Auditors at Deloitte & Touche LLP became aware of potential accounting problems at U.S. Foodservice Inc. after at least two of the company's suppliers disputed the rebate figures given them by the Columbia food distributor, according to sources familiar with the situation.
How U.S. Foodservice accounted for its rebates is at the heart of an accounting scandal at Royal Ahold NV, the Dutch parent company of U.S. Foodservice and Giant Food.
U.S. Foodservice receives substantial rebates from suppliers for selling large quantities of their products. Each year, Deloitte, the outside auditor, sends letters to many of the suppliers to confirm that they actually paid the rebate that U.S. Foodservice listed in its financial records.
In 2001, suppliers verified the figures provided by U.S. Foodservice. But in 2002, at least two suppliers said they had paid less than the amount listed by U.S. Foodservice, according to sources. Deloitte informed the company of the discrepancy. It suspended its audit for 2002 and later said it could no longer stand behind its audits for 2000 and 2001.
After Deloitte informed U.S. Foodservice officials of the rebate problem, the food company swung into crisis mode, according to sources familiar with the company's activities, ordering employees from the purchasing division and elsewhere to call suppliers and check the amount of rebates they paid. Some of the employees pressed into service have said they had no idea what they were supposed to be looking for or whom they were supposed to be talking to at individual companies, the source said.
A U.S. Foodservice spokesman declined to comment, saying that the matters are under investigation and that the company is cooperating with investigators. A Deloitte spokeswoman, citing client confidentiality, declined to comment.
According to another source, James L. Miller, the chief executive of U.S. Foodservice, was the first to inform Royal Ahold of the accounting problems. Ahold later announced that it would restate earnings by at least $500 million.
Federal prosecutors in Manhattan, the Securities and Exchange Commission, and the FBI are investigating the company's finances. Ahold has hired a law firm to conduct an internal investigation.
U.S. Foodservice, the nation's second-largest food distributor to restaurants, suspended Mark P. Kaiser, its chief marketing officer, and Tim Lee, a purchasing executive. Investigators have seen at least two letters signed by Kaiser in which he tells suppliers they don't have to pay as much in rebates as they officially agreed, effectively creating two sets of books, according to sources.
Attorneys for Kaiser and Lee did not return calls for comment, and a spokesman for Miller said he would have no comment.
In a letter to the firm's biggest customers this month, Miller criticized Deloitte, its longtime auditor, for the accounting problems. "Throughout its service to our company, Deloitte & Touche's auditors repeatedly assured me and other senior managers that our accounts were in proper order," Miller wrote. "Sadly, those assurances turned out not to be true."
In an interview last week, Robert Gillison, vice president and treasurer at U.S. Foodservice, said the supplier rebate programs were constantly reviewed by internal and outside auditors. Gillison said that as many as 10 Deloitte auditors worked at the company's Columbia headquarters.
Ira Solomon, head of the department of accountancy at the University of Illinois at Urbana-Champaign, said auditors generally should expend "a great deal of energy" looking at supplier rebates, given a history of accounting disputes in that area.
"If you see gross profit margins that deviate from the rest of the industry, then you ought to start asking some very tough questions," Solomon said. "The question then would be, are there signs in the environment" that an auditor should pick up?
Outside accounting experts have pointed to two signs. Ahold said in an SEC filing in November that issues "related to the collection" of vendor rebates had cut significantly into the company's cash flow. It blamed the problem on "higher investments in working capital" and "timing differences related to the collection of vendor allowances."
Ahold also reported that U.S. Foodservice's operating earnings had grown as a percentage of sales, even though sales were growing more slowly. The company attributed the change to savings from consolidation.
Accounting firms say that it is difficult for auditors to detect problems if people inside and outside a client firm collude. "Auditors say to each other, if the client is determined enough, they can almost always beat you," said Scott M. Univer, general counsel at BDO Seidman LLP, a Chicago-based accounting firm.
But accounting firms also acknowledge that investors are upset by the large number of accounting blowups in the past year. Dennis M. Nally, chief executive of PricewaterhouseCoopers LLP, in a recent speech to the Detroit Economic Club, talked about the "expectation gap" between what the public assumes auditors provide and what current accounting and auditing standards require.
He said PricewaterhouseCoopers is training auditors to look for any evidence of "significant" fraud, such as misconduct by senior executives, kickbacks and bid rigging, not just problems that would have a material impact on a client's finances in the year being examined.
Staff writer Sabrina Jones contributed to this report.