Everyday Fake Financials: How Wal-Mart Prospered On Chinese “Accounting”

From Zero Hedge

For many, if not most, companies and especially retailers, the great wildcard that is the “massive” Chinese market with the potential of hundreds of millions of buyers in the country’s nascent middle class, has been a slam dunk when it comes to boosting stock prices. After all, what can go wrong? America’s largest retailer was one of those hoping to capitalize on just this shareholder euphoria for Chinese exposure, and just like everyone else, it milked its Chinese exposure for many years. And then, unexpected everything did go wrong: as Bloomberg explains, “After years of heralding China as one of its best markets, Wal-Mart in August said its performance there was among the worst in its major countries.

How is that possible?

Well, as Bloomberg further explains, China’s reputation of fabricating every single number is there for a reason. And what’s worse, it isn’t just China, but it also includes US corporations operating in China. Such as Walmart, which succeeded in pulling the wool over its shareholders’ eyes for years thanks to “questionable accounting and unauthorized sales practices, according to employees and internal documents reviewed by Bloomberg.”

Among these: bulk sales to other retailers and some sales allegedly booked when no merchandise left the shelves. These illegal practices, and much more “made business appear strong even as retail transactions slowed and unsold inventory piled up, these people and documents say.

And nobody cared, because WMT (and every other) stock went up, clearly not on fundamentals but on the back of the biggest equity bubble blown by central banks in history. And it wasn’t until the relentless price appreciation finally slowed down that someone started asking questions, however with accountants and regulators both in China and the US corrupt and complicit to the underlying fraud, it goes without saying that nobody did or ever will go to prison.

So what are some of these fraudulent practices that WMT engaged in? We ask simply because we know that this massive canary in the coalmine will give us insights into what all other retailers in China are doing, up to an including famous recent Chinese IPOs. Here are the details:

  • Stores in China continue to make bulk sales, sometimes unprofitably and without required management authorizations, according to employees who’ve left the company this past month. Concerns about bulk sales, raised as far back as 2011 in an internal report, have been the subject of inquiries in China by Wal-Mart’s legal team as recently as May, according to an internal company e-mail and an employee interviewed by lawyers.
  • The report and interviews with current and former employees say Chinese Wal-Mart stores, under pressure to meet earnings targets, resorted to temporary markups of inventory as an accounting move that can burnish profits without any added sales of merchandise.
  • The bulk sales provided at least 1.6 billion yuan ($243 million) in sales, and the markups accounted for 4 percent of gross profits in 2010 alone at 98 hypermarket stores examined by Stanford Lin, who conducted the internal review. These stores accounted for about half of total hypermarket sales in China that year.
  • By 2010… Wal-Mart’s Chinese operations were expanding, the stores weren’t running as profitably as those operated in the U.S. by the Bentonville, Arkansas-based retailer.
  • Managers often told employees to raise prices in the last week of the
    month, and to move them down at the start of the next month.

    • The employees couldn’t understand why. Higher prices, even if temporary, didn’t jibe with the everyday-low-pricing strategy that founder Sam Walton and his successors used to turn his Arkansas five-and-dime into the world’s biggest retail chain, with more than $480 billion in annual sales.
    • The markups were part of a pattern of “unusual,” unauthorized, and “unsustainable,” accounting moves and deals with suppliers and rivals that made sales and profits look stronger than the underlying retail trends in the stores, according to Lin’s 32-page review, labeled “Highly Confidential.”
    • Altering reported income by marking up inventory “only to turn around and mark it down again” after the end of the quarter “would be fraud,” said Lynn Turner, a former chief accountant for the SEC and now a managing director at LitiNomics Inc., an advisory firm in Los Angeles. Turner was speaking generally, and not about Wal-Mart.
    • “The business was continually getting worse despite their pronouncements to the contrary,” Lin said earlier this year.
  • The time spent on markups quickly caught his attention. When buyers asked stores to change prices, they had 24 hours to comply — often scrambling to swap out labels on 1,000 or more products, according to one former operations executive for Wal-Mart China.
  • In his report, Lin highlighted “Department 14,” or housewares. He said the division marked up 183 products in the last week of December 2010, increasing gross profits by 2.5 million yuan. In the first week of January 2011, the products were marked back down.
    • It was an accounting entry, not added sales, that was behind these higher profits, according to Lin.
    • In simplified retail accounting, gross profits are sales minus the cost of goods sold. The cost figure can be calculated by subtracting ending inventory from beginning inventory. Lin’s report said the price markups were applied to ending inventory, giving the appearance of lower costs.

      • say a store had $20,000 of wine at the start of a month, and was left with $10,000 worth at month’s end. Its cost of goods sold would be $10,000. If sales were $15,000, gross profits would be $5,000. But if ending inventory is marked up 20 percent, the cost of goods sold drops and wine profit rises to $7,000.
  • “The store was under a lot of pressure from the HQ to meet certain sales and margin targets every month,” said Tom Huang, an administration manager at the Wal-Mart in the city of Changde, which closed in March. At around 8 p.m., when sales were slow, store-level managers responsible for various product categories would call wholesalers and “ask them to come down and buy” items in bulk, said Huang, a union representative who has been involved in legal efforts to get more severance for the laid-off Changde workers. 
  • The company was losing money on bulk sales of groceries and barely selling above cost on a range of other products, Lin’s report said. Bulk transactions of 10,000 yuan and above were supposed to be approved by store managers, but to avoid the sign-offs, employees would simply break them up into smaller lots ’’against company policy’’ — in one case splitting up a sale of 9,600 bottles of soybean oil into 32 separate transactions, Lin said.
  • In some cases, a store would register a sale to a supplier of the same goods the vendor had previously sold to Wal-Mart — but the goods didn’t go anywhere, according to Lin. Recording the transaction would automatically trigger Wal-Mart’s ordering system to place a new order for the same goods, he said. “It’s all engineered on paper,” Lin said. “The items never actually leave the shelves.” 
  • A sale like that is “a plan designed to mislead. It’s inflating sales,” said Douglas Carmichael, former chief auditor of the Public Company Accounting Oversight Board and a professor at Baruch College in Manhattan. ’’It certainly would create a distortion of the income statement.’’
  • During U.S. earnings calls throughout Chan’s tenure, Wal-Mart’s Bentonville executives highlighted Chinese sales performance. In August and November of 2008, the company said same-store sales in China were strong and driven by increases of up to 18 percent in the size of the average transaction — a sign that growth mostly stemmed from big sales.  No mention was made of sales of Wal-Mart merchandise to other retailers. In fact, individual customer traffic was beginning to fall, and transactions in the hypermarkets Lin examined fell 3 percent from 2008 to 2010.

And, of course, the oldest trick in the book: the most epic channel stuffing imaginary money can buy:

A back room at one South China store shown to Bloomberg News in September held boxes of goods piled to the ceilings, covering light switches and leaving only a foot-wide aisle for employees to move around in. A Wal-Mart store in Shenzhen provided an address for a warehouse one employee said was opened to handle added inventory five years ago. At the address, a security guard said Wal-Mart had two warehouses there.


When the findings of his Feb. 14, 2011, report were presented to his boss, Shawn Gray, then vice president of operations in China, Gray said the “best option was to keep things quiet,” according to Lin. After a discussion of the issues with Roland Lawrence, then chief financial officer of Wal-Mart China, Lin said he saw no action.


Phone calls and e-mails seeking comment from Gray and Lawrence weren’t returned.

End result, when Walmart first conducted an internal audit in 2011 it said the following: “None of the financial issues we’ve reviewed in China were determined to be material to Wal-Mart’s consolidated financial condition or results of operations,” the statement said. Wal-Mart didn’t address specific questions on accounting issues, and leadership changes. It said bulk sales to retailers are common practice in developing markets, monitored regularly, and a modest part of its Chinese business.”

And more recently, following the Lin report: 

Wal-Mart named Lin as a vice president of financial services in April 2012. He left in May 2013 for his job with Visa. Lin said he traveled to Bentonville at one point after the report and bumped into Price and McMillon, who, through a Wal-Mart spokeswoman, declined to comment on Lin’s account. “Doug took me aside, shook my hand and said, ’thank you very much for what you did over there,’” Lin said of the encounter. “That was it. No further follow-ups. Nothing more was discussed. It was like it all never happened.”

In short, WMT lied and kept lying for years. Why?

There is a general flexibility on ethics” in China, Lin said in an interview. “There was a huge desire to perform. In this market, they believe if they’re hitting the numbers, then they’re doing the right thing.”

How quaint: breaking the law and lying to shareholders in hope of “doing the right thing.”

The U.S. Department of Justice and the Securities and Exchange Commission have been investigating Wal-Mart for possible violations of the Foreign Corrupt Practices Act, the company has disclosed. Internal investigations of possible misconduct are open in four countries, including China, the company has said.

Nothing will happen: all it will take is a few multi-million wire transfers in donations, pardon, lobby spending to make sure the DOJ finds absolutely nothing.

The good news is that WMT is the only one who engaged in all these criminal practices. One company which certainly has not resorted to fraud, at least according to its exuberant underwriters (all of whom certainly performed underwriter due diligence, right) and its share price, is Alibaba. So as boring old WMT engaged in boundless fraud in China, we urge investors to buy Chinese “new normal” retailers built on hype surrounding the second dot com bubble, and operating in the most “ethically-challenged” country in the world.

Because, as above, what can possibly go wrong?