In 1955, James Luther Turner and his son, Cal, opened a small retail store in Scottsville, Kentucky. The Turners hoped to emulate (on a smaller scale) the business model of major discount retailers that had become well established in the United States in the decade following World War II. The Turners developed a unique marketing concept to differentiate their business from other discount retailers. Their store would sell only merchandise with a retail sales price of one dollar or less.  

The Turners’ business model was a financial success from its inception. Within three years, the Turners were operating more than two dozen Dollar General Stores in Kentucky and surrounding states. Under the leadership of three generations of the Turner family, Dollar General Corporation would become one of the most recognizable retail companies in the United States. The company would eventually own and operate more than 8,000 stores, produce annual sales approaching \($10\) billion, and have its stock listed on the New York Stock Exchange.1 In 1999, Cal Turner, Jr., Dollar General’s CEO, decided that if his company was to remain a major player in the intensely competitive discount retailing industry, he had to update its outmoded information systems. To accomplish that goal, Turner retained IBM to revamp his company’s technology infrastructure. For years, IBM had marketed itself as the provider of “solutions” to a wide range of information technology challenges faced by companies of all sizes.

The major feature of IBM’s technology solution for Dollar General was the installation of state-of-the-art electronic sales registers for each of the company’s retail stores. The new sales registers—manufactured by IBM—would collect and process a wide range of point-of-sale information. This information would allow Dollar General’s management to quickly identify important trends that could potentially impact the company’s profitability and competitive position. Cal Turner was pleased with IBM’s recommendation to replace the company’s antiquated sales registers and decided to purchase the new registers over a several year period beginning in 2000. However, Kevin Collins, an IBM employee involved in the Dollar General consulting engagement, believed that Dollar General should acquire and install the new sales registers much sooner. Collins recommended that the installation of the new equipment be completed by the end of 2000.

Dollar General’s executives agreed with Collins’ assessment that their company would realize significant benefits by installing the new sales registers as quickly as possible. But the executives were also aware that decision would have a significant impact on their company’s reported operating results for fiscal 2000. Since the thousands of old sales registers had no salvage value, the company would be forced to record a \($10\) million loss on their disposal. That loss, which was the approximate book value of the old sales registers, would reduce the company’s 2000 net income by an estimated six to seven percent.

On November 29, 2000, Dollar General contacted Collins and told him that the accelerated roll-out of the new sales registers was unacceptable due to the “accounting problem” it presented the company. The following day, Collins called a Dollar General executive and told him that he could solve that problem. Collins proposed that IBM purchase Dollar General’s old sales registers for an amount equal to their remaining book value even though Collins and his superiors at IBM knew that they were worthless. Under Collins’ proposal, the book value of Dollar General’s old sales registers would be added to the price of the new sales registers that Dollar General purchased from IBM. This arrangement would result in Dollar General paying about \($20\) million for the new sales registers, which was approximately double the original purchase price agreed to by the two parties.
Collins’ proposal called for the two-way transaction to be consummated in the final few days of Dollar General’s 2000 fiscal year. IBM would pay the \($10\) million for the old sales registers at that time. A few days later, in early fiscal 2001, Dollar General would pay one-half of the \($20\) million purchase price of the new sales registers. This \($10\) million payment would serve to reimburse IBM for the amount it had paid for the worthless sales registers. Dollar General would pay the remaining \($10\) million owed to IBM in several installments.

In an intra-company e-mail, Collins explained that his proposal would eliminate the “book loss issue” that was the major stumbling block to finalizing the Dollar General transaction. “A buyback of the Omron equipment [Dollar General’s old sales registers] will erase the book loss issue, removing this as an obstacle to a more rapid roll-out.”2 In a subsequent e-mail, Collins pointed out that his proposal would provide significant benefits for IBM as well. “This would be a quite nice deal to put this much business this far forward at a time when IBM desperately needs to show revenue growth.”.........

Questions

1. Identify audit procedures that might have detected the improper accounting treatment applied by Dollar General to the transaction with IBM.

2. Identify the accounting concepts or principles violated by Dollar General in this case. Defend each of your choices.

3. Under what circumstances, if any, are “earnings management” techniques acceptable under GAAP? Under what circumstances, if any, are such techniques ethical? Explain.

4. In addition to the parties identified in this case, what other parties bore some degree of responsibility for the improper accounting applied to the Dollar General–IBM transaction? Explain.