UPS Settles with SEC for $45 Million; Possible Actions to Follow

The United States Securities and Exchange Commission (“SEC”) recently issued an Accounting and Auditing Enforcement Release (AAER”) regarding the settlement of an action against United Parcel Service, Inc. (“UPS”) related to UPS’s failure to timely record the write down and impairment loss for the goodwill asset on its balance sheet for the UPS Freight business unit.? The settlement involved a $45 million civil penalty along with other requirements, including an obligation to cooperate in future proceedings.

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According to the AAER, UPS possessed internal analyses and market information that an impairment loss was necessary in 2019. However, rather than recognize the loss, UPS engaged a valuation consultant to prepare a report based on faulty assumptions that would support the overstated goodwill balance.

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Of significance, UPS’s internal analyses and market information were correct, as UPS sold the business unit in the fourth quarter of 2020 and recorded an impairment loss for the entire UPS Freight goodwill balance of $500 million.

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Below are select background facts from the AAER regarding UPS’s actions, a brief overview of the Generally Accepted Accounting Principles (“GAAP”) related to goodwill impairment tests and a discussion of the roles and responsibilities of those involved in presenting UPS’s erroneous financial statements. This latter discussion is especially relevant noting the cooperation requirement in the settlement.

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Background

In 2019, UPS began a process to evaluate what to do with UPS Freight, a poorly performing business unit. UPS’s balance sheet during this period included a $1.4 billion net-asset value for UPS Freight, including $500 as goodwill. However, also during this period, the UPS corporate strategy group estimated that UPS Freight may sell for $350 million to $650 million. Per GAAP, these facts indicated that a $500 million impairment loss would be necessary in 2019.

Instead of recognizing the impairment loss, UPS engaged a valuation consultant to prepare calculations for the business unit’s fair value, and provided flawed growth and costs estimates to the consultant. UPS did not share its internal analyses and market information with the consultant. The consultant valued UPS Freight at $2 billion.

UPS acted similarly in 2020, again providing flawed assumptions to the valuation consultant and without sharing its internal market analysis or that UPS began a process to sell UPS Freight in 2020. In fact, UPS executed a non-binding term sheet with a prospective buyer selling Freight for $800 million, subject to various downward adjustments. Without knowledge of these events, the valuation consultant again valued UPS Freight at $2 billion.

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In the fourth quarter of 2020, after reaching an agreement to sell UPS Freight for approximately $650 million, UPS reported that the UPS Freight goodwill was worthless. The $500 million impairment loss reduced UPS’s fiscal year 2020 income from continuing operations by approximately 6%, and its net income by approximately 20% percent.

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Goodwill Impairment Testing Requirements

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Guidance related to the financial reporting for goodwill is found in ASC 350 (Intangibles – Goodwill and Other) and requires entities to periodically test the carrying value of goodwill on its balance sheet, by reporting unit, to determine if it is stated at an amount greater than its “fair value.” ASC 350 further provides that fair value shall be determined in accordance with ASC 820 (Fair Value Measurement) which defines the term “fair value” as synonymous with a sale or exit price and that its determination shall be based on “assumptions market participants would use in pricing the asset or liability.”

When the carrying value of a reporting unit that includes goodwill exceeds the fair value, a registrant should record an impairment loss and reduce goodwill by the difference or in its entirety.

Roles and Responsibilities for UPS’ Financial Reporting

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Based on the facts described in the AAER, there are notable concerns related to the major parties with roles and responsibilities for UPS’s financial reporting for goodwill.

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Management

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Financial statements are the responsibility of a registrants’ management. Per the AAER, certain members of UPS management knew that an impairment loss was necessary but instead, UPS chose to rely on a valuation consultant’s calculations, after withholding information from the consultant and providing faulty assumptions to the consultant.

Valuation Consultants

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Registrants frequently engage valuation consultants to assist management fulfill their responsibilities for the financial statement judgements when presenting financial reporting assertions involving fair value. The consultants have no direct responsibility for the financial statement assertions. That said, they are expected to perform their services competently and in accordance with professional standards.

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While management integrity appears to be lacking in its dealings with the consultant, the facts also indicate the consultant failed to perform calculations for UPS Freight’s cost structure as a standalone business and as a unionized operation. Both flaws resulted in overstating the valuation.

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Audit Committee

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Audit committees are a select group of members of the board of directors that meet independence requirements and possess financial reporting expertise. The audit committee provides an oversight function for a registrant’s financial reporting and internal controls.

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While the AAER does not discuss the role of the audit committee related to the timing of the impairment loss, as members of the board, one would assume the committee had knowledge regarding UPS Freight’s performance and planned divestiture. If so, one would expect the audit committee to ask targeted questions regarding whether the business unit’s reported goodwill is impaired or not.

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Auditors

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Auditors plan and perform tests and procedures to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Auditors evaluate the accounting principles used by the registrant and the significant estimates made by management. Goodwill is an estimate and requires periodic testing to ensure its continued existence or impairment.

In the ordinary course, UPS’s auditor would review and test the valuation consultant’s calculations, and if true for UPS, would mean the flaws described by the SEC related to the consultant’s calculations would also be possible failures by the auditors to properly test for the existence of an impairment loss. In addition, the auditors would be aware of UPS Freight’s performance, a major factor when evaluating the business unit’s goodwill.

Possible Actions to Follow

The settlement includes a requirement for UPS to “cooperate fully with the Commission in any and all investigations, litigations, or other proceedings relating to or arising from the matters described in the Order.”? ?To use the accounting parlance of remote, possible, and probable, the combination of the facts in the AAER, and this clause, appears to meet the possible level, if not even the probable level, that additional actions from the SEC will follow.

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