Kraft Heinz's Accounting Issues Raise Red Flags

Some little accounting mistakes over the past two years are coming back to haunt the packaged foods maker.

The Motley Fool May 8, 2019

Kraft Heinz's (NASDAQ:KHC) stock hit a historic low earlier this year after the company took a $15.4 billion writedown of goodwill on its Kraft natural cheese business, Oscar Mayer cold cuts business and Canada retail business, slashed its dividend, and disclosed an SEC probe into its accounting practices. Kraft then delayed the filing of its annual report twice as it launched an internal investigation.

On May 6, Kraft Heinz stated that it would need to restate its financial statements for 2016 and 2017 by $181 million due to problems with its procurement and accounting procedures. $181 million is a tiny amount for Kraft, which reported $33.4 billion on its cost of products sold during those two years. But the mess that led to that revelation, along with its ongoing SEC probe, raises red flags for investors and casts a shadow over the company's appointment of a new CEO last month.

A timeline of events

Last October, Kraft received an SEC subpoena regarding its "accounting policies, procedures, and internal controls related to its procurement function" -- which includes "agreements, side agreements, and changes or modifications to its agreements with its vendors."

After its initial internal investigation in its inventory accounting, Kraft Heinz recorded a $25 million increase in its cost of products sold during the fourth quarter, after deeming the costs "immaterial" in previous quarters throughout 2017 and 2018. At the time, Kraft Heinz stated that it was "implementing certain improvements to its internal controls to mitigate the likelihood of this occurring in the future" and "continues to cooperate fully with the U.S. Securities and Exchange Commission."

However, Kraft Heinz then repeatedly delayed the filing of its annual report, which prompted Warren Buffett to warn Berkshire Hathaway (NYSE:BRK-A) (NYSE:BRK-B) investors that the company was likely stuck in a dispute with its auditor, PwC. A few days later, Kraft revealed that it needed to restate its financial reports for both 2016 and 2017.

Should investors be concerned?

Kraft Heinz told CNBC that it still didn't believe the misstatements were "quantitatively material to any prior period," but believed that it was "appropriate to correct the errors in previously issued financial statements." That decision was likely linked to the SEC probe and its rumored dispute with PwC.

The amount in Kraft Heinz's misstatement wasn't significant, but its recent writedown, delayed annual report, and SEC probe already caused S&P to threaten a downgrade to its BBB-rated bonds. A downgrade could significantly raise Kraft Heinz's future borrowing costs.

Questions

1) Is each of the Kraft Heinzs negative events labelled with a double underline above: A change in accounting principle, change in estimate, change in reporting entity, a correction of error, or an event that does not need an accounting adjustment?

2) What corresponding account would likely be affected (i.e., as credit) due to Kraft Heinzs $25 million increase in its cost of products sold during the fourth quarter (i.e., as debit)?

3) What corresponding account would likely be affected (i.e., as credit) due to Kraft Heinzs restatement of its financial statements for 2016 and 2017 by $181 million due to problems with its procurement and accounting procedures (i.e., as debit)?