Tuesday, February 24, 2009

SEC Investigating Bidz.com after Questions Raised in This Blog about Inventory Disclosures

After the market close yesterday, Bidz.com (NASDAQ: BIDZ) disclosed that the Securities and Exchange Commission started a formal investigation of the company's inventory accounting practices and other matters:

The Company was notified recently by the SEC of a formal investigation relating to certain aspects of its inventory accounting practices, as well as other matters. The Company intends to fully cooperate with the SEC regarding this matter. The Company remains confident its inventory accounting is correct and in full accordance with GAAP.

Apparently, the SEC responded to serious questions, first detailed in this blog, about Bidz.com's inventory disclosures and the company's possible violation of GAAP in accounting for inventories. I had contacted the SEC Los Angeles office.

For example, I examined Bidz.com's fiscal year 2007 10-K inventory disclosures. See below:

Inventories:

Inventories consist mainly of merchandise purchased for resale and are stated at the lower of first-in, first-out cost (FIFO) or market. We record reserves against our inventory equal to the difference between the cost of inventory and the average selling price that is lower than cost of inventory that is held for less than one year. In addition, for the years ended December 31, 2006 and 2007 we recorded reserves for obsolete and slow moving inventory of 100% of the value of inventory held for more than one year. If actual market conditions are less favorable than those projected by us, specific reserves or additional inventory write-downs may be taken.

According to Accounting Research Bulletin (ARB) No. 43, inventory must be valued at the lower of cost or market value. Market means the current replacement cost of inventory. If the current replacement cost of inventory is greater than its net realizable value (estimated selling price less cost of completion and disposal), net realizable value is considered market. If the current replacement cost of inventory is less than its net realizable value minus normal profit margins, than net realizable value minus normal profit margins is considered market. Therefore, the upper limit of market is net realizable value and the lower limit of market is net realizable value minus normal profit margins. Lower of cost or market may be applied to each individual inventory item, the total of each major category of inventory, or the aggregate total of inventory.

Inventory held less than one year

As detailed above, Bidz.com disclosed that "We record reserves against our inventory equal to the difference between the cost of inventory and the average selling price that is lower than cost for inventory that is held for less than one year."

The company's inventory disclosure for inventory held less than one year seems to violate GAAP. Bidz.com cannot use the "difference between the cost of inventory and the average selling price" in valuing its inventory. Average selling price is not net realizable value, since it does not deduct the cost of completion and disposal of inventory. Therefore, in this specific case, inventory may be overstated. Even if Bidz.com were to use net realizable value, the company could only use such a measure if the current replacement cost of inventory is greater than its net realizable value.

Inventory held more than one year

Bidz.com disclosed that "In addition, for the years ended December 31, 2006 and 2007 we recorded reserves for obsolete and slow moving inventory of 100% of the value of inventory held for more than one year." Here too, the company's inventory disclosure seems to violate GAAP. The lowest amount that inventory can be valued at is net realizable value (estimated selling price less cost of completion and disposal) minus normal profit margins.

It seems that Bidz.com's method of valuing inventory over one year old is arbitrarily based on the amount of time that the inventory is held, rather than the application of GAAP. Unless such inventory cannot be sold under any and all circumstances, Bidz.com cannot "record reserves of 100% of the cost of inventory held more than one year." Therefore, in this specific case, inventory may be understated.

In a follow-up posts (here and here), I detailed other Bidz.com questionable inventory disclosures from 2005 to 2008.

Meanwhile, Bidz.com founder and CEO David Zinberg is engaging in a retaliatory smear campaign against me for raising questions about Bidz.com's inventory disclosures. He has falsely claimed that I am short selling Bidz.com. I never owned any Bidz.com securities, long or short, and no one pays me to write about Bidz.com.

Written by:

Sam E. Antar (former Crazy Eddie CFO and a convicted felon)

Disclosure:

I have no position in Bidz.com securities long or short.

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