Misleading Accounting Exposed

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January 11, 2001

15 new items, including 6 submitted by an avid reader of this site. Items submitted by readers are now noted by the "MAE reader submission" phrase at the end of link descriptions. The phrase is not used here in the "What's new" area due to space considerations. However, in the Articles 1 - 2 - 3 pages, MAE reader submissions are noted. If you would like your name associated with a link you found, we can do that; if you wish to remain anonymous, we'll use the MAE reader submission tag.

If you want to submit an item, please consider the following: we are looking for linkable published articles that discuss legal, but misleading, accounting distortions of reported earnings and distortions of other financial statement items -- you know, the kind of articles that are already on this site. If you find an item that belongs here, send an email to stask_@yahoo.com for possible inclusion. Also, be sure your article's link works and is free.

While Misleading Accounting Exposed began as a way to keep track of interesting links while learning about misleading accounting tricks, if it can become a misleading accounting articles clearinghouse of sorts, so much the better. Of course we will continue scanning for excellent articles, but I am sure there are many great articles out there that we have never seen. That's where you come in.

Recently I came accross a book, Investment Gurus by Peter J. Tandus, that included an interview with Roger Murray, co-author of the most recent edition of Graham & Dodd's Security Analysis. Some excellent observations regarding the importance of accounting are found in a few excerpts located near the bottom of our Background page.

Now, on with some new links...In GE's Glowing Numbers we get a glimpse into GE's 100 consecutive quarters of uninterrupted earnings growth. How do they do it? In Net Income? It's Your Loss, Accounting Fireworks, Purchase and Pooling Headaches, and Why the Accounting Wars Matter to You you will find discussion relating to goodwill amortization, a recent hot topic that rearranges accounting numbers in interesting ways. In Mind the Gap: Charting the Disconnect Between Earnings and Cash Flow we see that CFO's now have an important task in addition to earnings management: revenue growth management. In The TSC Streetside Chat, Part 1: Marc Perkins of Gunther International a rather long but interesting, serious, sad, and at times hilarious interview we hear of things such as the following: "Senior management was, to put it mildly, incompetent, and there were no systems. No Wall Street analyst came in here and looked around and asked questions like, "What type of internal controls do you have?" "What type of integrated management package do you have to make sure your place is under control?" The answer to those questions [would have been] "none." There was no management software package. There was no accounting software package. It was all being done, literally, on legal pads. At the end of the quarter, they sat down with a legal pad, took stuff off of the printout they had of the general ledger, and put together financial statements." Quite exciting, no? $1 Billion Doesn't Buy Much These Days covers revenue items and how they are sometimes recognized. In New Math for Stock Options we see the U.K. trying to better report the cost of stock options. In THE DAY AHEAD: Lehman Bond Analyst Zaps Amazon Again, footnotes seem to prove that $900 million in cash and equivalents is really something like $730 million. Then, an article on stock options, How Stock Options Hurt Earnings explains how the ordinary shareholder is funding the option. Finally, in SEC: Warnings May Be Related to Crackdown the idea is floated that recent earnings warnings are due to SEC enforcement actions or the threat thereof. As a sidebar, the Wall Street Journal had an article on SEC revenue rules (Dec 14 2000 pC1), it seems out of 7,666 quarterly reports filed between Oct 1 and Nov 22 only 2,043 mentioned SAB 101. Of those, 1,258 said they would not be materially impacted, 602 haven't determined the impact, 183 thought there would be some impact, and only 91 companies qualified the impact in dollar terms. Also, if a company changes it's revenue recognition policy this quarter, it must restate it's financial results for the first nine months. All according to Bear Stearns.

Also, three new books were added: Managing by the Numbers, The Art of Short Selling, and Accounting for Growth. Note that all the items mentioned in this January update may also be found in Articles 1 - 2 - 3.

October 11, 2000

Four new items: CFOs Feel The Heat From The Street is a straight forward look at what a chief financial officer does; accounting is important, but so are the areas analysts want to see counted. This need to look at things in a certain way is often the force that shapes the way accounting information is reported. Overfunded pension plans affect earnings, Feathering the Nest Egg explores how "pension plans--in their ability to contribute to earnings--are becoming almost as significant as operating assets." Stock options are a very important earnings-related fact of life at many companies, in No Ifs, Calls, or Puts? you can learn some of the tricks used for soaking up the dilution caused by option grants. Finally, in Hard Lessons we look at new SEC rules on revenue recognition which cause financial services firms and real estate outfits to change the way they account for contingent rental income. And which cause retailers to change their policies on layaway sales, and biotechnology firms, computer manufacturers, telecommunications providers, and a host of other companies that have long-term service contracts to alter the way they record up-front fees. Note that all articles may also be found with pull quotes in Articles 2.

August 1, 2000

First up, The Number Runners is a must read, as an accountant outlines a few basic ways to massage the numbers. Perhaps most interesting is that he finds it is "absolutely critical" that such massages are done. In a similar article, The Crusade Against Smoothing, we find, "Clearly, something is missing in the SEC's presentation of the earnings management issue--dare we call it a material omission? What's missing is an acknowledgment of the fact that earnings management is legal and, thus far at least, unchallenged by the commission. Says Walter Schuetze, now a consultant to the SEC (and for many years the chief accountant in its enforcement division), about whether the smoothing-out of earnings is a legitimate business practice: To my knowledge, there's no SEC statement on that matter."

More or less on the same topic is What Earnings Reports Don't Tell You where we learn that "Companies feed information to the analysts to guide their estimates; often, companies will guide the estimates lower to make them easier to beat. That explains why companies such as Cisco Systems CSCO and General Electric GE are able beat analysts' estimates by a penny or two with monotonous regularity."

Next, Riding the Bull is a long article mostly about the compensation of CFOs, but it is very interesting to learn about the people who "turn the dials" that cause accounting numbers to appear in certain ways...and their compensation motivation. The Secret Balance Sheet is a nice article about information assets and how they "appear nowhere on the balance sheet. As Time Warner's 1999 annual report deftly puts it, generally accepted accounting principles (GAAP) do not recognize the value of such assets. And all public companies must follow GAAP."

Number Crunchers explores quality of revenue issues which are especially important when puting a value on internet companies. Also, interesting but pretty heavy for non-accountants, a link to an SEC document on Accounting Issues Related to Internet Operations.

In a series of Morningstar how-to articles, we learn in Five Essentials for Understanding Cash Flow that "Sometimes a company gets a big credit that boosts net income but doesn't result in cash inflow. For example, Internet portal CNET posted net income of $417 million in 1999, which looks impressive. But a big chunk of that came when the company traded its stake in Snap.com for a stake in NBC Internet NBCI. No cash changed hands, but CNET received a $324 million credit on its income statement. Overall, CNET's operating cash flow was negative, to the tune of $71 million." Also there are What Is Free Cash Flow? - Different Types of Profit Margins - and Stock-Option Basics.

Finally, a few older finds...The next two articles explain why good earnings and earnings expectations can send a stock down... Why good earnings aren't enough - Outlook: Navigating Wall Street's earnings maze. And in Forget the annuals, read proxies, Martin Sosnoff suggests: "It ain't pretty; it's written in legalese, and in small type, but that's the point. It contains lots of stuff the company is required to tell you but would just as soon you did not notice." And, an article about a company that pays for all of its stock option grants... Boots, the British drugstore chain, has broken the code of silence on the true cost of options to a company's shareholders. Note that all articles may also be found with pull quotes in Articles 2 - 3

June 1, 2000

Four new items. In The Hidden Value of Intellectual Capital we see in one example how a company can be damaged in one day because they changed their accounting method. In a related story playing off the example company above, Are Net Ad Firms Overstating Revenues? we see why a change in accounting method can affect revenue and then stock market prices. In yet another story on the same company, MicroStrategy: A Wake-Up Call? restatements are explored a little more and a profit of 17 cents becomes a loss of 51 cents per share. In Do the Math insurance maneuvers take a million dollar plus liability and turn it into $750,000 of bottom-line income, with a tax deduction to boot. Note that all articles may also be found with pull quotes in Articles 2.

March 25, 2000

Economics of Property/Casualty Insurance - (To jump to the proper area of the document, click on the link, wait for the document to load completely, hit CTRL-F and enter float.) Buffett says in 1999 a number of insurers announced reserve adjustments that made a mockery of the "earnings" that investors had relied on earlier when making their buy and sell decisions. And in Acquisition Accounting - (To jump to the proper area of the document, click on the link, wait for the document to load completely, hit CTRL-F and enter once again.) Buffett explains and proposes a new form of acquisition accounting. In Why Microsoft's Stock Options Scare Me Rob Landley exclaims "Forget Windows 2000. As far as I can tell, the single most lucrative product Microsoft sells is its own stock. Microsoft receives almost as much cash inflow from the stock market as it does by selling goods and services." And in AOL+TWX=??? Do the math, and you might wonder if this company's long-term annual return to investors can beat a Treasury bond's Carol J. Loomis points out several interesting accounting and valuation issues surrounding the AOL Time Warner merger. Note that all articles may also be found with pull quotes in Articles 1 - 2.

January 26, 2000

Intangible assets. Some new economy companies heavy with intellectual capital and knowledge assets say New Math for a New Economy is needed. To round out this topic Intangible Assets Plus Hard Numbers Equals Soft Finance considers financing "when the only assets are an idea and a team."

If you are still awake, or if conversely you are now too excited to fall asleep...More articles. Ariba's Earnings and the Cost of Compensation - "What does matter is that the two methods of accounting produce a $4.7 million difference in total net losses, more than a 50% increase." Goodwill Punting - Says to "end the practice of viewing goodwill as some sort of burden." IT to SEC: Wake up! - "book value is nearly meaningless for IT firms." Creative Accounting - "to get that handsome 30% figure, the bank added back noncash goodwill charges to its earnings. Then it subtracted goodwill from its shareholders' equity." Gaps in GAAP - "we take disaggregated data and have accountants aggregate it, only to have investors disaggregate it again." Gaps in GAAP - capitalizing R&D spending is aggressive because there is no way of knowing if the spending will ever pay off. But in the 1970s the U.S. steel industry poured tens of billions into new equipment that became obsolete almost as soon as it was installed. Plastic Profits - In amortizing goodwill, "We don't even know if many fixed assets like buildings will be around in 34 years, much less the Avco brand and its borrowers." AOL on the Street: Anything Goes! - "We really are out there on the cutting edge having to pioneer new territory." Accounting for Twinkies - "A stock's price is the market's estimate of the true value of a company's capital-hardware, software, worker training, ingenuity, the lot. Last year's net earnings, by contrast, are creations of government-approved tabulators." Reality Bites: How well Do Reported Numbers Represent True Economic Reality - "The concept of earnings quality can be reduced to the following three elements - forecastability, comparability, and how well reported numbers represent true economic reality. "Note that all articles may also be found with pull quotes in Articles 1 - 2 - 3