Inflating Profits

After years of heralding China as one of its best markets, Wal-Mart (WMT) in August said its performance there was among the worst in its major countries. A management shake-up and job cuts have followed.

Although the reversals seem abrupt, cracks in the foundation of Wal-Mart’s retail business in China have been developing for years, hidden by questionable accounting and unauthorized sales practices, according to employees and internal documents reviewed by Bloomberg.

The practices -- including bulk sales to other retailers and some sales allegedly booked when no merchandise left the shelves -- made business appear strong even as retail transactions slowed and unsold inventory piled up, these people and documents say. Wal-Mart said in August that it was unhappy with inventory growth internationally.

Stores in China continue to make bulk sales, sometimes unprofitably and without required management authorizations, according to employees who’ve left the company this past month. 

Concerns about bulk sales, raised as far back as 2011 in an internal report, have been the subject of inquiries in China by Wal-Mart’s legal team as recently as May, according to an internal company e-mail and an employee interviewed by lawyers.

The report and interviews with current and former employees say Chinese Wal-Mart stores, under pressure to meet earnings targets, resorted to temporary markups of inventory as an accounting move that can burnish profits without any added sales of merchandise.

After employees “recognized inventory pricing discrepancies” in 2011, the company’s senior leadership in the U.S. and China ordered an extensive investigation that led to “various leadership changes and disciplinary actions,” strengthened compliance measures, training, and regular audits, Wal-Mart Stores Inc. said in a statement.

“None of the financial issues we’ve reviewed in China were determined to be material to Wal-Mart’s consolidated financial condition or results of operations,” the statement said. Wal-Mart didn’t address specific questions on accounting issues, and leadership changes. It said bulk sales to retailers are common practice in developing markets, monitored regularly, and a modest part of its Chinese business.

Four top managers of Wal-Mart China left the company in 2011, including Ed Chan, then chief executive officer for the country. Chan, now vice chairman of C.P. Lotus Corp., a retailer based in Hong Kong, said the reason he left was known only to him and Wal-Mart and was unrelated to price markups or bulk purchases. At the time, Wal-Mart said he left for personal reasons.