Companies are not the only ones to feel the squeeze. Analysts are being
pressured by large institutional investors and companies seeking to manage
expectations. Everyone is seeking the win. Auditors are being accused of being
out to lunch, with the clients. Many accounting firms are coming under scrutiny
as some of their clients are being investigated by the SEC for irregularities in
their practice of accounting. Cendant and Sunbeam both left accounting giant
Arthur Anderson holding a big ol’bag full of unreported accounting
irregularities. Auditors from BDO Seidman addressed issues of GAAP with Thing
New Ideas company. The Changes were made and BDO was replace for no specific
reason. Herb Greenberg calls the episode, A reminder that the company being
audited also pays the auditors’ bill. The Kind of conflict of interests that
leads us to question the idea of how independent the auditors are. All of these
pressures allow questionable accounting practices to obfuscate the reporting
process. Generally accepted accounting principles are intended to be a guide,
not a procedure. They have been developed with intended flexibility so as not to
hinder the advancement of new and innovative business practice. Flexibility that
has left plenty of room for companies to stretch the boundaries of GAAP. Levitt
focus’s on five of the most widespread techniques used to deliver added
flexibility. Big Bath restructuring charges, creative acquisition accounting,
Cookie Jar reserves, Immaterial misapplications of accounting principles and the
premature recognition of revenues. These practices do not specifically violate
the letter of the law, but are gimmicks that ignore the spirit and intentions of
GAAP.
Gimmicks, according to Levitt, that are an erosion in the quality of earnings
and therefore the quality of financial reporting. No longer is this just a
problem perceived in small corporations struggling for recognition. Throughout
the financial community, companies big and small are using these tools to smooth
earnings and maximize market capitalization. The Big Bath restructuring charge
is the wiping away of years of future expenses and charging them in the current
period. A practice that paves the way to easy future earnings growth by allowing
future expenses to be absorbed by restructuring liabilities. Large one time
charges that will be ignored by analysts and the financial community through a
little convincing and notation. In note fifteen of the Coca-Cola company’s 1998
annual report shows seven nonrecurring items from the past three years. Fours of
these charges are restructuring charges, most significantly in 1996 in this
note. In 1996, we recorded provisions of approximately $276 million in selling,
administrative and general expenses related to our plans for strengthening our
world wide system. Of this $276 million, approximately $130 million related to
streamlining our operations, primarily in Greater Europe and Latin America.
These one time write-offs become virtually insignificant footnotes to the
financial reporting process. Extraordinary charges that are becoming unusually
common. Kodak has taken six extraordinary charges since 1991 and Coca-Cola has
taken four in two years. The financial community has to wonder how unusual these
charges are. Creative acquisition accounting is what Levitt calls Merger Magic.
With the increasing number of mergers in the 90’s, companies have created
another one time charge to avoid future earnings drags. The in-process research
and development charge allows companies to minimize the premium paid on the
acquisition of a company. A premium that would otherwise be capitalized as
goodwill: and depreciated over a number of years. Depreciation expenses that
have an impact on future earnings. This one time charge allowed WorldCom to
minimize the capitalization of goodwill and avoid $100 million a year in
depreciation expenses for many years. A charge hiding in this complex note on
WorldCom’s 1996 annual financial statement. (1) Results for 1996 include a $2.14
billion charge for in-process research and development related to the MFS
merger.
