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* All big listed supermarkets warned of reporting risks onsupplier rebates
* Rules on rebate accounting well known
* Analysts say managers may have felt pressured toaccelerate income recognition
By Tom Bergin
LONDON, Sept 23 (Reuters) - Tesco Plc's disclosure of hugeaccounting mistakes over contracts with its suppliers shockedindustry analysts and executives, but not because they didn'trealise the potential for disaster.
On the contrary, they assumed that everyone in retailing wasfully aware of the risks involved in accounting for rebates paidby suppliers to Britain's biggest supermarket groups, thanks toauditors' warnings.
Therefore Tesco's revelation on Monday that it hadoverstated its profit forecast for the first half of the year by250 million pounds ($409 million) came as a nasty surprise andwiped 2 billion pounds off its stock market value.
Auditors routinely list risks that companies may face, andthis year they have raised the supplier rebates - which havebecome a major part of the grocery business - in a number offirms' accounts following a change in disclosure rules.
The auditors for all three of Britain's biggestpublicly-quoted retailers - Tesco, Sainsbury's andMorrisons - told investors in their most recent annualreports that their businesses faced material risks regarding thereporting of the supplier rebates. Those at the smaller onlineretailer Ocado did likewise.
These cash payment or discount deals take many differentforms, but suppliers typically offer them to the retailers inreturn for additional efforts to promote their products.
Accountants said that such disclosures by auditors reflected more the growing importance of the supplier rebatesthan worries that companies didn't know how to account for them."The rules are pretty well established," said a senior auditorat one big accounting firm who asked not to be named.
Companies can even buy software packages to help to track,analyse and account for such payments.
Nevertheless, deciding how the rebates should be treated inaccounts requires companies to exercise discretion, and thereinlies the risk of the kind of trouble that has hit Tesco.
Companies don't publish how much they receive in paymentsfrom suppliers. But France's Carrefour, which vieswith Tesco as the world's second largest supermarket group byrevenue, said at the end of last year that it had over 1 billioneuros (now $1.3 billion) in outstanding receivables fromsuppliers in relation to rebates and other commercialincentives.
One industry executive said that rebate programmes typicallylasted less than six months so the actual payments - known assupplier or commercial income - for a group of Carrefour orTesco's size could run to billions of pounds.
This may explain the size of writedown at Tesco.
The company blamed "accelerated recognition of commercialincome and delayed accrual of costs" within its UK food businessfor the overstatement of its expected half-year profit.
Some analysts said the mistake could reflect grey areas thatsometimes exist when accounting for complex agreements, butothers were sceptical that such a big downgrade could haveresulted from a mere interpretational misunderstanding.
"This, in our view, is not all an accounting issue but morea behavioural issue instilled by previous management," said MikeDennis, retail analyst at Cantor Fitzgerald in London.
Dennis and other analysts said they expected the problem waslinked to attempts by the previous leadership team, includingCEO Phil Clarke who lost his job in July, to revive the flaggingbusiness. Analysts at Bernstein warned investors that theirregularities had probably gone on for years "since thepressure started on Tesco in 2011".
Reuters attempts to contact Clarke and former CFO LaurieMcIlwee were unsuccessful. Tesco declined to comment on whetherstaff might have felt pressure to account for promotionsaggressively.
A MATTER OF JUDGMENT
Tesco gave little detail about what kinds of mistakes itsuspects were made, but analysts said the statement aboutaccelerated income recognition suggested a number of possiblemechanisms.
Bernstein analyst Bruno Monteyne, who was previously asupply chain director of Tesco Asia, said managers - possiblyunder pressure to improve earnings - might have brought forwardpromotions and the right to book supplier rebates.
He said that managers might also have booked rebates thatbridged more than one period, in an earlier single period.
Sales forecasts could also have been a factor.
Rebates are often tied to volumes. Last year British mediareported that retailer John Lewis had told suppliers it expecteda 0.75 percent discount in prices, or a reduction of over 5percent if sales rose by 50 percent. In such a scenario, exactlyhow much rebate a manager could book would depend on theprojected sales growth.
John Lewis declined to comment on its programme.
David McCarthy, an analyst at HSBC, said slowing salesgrowth at Tesco could have contributed to any inaccuracy in suchcalculations. "We suspect Tesco may have been bookingpromotional rebates based on historic precedent rather than oncurrent volumes," he said.
Peter Pope, Professor of Accounting at the London School ofEconomics, said rebates were often tied to a retailer performingcertain tasks. This meant a manager might also wrongly recogniserevenues by booking them even when a supplier might feel theyhave not been earned.
Several of these methods of improving earnings were flaggedup in the auditors' notes included in the Tesco, Morrisons,Sainsbury and Ocado annual reports.
This highlighted, Pope said, how internal controls should bethere to avoid the kind of problems Tesco suffered. "Becausethere is so much need for judgment and discretion to beexercised, good internal audit procedures should really monitorthe veracity of all assumptions," he said. ($1 = 0.7779 euro) ($1 = 0.6102 British pound) (Additional reporting by Kate Holton and James Davey; editingby David Stamp)
