Key Accounting Policies and The Quality of Disclosure

Key Accounting Policies and The Quality of Disclosure

Reinvestment into mergers and acquisitions

In Amazon the most important strategic policy without doubt is the reinvestment of its capital into smaller (mainly) ecommerce companies. Amazon uses three different types of policies to account for these different purchases/acquisitions.

The ‘purchase’ method of accounting, which states that goodwill on purchases, should be included in the balance sheet.
The ‘pooling of interests’ method of accounting which are reported in the consolidated financial and
The ‘equity’ method of accounting, which reports statements in the consolidated statement of operations.

From the view of an unqualified accountant, this seems to be a very tedious and tricky way of manoeuvring accounts. Why cant they use one accounting standard, especially when their strategic focus is on ‘land grabbing’ smaller companies and on signing deals with other companies and associates.

A full list of all of the mergers/transactions are included in all the reports, but fail to give exact details of how the knitty gritty financial arrangements work.

Goodwill

Nearly all of these investments are purchased by issuing shares to the companies and the price of the sale is treated as goodwill in the consolidated balance sheets. In other words the fair value of services provided by Amazon to the partners is measured by consideration paid to the company by the partners and consisted of cash or equity or a combination of the two. Amortisation of goodwill is amortised on a straight-line basis over lives of approximately three years.

Amazon never point out how goodwill is measured and how companies are valuated. In the 2000 3^rd Quarter report it says:

"Estimates of fair value are based on the use of independent 3^rd party appraisals when appropriate".

Who are these 3^rd party appraisers? When is it appropriate to use their services? Amazon provides none of the answers to this conundrum. There appears to be a big problem here with the valuation of goodwill, as the companies being purchased appear to be overvalued.

For example during the first nine months of 2000 Amazon invested roughly $520M in new types of business ventures; the return on its investment was about $17M in recognised cash revenue, which suggests a massive loss with a strategy that was supposed to build long-term value for the shareholders. All management say on the issue is that the companies are at "an early stage".

It also seems strange that in the Chairman’s report for 1999 none of the key headings for the year included this massive expansion policy which cost the company over $1Billion in a long term debt.

Constantly Changing Estimates

Management are constantly revising estimates and forecasts. As a result, one tends to take some of the (gu)estimates with a large grain of salt, and leads to a certain lack of confidence in management. How are stockholders, creditors etc. supposed to know when a realistic, quality report is produced? For example in the 2000, 3 rd Quarter report, CEO, Jeff Bezos predicted $4 Billion sales in 2001. Yet three months later he was saying that sales would increase 20-30% on 2000 figures, which ultimately is saying that sales would be between $3.264 Billion and $3.536 Billion, which is well below the $4B estimate.

This is all part of the Amazon mantra which keeps saying that they will be profitable by the end of year 2001 but how can they justify this statement when they know that less revenue will be coming in from sales?

Amazon is very adept at selective presentation of ratios. Any disappointing ratio is usually left out and vice versa.

On the plus side…………………………..

Another of Amazons key strategic focus is on customer satisfaction and customer retention and Amazon perform well in providing data on these. Figures include

1998

1999

2000

2001(Expected)

Customer Accounts

6.2M

16.9M

29.4M

34.5M

New Customers

4.7M

10.7M

12.5M

6.05M

% Repeat Customers

73%

75%

Revenue per Account

$177

$148

$120.5

As Amazon invest a lot of their finances in branding, advertising and marketing, it is important that they have these means of analysis, which is a new style of accounting for the internet age.

Amazon do admit in their 1999 reports that the Securities Exchange Commission are investigating them for accounting irregularities and Amazon consistently deny that they are involved in this, which relates to their valuation of companies being merged.
In the 1998 report Amazon informed the public that their main supplier, Ingram was about to be bought by one of their biggest rivals BarnesandNoble.com.
Amazon always gives details of court cases, which they are involved in.

Red Flags

Obviously, the investments and land grabbing strategy has led to some odd accounting techniques involving over inflated measurements of goodwill which boosts the Balance sheet using tree different accounting policies. This has led to a Debt: Total Assets ratio of a staggering 99%. Surely management are running on a fine line and should re-evaluate their situation mainly because:

Their diversification strategy has been unsuccessful
They still are not running efficiently with operating margins getting worse.
Sales are lagging.

As a result, ROE decreased 250% in 1999.

All the falling liquidity ratios are extremely dangerous signals.
Even though $30 Million is relatively small, this amount was suddenly invented in 1999 for staff expenses and was never explained in the notes.

Notes on the Management of the Company

The board of directors is an extremely tight knit operation. It is headed by the founder Mr. Jeff Bezos who has a number of roles: Chairman, Chief Executive Officer, President, and Chief Operating Officer. For such a large public company it is strange to see one person having so much control and responsibility. The four other board directors have been there from 1996/97.

There seems to have been a lot of unsettlement in the positions held by the executive officers. During the 1999 year, 6 of the 9 executives were replaced with new executives and in 2000 2 more executives moved in, replacing 2 others.

This may suggest that that there may have been a lot of squabbling in the boardroom, especially during 1999 when Amazon’s major expansion plans began.

After Bezos the most influential person is Warren Jenson who is A Senior VP, CFO and Chief Accounting Officer/ He is the only person who has stock options. These are worth $75 Million and he has already cashed in $12M.

	1998	1999	2000	2001(Expected)
Customer Accounts	6.2M	16.9M	29.4M	34.5M
New Customers	4.7M	10.7M	12.5M	6.05M
% Repeat Customers		73%	75%
Revenue per Account	$177	$148	$120.5