Entergy Pays $12M on Poor Controls

Pull up a chair, SOX compliance professionals! Utilities giant Entergy Corp. just settled an accounting controls case with the Securities and Exchange Commission that offers several lessons about oversight of accounting processes and the failure to address weaknesses in a timely manner.

The settlement was announced last Friday. Entergy is paying $12 million to settle charges that for years it has allowed weak controls over its processes to value materials and supplies in the company’s possession. That’s a big deal for utility companies, which routinely carry huge sums of materials and supplies on the balance sheet. (Entergy currently carries more than $1.6 billion.)

Entergy’s accounting failure, as described in the SEC settlement order, is straightforward. The company has been reporting the value of materials and supplies as the average cost of purchasing those items over the years, rather than assessing (and then reporting) the actual value of the materials today. Such a maneuver can inflate the value of the materials when you list them on the balance sheet, and lets a company avoid its obligation to book a loss on any declines in value.

For example, if your utility company buys $1,000 worth of parts for future use, those parts are listed as an asset on the balance sheet worth $1,000. If you later determine that $500 of the parts will never be used (say, you’ve held them for so long that they’re now obsolete), you must write down the value of the materials to $500 and report a one-time $500 loss on the income statement. 

Here’s the issue: under U.S. accounting rules, utility companies are supposed to remeasure the value of their materials and supplies regularly so that the company can accurately report the materials’ actual value. Entergy hasn’t been doing that. 

Instead, since 2018 and continuing to present day, the company has been reporting the value of its materials using an incorrect method (average cost of purchasing them) even after repeated warnings that its processes for valuing materials were flawed. That’s the internal control failure we need to unpack.

Warnings For Several Years

The SEC settlement order paints an unflattering picture. Essentially, from 2018 into 2023, Entergy went through two complete cycles of hiring an outside consultant to review the company’s management of its materials and supplies, finding control weaknesses, and then taking no action. 

For example, at the end of 2017 Entergy was carrying $723.2 million in materials and supplies on its balance sheet. The company hired its first consultant, who identified $177 million worth of materials among that $723.2 million that were at least 10 years old and in all likelihood would never be used. The materials were deemed “surplus” and at best, might be sold for perhaps 20 percent of face value. The rest should have been written off and booked as a loss. 

The consultant’s report was shared with Entergy’s finance department, accounting managers, and supply chain officer; and the consultant recommended that Entergy do a more detailed analysis across the whole enterprise (Entergy works as five separate operating units). The company neither commissioned a follow-up analysis nor did any detailed review of its own. 

In 2021, Entergy hired a second consultant to evaluate its practices for materials and supplies. At the end of that review, Entergy concluded that it had more than 130,000 types of materials that exceeded the maximum amounts set by its business units. Again, however, no real effort to remeasure surplus materials to see which ones should be written off. 

Instead, Entergy executives established an allowance for surplus and obsolete materials. That was a step in the right direction, but as the SEC order noted, “the amounts were not derived from an analysis of the materials and supplies identified by Entergy’s consultants as potential surplus.” Meanwhile, the potential surplus materials jumped from $90 million in late 2020 to $193 million two years later. The line item for materials and supplies overall kept surging upward too; see Figure 1, below.

All along the way, Entergy employees raised concerns about the weak oversight of its materials. For example, in June 2021 supply-chain employees told accounting employees that only one of Entergy’s five business units had a well-defined process to review aged material and supplies, and suggested they “give consideration to how best to provide oversight” to the other business units.

That same year, the second consultant documented an Entergy employee’s view that “sub-optimal controls” over materials were “a key contributor to asset growth.” Translation: employees could purchase materials even when Entergy’s quantity on hand already exceeded maximum stocking levels, which bloated the materials and supplies line item.

So here we are. While Entergy neither admits nor denies the SEC’s findings, the company did agree to pay that $12 million penalty. It must also hire a third consultant, who will recommend changes to the company’s inventory controls within six months; and Entergy must implement those recommendations no later than three months after that.

Internal Control Lessons to Learn

Internal control and compliance professionals can ponder a few lessons here. 

First is the importance of tying policies to an effective procedure — because Entergy did have internal accounting policies that, as the SEC phrased it, “acknowledged the importance of properly accounting for surplus materials and supplies.” Moreover, U.S. Generally Accepted Accounting Principles do spell out that utilities, energy companies, and the like must remeasure surplus materials from time to time and book losses on overvalued assets. Still, Entergy didn’t have sufficient internal controls to put that policy goal into practice. 

Second is the importance of relaying information and communication to the right people within the enterprise to support effective internal control. The COSO framework for internal control devotes a whole component to “information and communication.” Consider Principle 14: “The organization is effectively communicating pertinent information necessary to support the functioning of internal controls to internal parties.”

That didn’t happen here. The SEC order expressly notes that Entergy “had information that this asset included materials and supplies that were slow-moving, aged, and potentially in excess of its business needs, and thus were not being used.” Information like that would be critical to executing the accounting policy we mentioned earlier about properly accounting for surplus materials.

So for compliance professionals at other companies, the abstract questions to ask are these: What information does the accounting team need to know so that it can follow the company’s accounting policies properly? Where does that information reside within our enterprise? How can we on the accounting team get that data in a timely manner? 

A third and final lesson is the importance of developing strong “control improvement” capabilities — so that when you do document instances of weak internal controls, you can implement compensating controls or new processes to fix the weakness promptly. Entergy didn’t do that, despite two rounds of outside consultants and internal employees raising concerns. Now the SEC is forcing it to hire yet another consultant and to make changes double-quick. 

I know that third time’s the charm, but really, the first or second time would’ve been a lot better.