Beazer homes was the sixth largest U.S. home builder during the 1998-2006 housing boom. Like other major home builders, Beazer’s market value grew by a factor of 8-10 during that period. However, the new home market slowed in 2006 and then collapsed in 2007.
The SEC alleged that Michael T. Rand, Beazer’s chief accounting officer, understated Beazer’s reported profits in every quarter but one from 2000 through 2005 by understating Beazer’s “land inventory” account and by overstating its “cost to complete” reserve. The SEC further alleged that during each of the four quarters in 2006, and in the first quarter of 2007, Mr. Rand increased Beazer’s reported profits by increasing the “land inventory” account, decreasing the “cost to complete” reserve, and fraudulently recording sale-and-leaseback transactions for model homes.
The case provides an excellent overview of the U.S. housing boom and collapse. It can be used prior to New Century Financial Corp (Chapter 3), which covers the collapse of a sub-prime and Alt A mortgage lender. The case is also excellent for covering the practical issues of accrual accounting in uncertain environments.
The SEC charges imply that it is relatively simple to estimate the value of the firm’s “land inventory” and “cost to complete” accounts. The SEC’s complaints on these matters made the valuation process for each process seem far more objective than it actually is in practice, particularly for a rapidly growing firm that almost certainly was relying on less experienced managers and workers, and less experienced accountants.
The case also covers a sale-and-leaseback transaction. Those accounting rules are complex, so again, it might not be clear that Mr. Rand engaged in fraud.
Finally, the cumulative alleged profit understatement for 2000-2005 was about $72 million for a firm that had about $2 billion of operating profits. In addition, during nine quarters from 2007-2009, Beazer recorded about $1 billion of impairment charges. Given the implicit subjectivity in those nine impairment charges, it seems highly likely that the “land inventory” and “cost to complete” accounts were also highly subjective numbers.
I use this case to consider the subjectivity of various accrual accounts. I also use it to consider who would make the accrual calculations. Beazer constructed housing developments throughout the nation. Michael T. Rand almost certainly was not personally responsible for preparing accrual estimates at the operating level.