The charge is based upon a valuation analysis of the technologies of MFS
worldwide information system, the internet network expansion system of UUNET,
and certain other identified research and development projects purchased in the
MFS merger. The expense includes $1.6 billion associated with UUNET and $0.54
billion related to MFS. (2) Additionally, 1996 results include other after-tax
charges of $121 million for employee severance, employee compensation charges,
alignment charges, and costs to exit unfavorable telecommunications contracts
and $343.5 million after-tax write-down of operating assets within the company’s
non-core businesses. On a pre-tax basis, these charges totaled $600.1 million.
The dollar amounts are staggering and the future implications far reaching.
Since this approach was introduced by IBM in 1995 these charges have become
commonplace for acquisition accounting. A popularity, largely due to the level
of room allowed in research and development estimations. The Third earnings
manipulation tool discussed by Levitt is what he calls Miscellaneous Cookie Jar
Reserves. The technique involves liability and other accrual accounts
specifically sensitive to accounting assumptions and estimates. These accounts
can include sales returns, loan losses, warranty costs, allowance for doubtful
accounts, expectations of goods to be returned and a host of others. Under the
auspices of conservatism, these accounts can be used to store accruals of future
income. Restructuring liabilities created by Big Bath’ charges also provides
these Cookie jar reserve effect. Jack Ciesielski, who manages money and writes
the Analyst’s Accounting Observer, calls these accounts the accounting
equivalent of turning lead into gold… a virtual honeypot for making rainy-day
adjustments. Various adjustments and entries that can produce almost any desired
results in the pursuit of consistency. The statement of financial accounting
concepts No. 2 (FASB, May 1980), defines materiality as: The magnitude of an
omission or misstatement of accounting information that, in light of surrounding
circumstances, makes it probable that the judgement of a reaonable person
relying on the information would have been changed or influenced by the omission
or misstatement. Today’s management has started to ignore this fundamental
principle.
Materiality is being defined as a range of a few percentage points.
Companies defend immaterial omissions by referring to percentage ceilings that
draw a line on materiality. The amount falls under our ceiling and is therefore
immaterial. The materiality gimmick is one more method companies are using to
stretch a nickel into a dime. Simply put, In markets where missing an earnings
projection by a penny can result in a loss of millions of dollars in market
capitalization, I have a hard time accepting that some of these so-called
non-events simply don’t matter, says Levitt. Finally, Levitt briefly touches on
the complex issue of the manipulation occuring in revenue recognition. Modern
contracts, refunding, delaying of sales, up front and initiation fees all add to
the complications in some industries to follow specific rules of revenue
recognition. With plenty of holes in revenue recognition the door is open for
tweaking. Microsoft is a good example of the problems facing today’s companies.
Concerned with proper revenue recognition, Microsoft started a practice in the
software industry that allows companies to recognize revenue over a period of
time. This recognition allows for better matching of revenues to future expenses
generated by the sale of the software. Expenses such as upgrades and technical
support are related to the revenue generated by the sale of the software but are
incurred at a later date. The complexities of modern business transactions have
left modern standards of accountancy years behind. Gimmicks, that all must be
addressed by the financial community. The task of returning integrity to U.S.
financial reporting is of paramount importance. The interests of our financial
system are at stake. Arthur Levitt and the SEC stand ready to take appropriate
action if that interest is not protected. But, a private sector response that…
obviates the need for public sector dictates seems the wisest choice. A nine
part plan that involves the entire financial community is proposed by Levitt.
Levitt has made it very clear that the SEC is prepared to start forcing change.
A line Levitt hopes will not be necessary to cross. The SEC will begin to issue
guidance on a wide array of issues concerning the credibility and transparency
of financial reporting. Guidance that must be acted on to Obviate the need for
large scale SEC involvement.
