Financial Accounting Blog

Friday, October 31, 2003

Stock Options Expense. This Accounting Web article talks about how the Financial Accounting Standards Board has decided that payment of stock options to employees will become a mandatory expense to report come 2005. Stock options have become a popular incentive compensation by more and more companies over the last ten years and the FASB believes it should be reported just as any other compensation should. Most companies are not pleased as they are concerned it will give the perception of a decrease of their net earnings which would make others believe they have become less profitable.

The Financial Accounting Standards Board met on October 29 to put some of the final touches on its decisions towards mandating expensing of stock options just like any other compensation - an issue which has been steadily gaining momentum for over ten years.

The board agreed on the objectives of disclosure of stock option information to help investors better understand the effects of expensing, but has not yet identified specific disclosure requirements.

Currently, most companies still do not expense stock options out of concern for the impact it will have on their profitability. Those companies do, however, need to identify the value of its options in the footnotes of its financial statements.

Book Value vs. Market Value. This Business Week article entitled What's Google Really Worth? is an example of the challenge of estimating a market value for a company going public. The discussion explains how early estimations are based on comparisons to other companies in the indutry like Yahoo and ebay. They even use share-price-to-sales ratios and p-e ratios of these other comanies to try to bracket it's potential net worth. Other analysts give arguments as to why this might be high or low.

As a point of reference, Internet leaders eBay and Yahoo currently command share-price-to-sales ratios of 19 and 22, respectively. If Google is in fact close to the $1 billion in sales mark, then a $15 billion to $20 billion valuation is probably a reasonable estimation," according to an Oct. 24 research note by Renaissance Capital, which manages the IPO Plus Aftermarket Fund

Nevertheless, some experts seem to be looking at their price-earnings ratios to come up with a valuation for Google of near $25 billion. Yahoo has a p-e of 82.7, and eBay's is 55.9.

Prior to the Yahoo-Overture merger, the market figured Overture's forward p-e was 44.4. And Verity's is a relatively conservative 38.8, given that it's a high-growth tech concern. If Google's hypothetical p-e is more in the range of Overture or Verity, then its valuation would be much lower than the numbers now bouncing around Wall Street, experts say.

Maybe Google is doing better than anyone realizes in terms of revenues and profits. It hasn't yet made financial disclosures to the Securities & Exchange Commission, a mandatory step before going public. The best estimates now are that Google boasts revenues of around a $1 billion per year and annual net income in the $100 million-plus range.

Thursday, October 30, 2003

Reconizing Revenue Tricks. This article (at the Motley Fool website) reviews the SEC conditions for booking a sale and describes how unscrupulous managers may ignore one or more of the rules..... S. Mitchell

Contingent Liabilities. ChevronTexaco has a contingent liability related to alleged pollution of the Amazon.
....plaintiffs allege, Texaco chose to dump 18.5 billion gallons of oily water brought up during drilling into some 350 open pits and streams instead of reinjecting it deep underground in order to cut costs.

Lawyers for the plaintiffs estimate it will cost $1 billion to clean up and provide medical care for the region's inhabitants.

IFAC & International Regulators Propose Reforms to Strengthen Audit Quality The international accountancy profession, together with international regulators, are spearheading reforms to improve the quality of standards and practices in auditing and assurance worldwide and to achieve global convergence of high quality standards. Their focus is on strengthening the international auditing and assurance standards process to bolster public confidence in the work of auditors and in the financial reporting process.

This article discusses a $1.2 billion accounting error found recently in Fannie Mae. According to their spokeperson, "THE ERROR, which Fannie Mae said was due to a change in accounting rules, does not affect the company’s net income. It resulted in increases to unrealized gains on securities, accumulated other comprehensive income and total stockholders’ equity..." The stock price declined due to this news. -KC Ho

Wednesday, October 29, 2003

Tax Breaks. Kroger, other local firms get tax breaks. Here is a good example of a company benefiting from incurring more debt. The Government is willing to "partner" with Kroger and incur some of this debt by way of a tax credit.

The authority granted Kroger a 10-year, 70 percent tax credit if the company chooses to expand its downtown corporate headquarters facility. The business benefit of the tax credit is expected to be $2.2 million over the term, and to receive the credit, Kroger is required to maintain operations at the site for 20 years.

Goodwill Accounting. This article is a little dated, but gives a good summary about how the Goodwill accounting changes we discussed in class were expected to impact different industries.
"Merrill Lynch's study of 44 industries finds that the FASB changes will result in accelerated merger and acquisition activity for companies with strong cash flows as well as a decline in P/E ratios for certain industries.... Pharmaceuticals will be disadvantaged because the new rules would require them to amortize acquired patents since the assets have a clearly defined life.... Waste, death care, engineering and construction may face significant impairment issues because a number of companies in those industries now carry a goodwill asset that exceeds their market capitalization (a potential trigger event for an impairment review). "

Halliburton revises earings due to pending settlement.
As we discussed in class on 10.28.2003 when covering contingent liabilities, companies will disclose information concerning liabilities that arise because of events that have already occurred. In the case of Halliburton, they have pending liabilities from asbestos related claims that were disclosed in their third quarter statement.

Earlier this month, Halliburton revised earnings projections down because of increased costs from a joint venture with Norway's DSND (DSND.OL) and increased legal fees for the planned $4 billion settlement of hundreds of thousands of asbestos injury claims.
Hugh Melzer

Tuesday, October 28, 2003

Cincinnati Financial profit jumps 44% but misses estimates :

This article demostrates the aspect of how a large gain can make it appear that a company had a very profitable quarter. But, in actuality this was the benefit of a one time occurence.

The company said the increase included a recovery of $23 million of a $39 million one-time charge taken in the third quarter of 2000 to write off previously capitalized software development costs.

Excluding the gain, the company's operating earnings per share were 49 cents, which was just short of analyst expectations of 50 cents per share, according to Thomson First Call.

An article was already posted on the announcement that Bank of America was going to buy Fleet Bank but I wanted to point something interesting out about it as well. An excerpt from the article is:
Bank of America was offering 0.5553 shares of its stock for each FleetBoston share. At Friday's closing prices, that was worth $45 a share and was a 41 percent premium over FleetBoston's Friday finish of $31.80.

In trading Monday on the New York Stock Exchange, FleetBoston shares climbed to $39.20, up $7.40, or 23 percent, while Bank of America shares fell to $73.57, down $8.29, or 10 percent. That reduced the value of Fleet's offer to $42.9 billion.

This is probably the closest example there is to a truly efficient market. The new information was priced into the two stocks within hours and ultimately the investors will determine the selling price of Fleet. I personally was very happy about the deal because I owned Fleet stock and made a mini-killing. Another interesting point is that Bank of America is willing to pay for Fleet at a premium over the fair market value(at the time of announcement). I assume this extra amount, which is certainly considerably over the book value, would go into their Goodwill account.

Doug Probasco

USA Today reports that State and federal regulators took action Tuesday against Putnam Investments and two of its former investment officers, the first formal accusation of wrongdoing against a mutual fund company over "market timing" trading practices in mutual funds.

The actions represent the first steps of civil lawsuits, outlining material facts. But they do not represent criminal charges. Mutual funds are generally intended for long-term investors, and prices are generally set once a day. But if allowed to move quickly in and out of funds, investors can sometimes take advantage of late-day information before the new prices are set.

Aiding and Abetting

This goes to show you that the SEC is widening their reach. Not only are they charging the company executives that cook the books, but also any customers that help them do it! In this case, the VP of sales at Logicon helped Legato sales executives improperly record revenues.

The Legato sales executives included a side letter granting Logicon the right to cancel the transaction. But the existance of the side letter was never made aware to the Finance Department who booked the transaction as revenue.

Notice the last paragraph...... as Dennis said in class, the SEC issues an order to "stop doing it", and the CFO says "OK". But it does say "former" CFO........

Laura Luchsinger

A U.S. Push On Accounting Fraud

This essay is from Stanford Law School and discusses how the Justice Department is really cracking down on Accounting fraud. In some cases, Washington is dispatching U.S. prosecutors to help state prosecutors that do not have experience in accounting fraud.

Laura Luchsinger

This press release from Multi-Color discusses the aquisition of Buriot International in Batavia, OH. The aquisition occurred in 1999 and it has a lot of local flavor. Thomas Vogt, a Xavier Graduate, is the VP of specialty labels. Pay particular attention to the disclaimer or "weasel words" at the bottom of the article talking about the information in their Forward Looking Statements.

Roy Reinertsen

Monday, October 27, 2003

RJR to buy British American's U.S. tobacco assets This merger seems to have gotten overshadowed by the Bank of America/Fleet Boston merger. This article delves into the way that the financials will be affected. The interesting portion is that one is a U.S based company and the other is based in the UK.
R.J. Reynolds Tobacco Holdings Inc. agreed on Monday to acquire British American Tobacco PLC's U.S. cigarette business and a second unit for about $3 billion, creating a stronger No. 2 competitor to market leader Philip Morris. The new entity, to be called Reynolds American Inc., will boast annual revenues of about $10 billion and more than 30 percent of the cigarette sales in the United States, the companies said.

Getronics Operational and Financial Recovery continues: "Net debt was reduced to EUR 125 million, resulting in an improved net debt / equity ratio of 39% (31 December 2002: 257%). "
A big part of this turn-around was due to a tax optimization program. With a switch like this, it does make one think about the direction of the company. In this industry though, you probably do not want to be over-leveraged.

Jeff S.

This article from Markkula Center for Applied Ethics discusses California's current budget crisis. It points out the differences between private sector and public sector fudging of the numbers. The Bottom Line is future taxpayers bear the brundt of the solution in California.

Roy Reinertsen

This article talks about the recent deal where Bank of America is to buy FleetBoston. It discusses how combining companies will give it assets of nearly $1 trillion, becoming the second largest bank only behind JP Morgan Chase and Co.

Sunday, October 26, 2003

Tech Central Station looks at how Middle East stock exchanges have responded to the American intervention in Iraq.
Anti-American demonstrations, comments in Arab language newspapers, acts of violence against the occupation government of Iraq and even opinion polls have been sited as support for the argument that we and our institutions are unwelcome in the Arab world and have made matters worse there.

What do people who live in or invest in the Middle East and Central Asia really think about American intervention in Iraq? At a minimum, they think it's good for future -- and for future profits. Looking at the countries with readily available market indices -- Israel TA-100, Turkish ISE National-100, Pakistani Karachi 100, Egyptian CMA -- we find that every one of those indices has risen over the time period, from George Bush's ultimatum on March 17th to now. Egypt is up 19.3%; Israel is up 29.3%; Turkey is up 45.1%; and the-powder-keg-known-as-Pakistan is up an astonishing 67.5%!

Friday, October 24, 2003

Microsoft posted 3rd quarter earnings of $0.30/share [$0.24 to account for the company’s new compensation program] that were slightly higher than first call consensus estimate of $0.28/share. “But the company’s unearned revenue, representing sales that have been booked but not yet recognized, fell $768 million in the quarter, about $450 million more than the company had expected…” The stock price has been falling due to this surprise and disappointment.

K.C. Ho

MSNBC covers "The Dirty Dozen" of american accounting scams and how they ripped off the public. Mini videos on Keating, Millikin, etc.

Roy Reinertsen

Thursday, October 23, 2003

This MSNBC Reuters article has an interesting take on the stock valuation of Jet Blue. We discussed in class how investors look at future cash flow and risk when valuing companies... the Chase analyst suggest that the success of the stock price is actually driving the expectations of future earnings/ cash flow.
“We have voiced concerns frequently with JetBlue’s valuation in the last several weeks,” said Chase, who said there was a sense that JetBlue’s rocketing share price had driven earnings expectations, instead of the reverse.

Wednesday, October 22, 2003

First glance at Ashland Inc. third quarters earnings would look like they were turning things around. Third quarter of 2003 earnings were $1.99 per share vs $0.68 last year. However included in this years earnings are revenues generated from the sale of a business unit. Unit's sale pumps up Ashland posts 3rd-quarter profit states that Amazon beat analysts estimates by .01 but still fell short of expectations.

Tuesday, October 21, 2003

Reuters reports on audit findings that AT&T underreported expenses in 2001 and 2002 in this
this MSNBC article. said two employees circumvented internal controls in the accounting of costs, and access and other connection expenses were understated by $125 million in 2001 and 2002.

Had the access expense been properly recorded, AT&T said it would have decreased its annual income from continuing operations for 2001 and 2002 by $32 million, or 4 cents a share, and $45 million, or 6 cents a share, respectively.

According to this article by PriceWaterhouseCoopers, Sarbanes-Oxley is losing favor with US businesses as they struggle to implement its regulations. Although more companies (91%) surveyed are making changes to comply, fewer (68%) are confident that their company is in compliance.

This Auto News Article shows how much the accuracy of management estimates of pension fund liability for a huge company with a huge retired employee pool can swing the company's financials. GM, which has been sporting a pension fund shortfall in the tens of BILLIONS (yes, with a B) of dollars, now says that based on current returns, they expect this shortfall to disappear within a year or so. I read in another article that GM has about 2 retired workers for every currently employed worker.

I thought it would be neat to include an article from a non-financial magazine that shows the impact of accounting. I think you need to register (free) to actually follow the link, but the article is short so I've copied the whole thing below:
"GM may eliminate pension liability problem in '04
By Dave Guilford
Automotive News / October 20, 2003
TOKYO -- General Motors will likely wipe out its underfunded pension liability early next year, Vice Chairman John Devine said.

A resurgent stock market will likely rid GM of the liability, part of the “legacy costs” which have drawn strong criticism from Wall Street. GM’s pension fund was underfunded by more than $19 billion at the end of 2002.

As a result, Devine said, “We could get this thing behind us.” Devine spoke to reporters here at a press event before the Tokyo Motor Show.

Devine said GM is getting a 14 percent return on its fund’s investments, compared to the 9 percent it had projected. GM will also reap $4 billion in cash from the sale of Hughes Electronics and $13.5 billion from a massive bond sale last summer.

GM is still burdened with projected retiree health care costs that are more than $50 billion greater than its fund to cover such expenses. But, unlike pension costs, GM does not have to pay into the retiree health care fund to meet federal funding requirements, diverting capital from operations."

Money Management reports that the S&P 500 could be forced to write off as much as 25% of earnings due to US Accounting Scams. The author contends it's only a matter of time until a "Time Bomb" occurs.

Roy Reinertsen

Monday, October 20, 2003

The article discusses the revenue recognition issues that have plagued Computer Associates. As a result of the audit committee's findings, the CFO and two other top executives have been asked to step down from their positions.

Finance Execs Resign from Computer Associates...Revenue recognition is at the heart of the issue.

In its continuing probe, the audit committee found "that CA recognized certain revenue prematurely in the fiscal year ending March 31, 2000," said Walter P. Schuetze, the committee's chair and a former SEC chief accountant.

Some software contracts signed in that year seemed to have been signed after the end of the quarter in which revenues associated with them had been had been recognized, according to Schuetze. "Those revenues should have been recognized in the quarter in which the contract was signed," he added. The committee, however, found no evidence "that the revenues and cash flows associated with these contracts were not genuine. The contracts were valid, products were delivered and cash was received."

In October 2000, CA started to book revenues over the life of the company's software licensing agreements. Before that, the revenues of entire contracts had been booked when the contracts were signed.

10 Ways to Help Increase Your Cash Flow

This article is a reprint from the New York Times archives. As the title states, it discusses 10 ways that a business can increase its cash flow. An increased, consistent cash flow is important to help smaller businesses plan for future growth.

Laura Luchsinger

How to Spot Signs of Companies' Distress

This article is an older article from the Wall Street Journal, but it lists several indicators of a company in distress. The link only provides a short synopses. I have a copy of the article if you are interested.

Laura Luchsinger

Sunday, October 19, 2003

Expectations Outrun eBay's Growth

This article brings up great questions about what drives a company's stock price. The article states that eBay is still expected to grow EPS next year by 34%. But yet, the stock price fell on that news.

eBay's growth would please just about everybody -- except the company's own investors. The online-auction company's stock has been priced at sky-high levels. That's been OK as long the company has been able to deliver stratospheric growth.

But with eBay's growth rates starting to fall, as the company warned Thursday, investors may wonder what exactly they're paying for. Actually, they did more than wonder, promptly taking eBay shares down $3.59, or 6.2%, to $53.91 in after-hours trading.

"How Following Orders Can Harm Your Career" presents a sort of blow-by-blow story of Ms. Vinson, an accountant who was one of the key people making fraudulent financial statement entries for Worldcom. Interesting but long read.

Yahoo! site to look at cash flow data. Here is a link to GE's data, and you can search for other companies by their ticker symbol.

Thursday, October 16, 2003 reports that EDS is considering offering part of its subsidiary in an IPO. This offering would be to finance other businees interests of EDS. The intent is to increase cash flows.
"EDS said it would consider selling off a minority stake of its Product Lifecycle Management (PLM) Solutions Subsidiary either through an initial public offering or privately negotiated transaction as a strategic alternative to help the Plano, Tex.-based IT services giant back on its feet"

Wednesday, October 15, 2003

SEC Accounting Probe Turns On KPMG
regulators are continuing their probe into accounting irregularities having filed a suit in Manhattan federal court against KPMG. The suit against KPMG alleges the accounting scheme allowed Xerox to claim it met performance expectations of Wall Street analysts, to mislead investors and boost the company's stock price.

This article highlights the importance of cash flows.
Cash Flow

Tuesday, October 14, 2003

GE entitled to accounting kudos, but it can do more

A good short article on GE's financial statement disclosure

Article reports many companies reported double digit growth earnings today that significantly exceed Wall Street predictions as a result of cost reductions - Delta Air Lines, Merrill Lynch, Gannett Co. Inc. to name a few.

Interesting article regarding the expansion of two of the more successful low-cost air carriers, JetBlue and Southwest. Both airlines have gained substantial profits in the time since 9/11, but the article states that a downturn for both companies is imminent. Both companies are continually expanding into larger markets but the demand in these markets have not hit an upturn. Both these low-cost carriers are betting that the demand will increase in the upcoming future.

New Balance Sheet Accounting Rule Pushed Back

"The Financial Accounting Standards Board is giving corporations until the end of the year to bring their balance sheets into compliance with the Enron-inspired accounting rule called Fin 46. The nation's top bean counters granted the delay because of confusion about the rule, which is meant to deter the illegitimate use of off-balance-sheet accounting strategies."

Note that GE has already implemented Fin 46 and see its impact:

General Electric (GE:NYSE - commentary - research), which reported third-quarter earnings on Oct. 10, already is following the mandates of Fin 46. In its quarterly earnings, GE said it had consolidated $51 billion in assets onto its balance sheet and took a noncash charge of $372 million. The Fin 46-related charge reduced GE's net earnings by 4 cents a share to $3.64 billion, or 36 cents a share.

The Athens NEWS: Twice weekly alternative
The following article is about the KPMG audit of OU Foundation's which revealed investments floundered during 2002.

The OU Foundation is a private non-profit corporation that was set up in 1945 to handle the university's charitable endowment.
Net assets of the Foundation took a hit of more than $31 million for the audit period, dropping from more than $192 million to around $161 million.

This is from back in August but found it interesting and applicable. It talks about how SK hid losses from its shipping unit. SK Shipping in Accounting Scandal

Partners in Crime is an interesting article in how the banks contributed to the Enron scandal. Enron, in partnership with the banks, used prepays as a way to hide loans the banks had made to them.

Monday, October 13, 2003

Revenue Recognition at Qwest. A former sales manager with Qwest Communications International has agreed to pay a $25,000 fine to settle an SEC case of "swapping" communications lines to create higher revenues.
The SEC said Monday that it found that in the final days of each quarter from December 2000 through June 2001, Qwest used fiber-optic cable sales to meet its aggressive revenue targets.
'Qwest employees and management commonly referred to (the sales) as 'gap fillers,' in other words, a means to make up the shortfall between the aggressive revenue projections announced by Qwest and the actual revenue earned,' according to a SEC statement.

According to the SEC, Pfau 'along with Qwest senior management,' made or assisted in providing verbal or e-mail secret side agreements that allowed buyers to exchange their fiber for different capacity at a later date. 'The explicit purpose of making the side agreements was to conceal (them) from Qwest's accountants and outside auditors,' the SEC charged in its complaint.

Such an exchange provision, under generally accepted accounting principles, would have invalidated Qwest's accounting of the deals.

3 Companies Finance Accounting Think Tank.

Columbia University's business school launched the center with grants from investment bank Morgan Stanley (MWD), IBM Corp. (IBM) and General Electric Co.'s (GE) GE Foundation.

The Center for Excellence in Accounting and Security Analysis, being chaired by former U.S. Securities and Exchange Commission (news - web sites) Chairman Arthur Levitt, will examine some of the same corporate governance and accounting concerns that GE, IBM and Morgan Stanley themselves have been touched by.

When asked if there would be a conflict if the findings of the center went against the commercial interests of the center's founding financers, Penman said, "That is not a concern."

This article talks about adding into publicly traded company's annual report a section on what they are doing to safeguard computer security systems. Being proposed by the Homeland Security Agency.
Pete Messerle

Business Courier: The Health Alliance Laboratory Finds a Buyer
"The Health Alliance is selling its Laboratory to raise cash for other technology investments. They are looking to increase their Cash Flows."

Sunday, October 12, 2003

This WSJ article has it all...goodwill impairment, the impact of a foreign company restating their books to be in accordance with US GAAP, and other accounting improprieties:

Ahold Posts Loss Linked to Concerns Over Accounting
Deborah Ball. Wall Street Journal. (Eastern edition).New York, N.Y.: Oct 3, 2003. pg. B.5

Copyright (c) 2003, Dow Jones & Company, Inc.

LONDON -- Shares in Ahold NV climbed yesterday, despite a posted loss of 1.2 billion euros ($1.41 billion) for 2002, due largely to accounting improprieties disclosed earlier this year.

It was the company's first release of results in nearly a year, and the retailer said its underlying business has weathered the scandal at its U.S. Foodservice unit. Investors seemed to agree. Shares in the Dutch retailer rose as some analysts said they planned to raise their price targets on the stock.

Ahold's net loss, reported under Dutch accounting standards, was largely due to impairment of goodwill and other intangible assets amounting to 1.3 billion euros. That loss will swell to about 4.4 billion euros under U.S. Generally Accepted Accounting Principles, as a result of additional goodwill impairment of about 3.2 billion euros. The gap stems largely from the different treatment of the impairment at Ahold's U.S. Foodservice subsidiary, the unit that sparked a massive accounting scandal earlier this year, when its executives were found to have inflated vendor rebates. Sales came in at 62.7 billion euros, up 16%.

In Amsterdam trading, the share price rose 7%, to close at 8.81 euros, on relief that the underlying business appears to be holding up relatively well. Ahold is the third-largest supermarket group in the world by sales, trailing U.S.-based Wal-Mart Stores Inc. and France's Carrefour SA, and is the fifth-largest in the U.S., with chains such as Stop & Shop and Giant.

"This draws a line under recent events and enables us to move forward," said Anders Moberg, the company's newly appointed chief executive.

The company has been under a cloud since February, when it disclosed one of Europe's worst accounting scandals. Ahold revealed that executives at U.S. Foodservice, the second-largest institutional food supplier in the U.S. after Sysco Corp., had booked inflated figures for vendor rebates. Those revelations were followed by disclosures of a series of smaller improprieties, including improper consolidation of joint ventures and fraud in some of its Latin American operations. The company is under investigation by the U.S. Securities and Exchange Commission and the U.S. attorney's office in Manhattan.

The company also announced that last week it suspended 20 midlevel employees at U.S. Foodservice for suspected involvement in the rebate scheme. Ahold already ousted the unit's top officials, including the chief executive, earlier this year. It said yesterday that it expects to announce a new CEO within the next 10 days. It will release first- half results within the next two weeks and expects to present a strategic and financial plan for the company's future midmonth.

The figures it reported yesterday include major restatements of 2000 and 2001 results due to the accounting irregularities. Net sales for 2001 were lowered to 54.2 billion euros from an originally reported 66.6 billion euros, while net profit was lowered to 750 million euros from 1.1 billion euros. Restated net sales for 2000 came in at 40.8 billion euros, compared with the original 51.5 billion euros, while net profit was 920 million euros, compared with 1.1 billion euros.

Despite the restatements, the figures contained some reassuring numbers, particularly for Ahold's U.S. supermarket business and U.S. Foodservice, which together account for about 75% of global sales. U.S. Foodservice posted an operating margin of 1.7%, up from 0.9% in 2001. While that is far lower than the original 4% operating margin reported for 2001 and trails Sysco's 5% level, it was higher than most had expected. Furthermore, the supermarkets division posted a rise in operating margin to 5.4% from 5.3%, despite laggard performance at Tops, BI-LO and Bruno's, three U.S. chains, due to the economic downturn and competition from Wal-Mart. Organic growth at the supermarket division was 5%, higher than growth at some rivals.

Ahold also reported 2002 net cash from operating activities of 2.5 billion euros and suggested that cash flows have been relatively healthy this year, enabling it to repay a 678 million euro convertible bond that matured this week without tapping an unsecured tranche of an emergency credit facility hastily arranged in February.

The healthier cash flow sent a positive signal regarding the financial restructuring. That package will consist of a rights issue, asset sales and possibly a convertible bond to cut its 11.6 billion euros in debt. Analysts say good cash flow could help contain the size of the rights issue. That, however, is balanced by Ahold's disclosure yesterday that it expects to have to pay at least 1.3 billion euros to buy out its partners in the Scandinavian ICA Ahold chain when their put option matures next May. As a result, analysts expect the company to seek a rights issue of anywhere between 2 billion and 4 billion euros when it announces its financial plan in a couple of weeks.

While many analysts are awaiting the first-half results and the financial package's details before setting new price targets, they said yesterday's news could spark an upward rerating of the stock, which hit a record low of 2.47 euros in March.

"If you look at the fundamentals of the company, you still have a huge credibility discount," said Jurgen Veenker, analyst with Fortis Bank, who has a buy on the stock with a price target of 12 euros. "With every set of figures that comes out, you have some relief and some more steps towards normalization."

This article from the WSJ talks about Tyco's recent woes over the $26 million of goodwill shown on their balance sheet and the potential impact of a write-down.

Tyco's Problems On Accounting May Not Be Over
By Mark Maremont and Jonathan Weil. Wall Street Journal. (Eastern edition).New York, N.Y.: May 5, 2003. pg. C.1
Copyright Dow Jones & Company Inc May 5, 2003

TYCO INTERNATIONAL Ltd. wants investors to think its accounting woes are over. After discovering yet another round of faulty bookkeeping, Tyco Chief Executive Edward Breen assured investors last week that "we believe we have identified all or nearly all" past accounting problems.

But some accounting experts aren't so sure. For starters, they say Tyco International didn't even correct its past errors the right way. In an attempt to set the record straight, Tyco took five years worth of problems and lumped them into one-time charges that chopped more than $1.6 billion from this year's pretax earnings. But what the company should have done, these experts say, is to restate past results -- a far more severe step.

They also believe Tyco has yet to grapple with another issue: $26 billion of "goodwill" on its balance sheet. Goodwill is the asset that a company records when it pays a premium over net asset value to buy another company. Some critics say it appears that figure was inflated by improper acquisition accounting during Tyco's go-go years under its prior management. Even if the goodwill was recorded properly, these critics argue it should be written down because it has become less valuable as Tyco's fortunes faltered. Any large write-downs could put Tyco in hot water with its lenders.

The difference between charges and restatements is more than academic. A restatement would be an admission that the numbers Tyco originally posted were materially inaccurate. That could be costly for Tyco and its auditor, PricewaterhouseCoopers LLP, in shareholder litigation. Although shareholders already are suing, primarily over allegations that former Tyco executives looted the company, attorneys say a restatement would make the plaintiffs' case much stronger.

Tyco spokesman Gary Holmes says the company, its auditors and its lawyers concluded that the accounting charges weren't material to past results, and therefore no restatement was needed. But Mr. Holmes says Tyco plans to discuss this analysis with the U.S. Securities and Exchange Commission staff, and "we will, of course, abide by their guidance." Steven Silber, a spokesman for PricewaterhouseCoopers, says, "We concurred with the company's belief that its prior financial statements do not require restatement."

As for the goodwill issue, Tyco referred to comments made by David FitzPatrick, its chief financial officer, who said last week that the matter would be reviewed July 1, but "we certainly do not expect any impairments at this stage."

Mr. Breen came to Tyco last July vowing to quickly clean up Tyco's books, but instead has dribbled out disclosures of accounting problems four times in six months, with the running total now more than $2.1 billion. By not biting the bullet on the need for a restatement, Mr. Breen raises further questions about his oft-repeated commitment to make Tyco's accounting more conservative and transparent, some critics say.

Lynn Turner, an accounting professor at Colorado State University and a former chief accountant at the SEC, says it appears that Tyco's accounting adjustments are so significant that it should "have to restate" its earnings. "Failure to do so," he adds, "will only continue to leave a cloud of doubt hanging over this company's financial reporting."

For now, at least, the marketplace is shrugging off the latest round of ugly news -- perhaps relieved that the accounting problems weren't even more significant. Tyco stock has climbed 9% since news of the new charges broke in The Wall Street Journal last Wednesday. The shares stood at $16.78 at 4 p.m. Friday in New York Stock Exchange composite trading. Based in Bermuda but managed from the U.S., Tyco is a conglomerate with about $36 billion in annual revenue and operates in electronics, fire and security products, medical supplies and other industries.

The question of when to restate financial results can be a difficult one, involving considerable judgment. The standard long has been that a restatement is required if errors would have been "material" to prior periods' results.

Concerned that companies were defining materiality too narrowly, the SEC staff in 1999 tried to tackle the issue. They said, among other things, that a number is material if it would have influenced the opinion of a "reasonable" investor had it been properly recorded to begin with. They also said that if accounting practices were intentionally misleading "to impart a sense of increased earnings power, a form of earnings management, then by definition amounts involved would be considered material."

Tyco's Mr. Holmes says that the company examined that issue, but "an intention to mislead hasn't been determined yet."

But Tyco's own statements and actions seem to belie that. In announcing the latest round of accounting problems last week, Mr. Breen said he had a "zero-tolerance policy here regarding the type of conduct that has given rise to some of the charges." He added that he planned to fire "a number of people . . . because of the issues we identified." Mr. Breen fired several others in March after a prior round of accounting discoveries.

Further, in a Tyco-commissioned report in December, attorney David Boies said he found a general "pattern of aggressive accounting" that was "undertaken with the purpose and effect of increasing reported results." Although the Boies report has since come under fire because it failed to find problems that led to the additional charges, it clearly implicated Tyco's old management in earnings manipulation.

Charles Mulford, an accounting professor at Georgia Institute of Technology in Atlanta, who examined Tyco's filings, says "any reasonable person would conclude this was earnings management," adding "that suggests that a restatement would be the appropriate accounting treatment."

In general, companies and auditors "try like the dickens to avoid restatement," says Sean Coffey, a partner at the New York law firm Bernstein Litowitz Berger & Grossmann, which represents plaintiffs in securities-fraud lawsuits but isn't involved in Tyco litigation. When a company restates, he says, plaintiffs no longer have to prove the original financial statements were wrong.

Abraham Briloff, emeritus professor of accounting at Baruch College in New York, has blasted the Boies report as a whitewash -- in part because it found nothing wrong with Tyco's goodwill accounting. In a commentary published last month in Accounting Today, Mr. Briloff pointed to Tyco's year ended Sept. 30, 2001. Aside from its purchase of the since-sold CIT Group Inc., the company that year paid $11.4 billion for acquisitions, recording $13.3 billion of goodwill.

One explanation for why goodwill would be so large, according to Mr. Briloff: When Tyco bought those companies, it may have artificially inflated the size of their liabilities and understated their hard assets. That would have the effect of depressing future depreciation and amortization expenses, thus boosting future earnings. Under new accounting rules first announced in 2000, goodwill, unlike hard assets, can remain untouched on a company's balance sheet until management concludes its value has permanently declined.

Tyco's goodwill, Mr. Briloff contends, was "severely, excessively overstated," and must be restated. Other accounting experts say several recent developments at Tyco, including the departure of top management and sharp declines in profitability and market value, are normal indicators that goodwill has declined in value. Companies that recently have taken multibillion-dollar goodwill write-downs include AOL Time Warner Inc. and Nortel Networks Corp.

To see how significant goodwill is to Tyco, look at the company's March 31 balance sheet. It shows $25.39 billion in shareholder equity, or assets minus liabilities. Of that, $26.03 billion is goodwill, meaning the company's shareholder equity would be negative without the goodwill. Any substantial write-down in goodwill would send shareholder equity plunging, potentially putting Tyco in default of one credit agreement that caps its total debt relative to total capitalization, or total debt plus shareholder equity.
Mr. Holmes, the Tyco spokesman, declines to address Mr. Briloff's analysis directly, but says the company has a "significant cushion in the ratio should any goodwill write-downs be required."

Saturday, October 11, 2003

G.E. Earnings Decline 11%; Key Product Lines Sluggish - The Lowly p-e Ratio is back!
Ref: NY Times article, Published October 11, 2003.

Hobbled by high costs and sluggish sales in formerly stellar industrial businesses like power systems and aircraft engines, GE said yesterday that its third-quarter earnings were 11 percent lower than those of last year, and that full-year earnings would be $1.55 to $1.57 a share.

The announcement, however, came at the end of a week of big acquisitions that have laid out a blueprint for a GE that will be less dependent on old-line production businesses and their services, and far more tied to fast-growing ones like health care and communications.
This week alone, GE completed plans to merge its NBC unit with Vivendi Universal's entertainment assets, GE Medical Systems completed the acquisition of Instrumentarium, a Finnish company that makes hospital equipment, and GE said that it would acquire for about $9.5 billion in stock Amersham of Britain to add chemical expertise in drugs and diagnostics to the GE Medical Systems portfolio of equipment, software and services.
"We are positioning the company for long-term, high-value growth," Jeffrey R. Immelt, GE chief executive, said. However, he conceded that some of these acquisitions were unlikely to add to earnings before 2004.

Prior to Sept. 11, 2001, the company's profits were growing at a double-digit pace. The events of Sept. 11 knocked the economy into a tailspin — and saddled GE’s insurance unit with huge claims. Since then, the persistently sluggish economy has hurt sales of such disparate GE items as plastics, gas turbines and aircraft engines.

The acquisitions also make it clear that Mr. Immelt, while still intent on growing consumer finance and other select parts of GE's large financial services portfolio, still sees inventing things and selling services against them as a way to future growth. Because the shares of industrial companies generally trade at higher multiples to their earnings than those of financial companies, that emphasis could lift GE's share price.

The stock could use the help. Shares of GE, which topped $32 in mid-September, fell 81 cents, to $29.32, yesterday.

During the boom years, price-to earnings ratios zoomed off the charts. Wall Street analysts told us p-e ratios did not matter. Well, the lowly p-e ratio is back, and at least in the short term, the p-e ratio will be a good measure of the success of GE’s acquisition strategy to bolster growth in a struggling economy.

Joseph Thodiyil
October 11, 2003.

Friday, October 10, 2003

This article from discusses the resignation of two executives from Computer Associates in connection with revenue recognition improprieties. Unlike some of the cases we have discussed in class, the investigators (for the moment, anyway) are not accusing the executives of falsifying revenues, just recognizing them at the wrong time.

In its continuing probe, the audit committee found "that CA recognized certain revenue prematurely in the fiscal year ending March 31, 2000," said Walter P. Schuetze, the committee's chair and a former SEC chief accountant.

Some software contracts signed in that year seemed to have been signed after the end of the quarter in which revenues associated with them had been had been recognized, according to Schuetze. "Those revenues should have been recognized in the quarter in which the contract was signed," he added. The committee, however, found no evidence "that the revenues and cash flows associated with these contracts were not genuine. The contracts were valid, products were delivered and cash was received."

In October 2000, CA started to book revenues over the life of the company's software licensing agreements. Before that, the revenues of entire contracts had been booked when the contracts were signed.

This article discusses the buyout of Amersham Plc by GE. This represents the biggest European takeover for GE and increases the size of GE's Medical Systems unit. "Amersham is the biggest maker of injectable dyes used in magnetic resonance imaging and other medical-screening machines".

This buyout closes out a week where GE has also put some of the initial details in the merger with Vivendi Universal. This buyout further emphasizes Jeff Immelt's strategy to invest in technology.

Thursday, October 09, 2003

PE Ratio. The Investing for Beginners-P/E Ratio: The Key to Understanding Value is an article which explains what a P/E ratio is and also touts the P/E ratio as the single most important number available when evaluating a company's stock price. It also explains some of the limitations when only using the P/E ratio to evaluate stock prices.

MCI. This article discusses how MCI, formerly WorldComm, is trying to dig out from the rubble of $41 billion in debt. MCI has hired Deloitte and Touche to research the circumstances which led to the problems and then ensure they do not happen again. Reportedly, D&T has $200 million to work with and 600 personnel involved in the project.

Papa John's. This Restaurant Business article states that Papa Johns is going to shut down 20 restaurants. This move will cost Papa Johns between $5 and $6 million.

Papa John's also announced that it is consolidating its financial results with those of various franchise entities, including BIBP Commodities, a cheese-purchasing firm. The move could affect Papa John's operating income in the future because of large swings in cheese prices, the company said.

Tuesday, October 07, 2003

Can a $6000 Shower curtain be counted as an asset?
Opening Arguments Begin in Trial of Former Tyco Execs

Using Software to Sniff Out Fraud. This BW article describes a new software program on the market that uses Benford's Law to look for breaks in statistical patterns of number sequences as a method to detect accounting fraud. The software can be used to identify made up numbers or repeated numbers that could be potential mistakes.
Forensic accounting" sleuths are taking advantage of sophisticated programs to catch the crooks in action. Applied to accounting, Benford's Law makes for a great way to check to see if numbers are fabricated (since when liars make up figures, they usually don't follow the same statistical pattern Benford identified). The law is now enjoying booming popularity as the basis for a fairly easy, routine test that's used to uncover accounting fraud. Easy, that is, if you have a sophisticated software package and enough high-powered computers to crunch numbers from reams of documents.

Large accounting firms tend to develop their own, proprietary software for forensic accounting that performs many of the same checks as off-the-shelf programs. And internal auditors at companies that want to do detective work on the cheap often use basic desktop applications such as Microsoft Excel and Access (a database management program) to hunt for fraud. For example, they might use those programs to identify duplicate payments to the same vendor.

While this software may be time consuming and costly, with recent accounting fraud scandals with Enron or Andersen Consulting, I think we will see a lot of technology advances to crack down on fraud. As the article mentions, companies themselves are already putting together their own software fraud detection systems. With the need and the number of people generating solutions on their own, I'll bet soon there will be a lower cost effective alternative that will become a common tool in the industry.

Monday, October 06, 2003

Copyrights. The texbook is right--copyrights now last 70 years from the death of the creator. This old CNN article states that...
...a 1998 law...extended copyright protection an additional 20 years for cultural works, thereby protecting movies, plays, books and music for a total of 70 years after the author's death or for 95 years from publication for works created by or for corporations.

The Supreme Court agreed to hear a challenge to Congress' extension of copyright terms. However, in January the Court ruled 7-2 to uphold the extensions. The Court said that the decision from Congress was "rational" and also said "we are not at liberty to second-guess congressional determinations and policy judgments of this order."

After 50 years copyrighted items would have then belonged to all of us. But by extending the term 20 years Congress arguably has taken property from the public and has given it to corporations. Dan Gillmor thinks this decision stinks.
Swipe a CD from a record store and you'll get arrested. But when Congress authorizes the entertainment industry to steal from you -- well, that's the American way.

This article deals with the "creative accounting" that has been rampant in the business sector the last few years. It'll be interesting to see if this debacle has similar results on KPMG that Enron had on Anderson Consulting. A quote from Federal Reserve Chairman Paul Volcker said, "That great profession has lost its discipline ... It's a sad story."

These incidents are beginning to weed out the unscrupulous practices in the accounting firms today. Unfortunately the unethical decisions of a few are ruining the general perception of many of these accounting firms. It'll be interesting to see how accounting practices are changed in the next few years to cope with this unethical behavior.

Frank Ayoung-Chee

Sunday, October 05, 2003

A Post-Enron Lexicon for Wall Street. I found this BusinessWeek article interesting because it's about the new Webster's World Finance and Investment dictionary which lists terms like "Enronitis".
Much has changed in the financial world in the last few years. A three-and-a half-year bear market, corporate scandals, and technology's relentless march have left their mark -- and changed Wall Street's vocabulary. The recently published Webster's New World Finance and Investment Dictionary -- the first ever from Webster -- reflects those changes, with such additions as "Enronitis," "Wi-Fi," "digital piracy," and "special-purpose vehicle" to the financial lexicon.

The following examples probably don't show up in finance and investment dictionaries that are more than five years old (and didn't appear in Houghton Mifflin's 1988 Every Investor's Guide to Wall Street Words, to name one):

• Accounting fraud: "Knowingly falsifying accounting records, such as sales or cost records, in order to boost net income or sales figures. Accounting fraud is illegal and subjects the company and the executives involved to civil lawsuits."

• Chinese Wall: "The separation that should exist between a bank's investment banking department and its research department.... [After the market began to fall in 2000] it became apparent that the Chinese Wall had developed some gaping holes."

• Cooking the books: "A slang term that means illegally falsifying financial statements."

• Off-balance-sheet transactions: "Financial deals and arrangements that can have a material effect on a company but are structured in such a way that they do not show up on a company's balance sheet and do not affect a company's borrowing capacity."

Mike O'Sullivan at Corporate Law Blog has a good short commentary on two recent GAO reports about the accounting industry.
it found that the Big-4 accounting firms audit 78% of U.S. public companies. This 78% includes virtually every firm of any consequence -- the Big-4's public company audit clients account for an amazing 99% of all sales reported by U.S. public companies. The gulf separating the Big 4 firms from the others is wide -- the smallest Big 4 firm (KPMG) had revenues of $3.2 billion, 8 times the revenues of the next biggest firm (Grant Thornton with $400 million).

This article from titled "Whistle-Blower Woes" notes that there is a growing feeling that the provisions of Sarbanes-Oxley (Congress Act of 2002) will spark nuisance lawsuits by disgruntled employees. The truth of the matter is far more complex. CFOs are now in the hot seat!.

Comment. While there is a potential for sparking nuisance lawsuits by disgruntled employees, this act of congress will put the burden on CFOs to clean up house and pay more attention to integrity and ethics when it comes to preparing company financial statements for its external decision makers.

Thursday, October 02, 2003

This lengthy BW article reports that CFOs are turning to technology to automate the financial-reporting process to meet new regulations imposed by the Sarbanes-Oxley Act. This is a good example of how legislation and stricter enforcement by the SEC can induce a structural change in businesses across the nation.

It's a familiar refrain throughout Corporate America. Within companies large and small, demand is "greater than it has ever been," says Packard, for better financial information that's available at the speed of a keystroke. Shaken by the Enron and WorldCom accounting scandals, shareholders want companies to provide more granular reporting. CEOs and boards of directors want more data at their fingertips so that they can intercept and fix problems before they hurt the quarterly numbers. And regulators are requiring greater consistency and transparency of financial data.

The Sarbanes-Oxley Act, passed in reaction to the corporate scandals of the past two years and set to take effect next summer, will hold CEOs and their chief financial officers personally responsible for the accuracy of their companies' numbers. Execs who mess up could face 20 years in jail.

CONTRADICTORY REPORTS. This new reality has registered with CFOs -- especially since many of them are ill-equipped to guarantee accurate financial reporting and forecasting. In fact, Roth argues that even the most basic financial reporting is flawed in many instances. To set things straight, corporate financial analysts have to perform tedious "reconciliations" that require lots of time and money -- resources that corporate finance departments increasingly don't have.

NEW CLOUT. Increasingly, these execs are turning to technology for help. They're buying packages that allow them to collect data consistently across their organizations, from the usual suspects. They're also buying software that helps them do better data analysis and planning. One thing that has changed already -- no doubt in part because such software is so expensive -- is that the CFOs, instead of CIOs, increasingly have final say over their companies' tech budgets. The increasing influence of CFOs over technology is boosting investments in finance-related hardware and software even as overall corporate tech spending remains flat.

The hottest areas in financial software are tools that help create more accurate budgets, pull relevant data out of various reports, and do better financial analysis. One popular product is called a dashboard. Sold by several dozen companies, a dashboard provides a daily summary of a corporation's most important performance indicators -- just a few key ones vs. hundreds some CFOs get now. The indicators might include information such as how many days it takes to collect money from customers or a company's current debt.

MATERIAL EVENT, OR GOOF? Some dashboards -- which essentially overlay many other programs in a finance department -- can also create income statements and other mandated reports in three to five days. That's a huge help in meeting the requirements of Sarbanes-Oxley.

FREE TO FOCUS. Because the latest technologies automate what was previously hand work, they can also allow financial analysts and CFOs to focus on more important tasks. "Now, technology frees you up to do qualitative work," he says. So, if sales spiked in a quarter, he can analyze what changed from the previous quarter and which event or decision triggered the change, Blinn says. The new systems "give ammunition to the CFO to show that we're delivering value to the company," says the WCCFO's Roberts. They also disperse responsibility for making smart financial decisions, by turning unit or store managers into mini-CFOs. Within the next year, however, Kinko's will move to a Web-based system that will let store managers look at the information for their location at any time -- down to any level of detail they desire. This will "enable them to understand the impact of their decisions faster," Blinn says.

"ENTERPRISEWIDE VIEW." Many CFOs are quick to note that technology doesn't solve every problem. Most say even the latest packages leave plenty of room for improvement. "I don't see an immediate forecasting software solution [that works well]," says Blinn. So for now, financial planning remains as much art as science. "It's about understanding your business," Blinn says.

"At the end of the day, CFOs have to have an enterprisewide view, and they need as much information as they can get," says Roberts, of the WCCFO. "Nobody wants to be jailed," adds Boston University's Lataif. "CFOs have to rely on good technology tools."


Wednesday, October 01, 2003

The Wall Street Journal reported that Espey Manufacturing fired its auditor and didn't give a reason to the SEC. I copied the whole article since you need to subscribe to the Wall Street Journal to access the articles.

Espey Manufacturing Fires Auditor PricewaterhouseCoopers

WASHINGTON -- Espey Manufacturing & Electronics Corp. (ESP) said Tuesday that it dismissed PricewaterhouseCoopers LLP (X.PWC) as its auditor and is in the process of hiring a new one.

Espey Manufacturing, a developer of specialized military and industrial power supplies, didn't give a reason for the Sep. 9 dismissal in the 8-K filing with the Securities and Exchange Commission.

Espey said PricewaterhouseCoopers' audits for its fiscal years ended June 30 and June 30, 2002, didn't contain any adverse opinions. Espey also said it didn't have any disagreements with the auditor related to accounting practices or auditing procedures during that period and through Sep. 9.

Shares of Espey closed Tuesday at $21.36, up 10 cents.