.  The payout of insurance is a mortgage on the future, in all cases. 

formadesika3's picture

Reread my post. I didn't say the world needs more insurance. In some cases, it needs less. Health insurance for example was a very bad idea and is the underlying cause for the crisis in the US healthcare system. I was simply expressing a fix for what's wrong with the auditing model.

It wouldn't have to be mandatory. Buyer beware. Prudent individuals would demand it before buying stock in a publicly-traded company.

ParkAveFlasher's picture

You are advocating what is essentially corporate health insurance. 

You would attach auditing firms to insurance firms, which is analogous to attaching medical diagnostic firms to insurance firms.  You are deemed healthy, you get insurance easily.  You are not deemed healthy, you do not get insurance easily. 

You would empower insurance firms with the clarity of audit.

Rules that mandate insurance did not start out as rules that mandate insurance.  They were born as optional and voluntary.  However, once accidents happen, once litigation enters the game, and once litigation burdens the law providers with liability, the law providers respond by offsetting their liabilities, and mandates are born.  Invariably

Insurance is a wager that things will fail, or not.  Most things don't fail, however when they do, the failures disproportionately weigh upon the system.  Thus insurance. 

formadesika3's picture

Your criticism is that this type of insurance might/could/possibly turn into a mandate. I'm not sure that would be an inevitable outcome in this case but to the extent that everything seems to devolve into more governmnet involvement in the private sector, point taken.

ParkAveFlasher's picture

I'm glad you can see it or least react politely. 

I would go on to say that the entire concept of insurance is misconception.  Once value is lost, it is lost, and you can assign a nominal value to the loss and pay out to victims, however, you are simply extracting from yourself and non-victims on a past, present, and forward basis.  Insurance is an individual betting on failure of something, however the ante of that bet is reduced by the number of policy holders, and if insurance is ubiquitous or mandated, the meaning of that bet is nearly dissolved because your payment is low compared to the max risk. 

This is subject, in a fiat currency, to pricing controls and fixes, in that if the costs to replace or fix your lost value are made artificially high, than you would never think twice about paying your comparatively low insurance rates.  It is a numbers game, it is a pyramid like any other.

Thus in a world where more things fail that don't, there should be no insurance.

I would put the burden of audit on the shareholders.  Let the buyer beware.

ParkAveFlasher's picture

"This would eliminate the pressure auditing firms are subject to by company management."

No, it would simply revector pressure, not eliminate it. 

If a company is a dog, it is a dog, it should go bankrupt, and the share issuers, by name, will be known to the share holders who may seek recompense. 

If you seek to create pools (insurers) that refill reservoirs (busted firms) on an emergency basis, you still need to fill those pools. 

You would disassemble one pyramid scheme, and replace it with another.

formadesika3's picture

A soundly-run insurance company is not a pyramid scheme.

A large well-capitalized insurance company is much better positioned to resist corporate pressure than auditing firms can ever be.

ParkAveFlasher's picture

A soundly-run insurance company takes in more than it pays out.  Or, what?

formadesika3's picture

Actually, I'm trying but fail to see your point. (I've never been a part of the insurance biz, btw.) You say the whole idea of insurance is a misconception but if people voluntarily buy it, then by definition, it must provide value, if you believe in the subjective theory of value at any rate.

formadesika3's picture

A soundly-run insurance company takes in more than it pays out.  Or, what?

It fails, of course. But that's true of any company. The value of insurance is to arbitrage risk. People and organizations should have the right to self-insure of course. No argument there.

Buckaroo Banzai's picture

You can't conflate human health with corporate health.

Human health, outside of physical trauma, is very poorly understood, and is impossible to underwrite on a person-by-person basis. Corporate health is much easier to understand in general, and while some businesses are more complicated than others, it isn't hard to classify the differences for underwriting purposes.

That is what makes corporate health an insurable risk, and human health an uninsurable risk.

 

ParkAveFlasher's picture

I'm trying not to drive at "corporations are people". It is irrelevant to my point.

I would say that one can INDEED assess the health of either, if one has the expertise and the tools and the access, however that assessment has no direct bearing on the actions of both people and corporations. 

Saying that one is not obese, with good heart health, and a cheerful demeanor according to standard psych surveys, speaks nothing to their propensity to drive too fast or walk very close to the train platform edge or never look down the dark alleys while walking home. 

Likewise, saying that a company has healthy growth in established markets, good cash flow, and solid profitability speaks nothing to the propensity for its directors to peddle favors, tempt regulators, or yes, cook books, either directly (lying) or indirectly (moving or revaluing inventory, revisions after actionable data is actioned upon, etc.).

A healthy man goes home one day and sticks his finger in the socket.

A healthy company goes to market one day with a fifth row of icons. 

Insurance is a stubborn illusion, but it is a pyramid.

MachoMan's picture

It's dart throwing at present...  we'll upgrade to PLAID blindfolded dart throwing...  followed by dizzy bat.

Stoploss's picture

Here's to hoping every body doesn't figure out ( at the same time )

everything thing is, and has been, a lie.

 

kralizec's picture

GAAP is being phased out, we are all moving towards IFRS - International Financial Reporting Standards.

Really all it means is we will all be using the same playbook, it still comes down to gaming the system with new terms and assumptions, and it is likely compliance & enforcement will be spotty and there will be lots of opinions offered on the concept of value.

Other than that it should be a kick-ass transition!

http://www.ifrs.org/Pages/default.aspx

Raymond K Hessel's picture

ASC 820 won't go away because of IFRS.  They also have to MMKT. IFRS is probably why we adopted FAS 157 / ASC 820.

californiagirl's picture

IFRS leave a lot more room for subjective "manipulation" as they are less stringent than U.S. GAAP. Falsifying revenue recognition and gross margins contributes to false reveue/income projections and an overvaluation of Goodwill. The accounting rules are not creating the fraud.

One of the underlying principals of GAAP is that the accounting is supposed to reflect the economic reality of the underlying transaction. However, unethical management often purposefully manipulates legal and other documents to misrepresent the economic reality and makes other verbal agreements that are difficult for the accountants to discover, particularly when high level collusion is involved. I could write a very thick book on the tricks and fraud I discovered during my years of auditing.

Ignorant accountants that are inadequately trained in GAAP, or don't have the balls to rock the boat or risk losing an angry clients, are also to blame.

Software revenue recognition is one of the most heavily abused areas in accounting. Because accountants are not software and computer eexperts, they can be more easily misled. They need to make extra efforts to understand a comprehensive arrangement with a customer/client and the product than have been promised, significantly beyond reading the paperwork.

HP will need to disclose more about the fraud when they file their financials.

LawsofPhysics's picture

Anyone suprised?  Fraud is the status quo, there is no accountability at the top anywhere.    Once again, it appears that only collapse will bring back real consequences for bad behavior AT ALL LEVELS of society.

< sigh > Same as it ever was.

Mitch Comestein's picture

What they are writting down is the goodwill on HP's books and the goodwill & intangibles that were on Autonomy's books.  They obviously found out that whatever Autonomy had technology-wise, for which they were buying, was a scam or worthless.  Therefore, all the intangibles and goodwill is worthless.  In GAAP accounting, the goodwill/intangible has to produce a cashflow or expected to produce it.  If that cashflow is later determined to be zero, then the intangible/goodwill needs to be written off.  They have to do a test every year. 

LawsofPhysics's picture

so, "mark to fantasy" accounting strikes again.  Color me shocked.

Zero Govt's picture

HP Execs didn't bag/buy a 'winner' then?!!

..you should see what Bernanke is buying, shit isn't the word!!!

LawsofPhysics's picture

What Bernanke is doing is criminal, end the damn Fed.

Zero Govt's picture

Govt is criminal (theft). Period. End it...

Stop Paying Tax ...take your chips off their menu.

 

LawsofPhysics's picture

I have been long black markets since 2001.  Nice (tax free) returns.

Winston Churchill's picture

They (HP) ran the company for 12 months prior to closing on the

purchase.

Run Muppets,run.

Smells like a fish market.

LawsofPhysics's picture

Related to the article and all the "mark to fantasy" bullshit going on.  Say it with me now; "Show me the collateral and assets behind that balance sheet bitchez!"

 

Dr. Engali's picture

Shock of shocks...a poorly managed dying company is lying, before you know it they will be trying to tell us that Goldman isn't doing God's work.

Zero Govt's picture

Blankfein is doing Gods work, Bernanke is buying the shit results

Lucifer must be laughing his socks off

Rustysilver's picture

So another company lied. Tyler reports it as news: it's not.

Sudden Debt's picture

your boss just called me. He's going to double your salary and give you a extra fat bonus cheque for christmass... promise...

unless the economy is going to have another crisis of course... but everything is looking good... promise...

 

 

prains's picture

then explain what it's not then cornhole

EscapeKey's picture

The mind boggles thinking about the "goodwill" associated with the Fed's MBS purchases off of primary dealers.

LawsofPhysics's picture

Bingo.  Criminal for everyone else (especially the individual person/corporation) except a banking cartel.  End the damn Fed.

ParkAveFlasher's picture

I always loved that "goodwill" in the corporate balance sheets.  It's as if Santa Claus arrives quarterly.

orca's picture

Good rebuttal http://tinyurl.com/cjvyzjp
Whichever way you slice it, HPQ is a shithole of a share.

AynRandFan's picture

Oracle wasn't fooled but HP was.  

Stupid is as stupid does.