A pretty good CFO.com article on off balance sheet financing

Atheros files for an IPO. Private wireless chipmaker that competes with Intel plans to go public.. IPOs are making a comeback, displaying further evidence of a strengthening U.S. economy.

""Atheros Communications, a privately held maker of wireless chips that competes with Intel, has filed to go public. Atheros, which has been the subject of a fair amount of buzz in the tech world, is planning to raise as much as $100 million through an initial public offering. The Sunnyvale, Calif.-based company makes the Super G line of chipsets, which help enable devices to connect to the Internet wirelessly. Atheros said that it intends to use proceeds from its offering for capital expenditures and to pay off debt. The filing caps off a busy month for the IPO market, which has been picking up steam following a more than two-year drought. "

Rich Muny

Planned Orbitz IPO Could Net Over $300 Million . Another indicator that IPOs are picking up....

"Orbitz Inc., the No. 3 online travel site, Wednesday set the terms of its long-awaited initial public offering, indicating the deal could gross nearly $304 million for the company and shareholders.

Orbitz, which allows customers to make reservations for airlines, hotels, cruises and rental cars through its Web site, said 11 million class A common shares will be sold to the public for $22 to $24 apiece.

It will sell 4 million shares and stockholders will sell 7 million, the Chicago-based company disclosed in a filing with the Securities and Exchange Commission.

Rich Muny

Visteon falls after CFO-elect quits. Shares drop sharply after George Strickler, set to assume CFO slot Monday, turns down the job. Shares of auto parts supplier Visteon Corp. were down about 5 percent on Friday after the company's pick for chief financial officer, George Strickler, declined to take the job, citing personal reasons.

Analysts had hailed Strickler's appointment as a sign that Visteon might intensify its cost-cutting efforts. Since its spinoff from Ford Motor Co. in 2000, Visteon has been in a near-constant state of restructuring, facing pricing pressure from Ford and stiff competition for new business from lower-cost suppliers.

This article discusses how Microsoft smoothed earnings in the past decade.

...That involves something that looks a lot like earnings management--although not of the sort that provokes penalties from the Securities and Exchange Commission or nasty newspaper articles about inflated profits. Starting around the unveiling of Windows 95 in August 1995, Microsoft has followed a uniquely conservative method of accounting for the software it ships--deferring recognition of large chunks of revenue from a product until long after the product is sold. The reasoning is that when somebody buys software in 1996, they're also buying the right to upgrades and customer support in 1997 and 1998. If it hadn't been for the new accounting technique, the company would have had to report a sharp rise in profits in the latter half of 1995, then a sharp drop in the first half of 1996--a turn of events that might have sent its stock price reeling--instead of the smoothly rising earnings that it did post. By the end of 1996, Microsoft had taken in $1.1 billion in unearned revenue that it had yet to recognize on its income statements. 'Because of this, they know what they've got in the bag from one quarter to the next,' says Marshall Senk, a Robertson Stephens analyst who follows the company. Which leads him to conclude that Microsoft does a better job of leveraging accounting--I would almost say it's a competitive weapon--than anybody else in the industry.

-KC Ho

The United States Small Business Administration has a good article, Financing Basics, that explains the equity versus debt financing for small businesses. The article contains a list of questions that will help businesses determine the best means of financing and how to the debt-to-equity ratio results can help them in their decision making.

Here's a short exerpt from the article emphasizing the importance in understanding a businesses financing options:

While poor management is cited most frequently as the reason businesses fail, inadequate or ill-timed financing is a close second. Whether you're starting a business or expanding one, sufficient ready capital is essential. But it is not enough to simply have sufficient financing; knowledge and planning are required to manage it well. These qualities ensure that entrepreneurs avoid common mistakes like securing the wrong type of financing, miscalculating the amount required, or underestimating the cost of borrowing money.

In Forbes.com, Oracle Digs Deeper, Oracle charges PeopleSoft with improperly recognizing revenue in order to make themselves look less attractive for takeover. Interesting...

Below are some excerpts from the article:

Oracle, taking its hostile bid for PeopleSoft up a notch, said PeopleSoft may have improperly recognized revenue for its September quarter, thereby inflating its sales to make it a less attractive target to Oracle.

At issue is a program PeopleSoft put in place over the summer, which promises to pay customers two to five times the cost of their software licensing fees if PeopleSoft is acquired and certain conditions, such as updates and support, are not met by the acquiring company. The company later amended the plan, saying that refunds could be triggered only by a change in minority control of the company.

The plan prompted about $156 million in incremental sales in the September quarter and heaped more than $800 million in potential liability onto PeopleSoft, which would theoretically be transferred to Oracle in the event of an acquisition. Oracle is questioning whether PeopleSoft violated an accounting rule which states a company can't recognize revenue until all contingencies are removed from the sale of the license.

That's a hard question to answer, and one that can't really be known unless PeopleSoft's contracts with its customers are examined. That is unlikely.

"PeopleSoft and their auditors have seen the documents, and the auditors are comfortable with it," says Charles DiBona, analyst at Sanford Bernstein. "But it's a legitimate issue to be raised and people should be aware of it. In my mind, it does affect the value" of PeopleSoft.

The MSNBC reports that H.J.Heinz quarterly earnings fell 10 percent

"In line with Wall Street expectations, reflecting the spin-off of some underperforming units in December. In December, Heinz spun off about a fifth of its business, including its tuna, pet and baby food divisions, to Del Monte Foods Co. to focus on core products like condiments. "

Boeing Fires CFO This is a great article that really brings home the emphasis that ethics is playing in business. It would be interesting to know if this type of behavior would have been punished in the era pre-Enron, Worldcom and Tyco. I think this is a good job by Boeing to increase the stockholders' confidence that they will operate in an ethical manner.

The AccountingWeb reports that 'Tough Love' will be used with firms that are unethical.

"Under the PCAOB’s rules, firms will be given 12 months to fix problems that show up in the board inspections. Unless the case is particularly egregious, the firm’s violations will not be made public. If the board is satisfied with the firm’s solution, no further action would be taken. If the fixes are not satisfactory, said McDonough, “Then we have to get very tough.”

Civil penalties may be as high as $750,000 for individual auditors and $15 million for firms, as well as temporary or even permanent suspension from auditing public companies."

Along the same lines as the last posting this article talks about Calculating the real value of High Tech companies. Because of such high stock prices we've seen in these companies recently (at least before the tech bubble burst) it has been really difficult to put a fair market price on them. This article talks about some of the ways to value these companies.

Good article talking about coming up with the valuation of a company...Business Valuation. Goes back to our topic on why is the book value of a company different than the market value.

This article is from "AccountingWeb.com" SEC adopts stricter rules to improve disclosure talks about new rules adopted by the SEC. The rules are in regard to improved disclosures to investors. The 2 main areas of improved transparency are in the regarding the process of nominating directors and shareholder communication with directors. The SEC goes as far as requiring companies to explain if they have a process, and if they do not, why they do not have a communication process. These questions are intended to drive companies to institute a process if one does not exist.

The power of cash flow ratios talks about how important it is to analyze the cash flow statement. He states that many auditors use the income statement and balance sheet and ratios that apply to those financial statments instead of the cash flow statement. Balance sheet data measures a single point in time whereas the cashflow statement focuses on what shareholders really care about:cash available for operations and investments. The author believes that for liquidity analysis, cash flow information is more reliable.

This article addresses how prevalent Revenue Recognition issues are in today's financial scandals. Revenue recognition accounts for 4 out of 10 earnings restatements.

Here is an interesting article on Nexstar Broadcasting's IPO today. Some very unusual things going on with a bonus payment and loan guarantee for the CEO that would no longer be allowed under the Sarbanes-Oxley reforms. Some of the proceeds from the IPO went to a "success fee" for the CEO for successfully completing the offering. Most of that money from the bonus ultimately went to pay off a loan that the CEO had taken out from Bank of America(IPO underwriter). It's no wonder why it's currently priced under the IPO price of $14.

Doug Probasco

This MSNBC article reports on Hollinger's overstatement of prior year's profit. The article goes on to describes the company's inability to have their top management or auditors sign the financial statements and the trouble this is causing with the SEC.

BUT NEITHER EXECUTIVES nor its auditors signed off on the filing, meaning the numbers are incomplete and the company would have to file an amended report with the U.S. Securities and Exchange Commission. ... Hollinger also said KPMG has been unable to complete its audit of the financial statements and that the figures in the third-quarter report were not certified by interim CEO Gordon Paris and others in top management. Because of that, “the staff of the SEC will take the position that this Form 10-Q is deficient ... “ the company said in the filing.

This BusinessWeek article speaks about some tremendous mismanagement at Kmart over the last few years. It speaks about the "Frat Boys" and the lavish spending that took place, over ordering that left Kmart with $500MM in inventory it couldn't sell and affected Kmart's ability to borrow in the short term. The article speaks of lavish trips and excess perks for top executives all the while knowing that the retailer was on the break of bankruptcy. Very interesting reading.

Annuities: The Other Variable in Abusive Fund Trading . According to this article, regulators are taking a greater interest in variable annuities.

Based on the slew of money moving into and out of dozens of international funds within variable annuity accounts, the arena may have been a gold mine of questionable trading that took money right out of the pockets of long-term annuity investors.

Variable annuities -- a group of investment offerings, typically mutual funds, wrapped inside an insurance contract that guarantees part of the holder's investment -- seem to reside at the opposite end of the investment spectrum from go-go arbitragers and market-timers. The average participant is 65 years old, and 53% of annuity accounts hold less than $100,000, according to the National Association for Variable Annuities, an industry trade group. However, industry participants and watchers say a growing number of institutional clients have jumped into variable annuity contracts in recent years for market-timing purposes, because such contracts allow investors to move freely among funds on a tax-deferred basis.

Rich Muny

The Race to Reform the Fund Industry Is On. According to the article, the SEC is under pressure from Congress to implement significant mutual fund reforms.

Rich Muny

How We Smoothed our Earnings.

The long-awaited numbers from the accounting scandal included an admission that the No. 2 mortgage finance company overstated earnings by almost $1 billion in 2001 and understated profit for 2002, 2000 and earlier periods by more than $6 billion.

Freddie Mac shares rose as much as 4 percent initially but ended the day virtually unchanged as investors looked for closure to the scandal, in which financial results were massaged to show the sort of steady growth Wall Street favors.

This msn Money article criticizes the job the SEC is doing, accusing it of becoming "a critical link in protecting the profits of mutual funds and Wall Street traders and market makers." The pressure on the SEC to reform will continue to grow as the mutual fund controversy continues to unravel.

This has been a huge week for quantity of IPO's. Not since 2001 have so many companys gone public at once. Most economists are looking at this as a positive sign of an all-over economy boost. One of my personal favoires, Buffalo Wild Wings (BW3's) went today and is doing great! Check out CNN Money for the full article.

This article at CFO.com is about Sarbanes-Oxley and private companies that find themselves complying with the Act even though it doesn't necessarily apply to them. Some comply because they just think it's the right thing to do, while other find their raised capital leaves them no other choice.

New York Times Here is an article that appears to contradict one traditional information stream and it’s impact on EMH. Why isn’t a Democratic presidency thought to be the market’s party?

"Using this measure, they find that during those 72 years the stock market returned about 11 percent more a year under Democratic presidents and 2 percent more under Republicans - a striking difference.

This nine-percentage-point excess can be broken down further into an average 5.3 percent higher real return for the stock market and a 3.7 percent lower return for Treasury bills under Democratic administrations.

An Irresistable Offshore Tide for Jobs. Here's an article about HIGH PAYING JOB's leaving the US. The business week article is part of a converstaion with the CEO of TCS; which is India's largest IT services company. TCS claims they were the 1st of India's BIG 3 to top 1 Billion in revenue.

The article focuses on whether or not "politics" can reverse the trend of high paying IT jobs being sourced to foriegn companies. TCS is not concerned in least bit, as they believe the need for US based companies to remain comptetive will force US based companies to use foriegn labor one way or another......regardless of what the politicians state.

This MSNBC article reports a $1 billion error in earnings for the year 2001.

Freddie Mac, mired in an accounting scandal, is still expected to report that, on a cumulative basis, it understated earnings by $4.5 billion or more in 2000, 2001 and 2002, the paper said. An independent report last summer said the company ignored accounting rules to push earnings into the future to smooth its results and make it easier to meet profit targets.

GE Article CNNMoney has a good article on GE's sudden increase in stock price based off of recent released information on earnings for the next year. Acquisitions are a major driver in the increase.

Using ROE to pick stocks. This Forbes article notes how managers of the Jensen mutual fund use Return on Equity as a starting point for choosing which stocks to purchase.

In picking stocks, Jensen managers Robert Millen, 55, and Robert Zagunis, 49, start with a rigid and simple rule: They look only at companies that have posted a 15% or better ROE in each of the past ten years. (For the earnings numbers used in the numerator, they decide whether or not to count nonrecurring items on a case-by-case basis.) That leaves out erratic performers like Intel that have a good long-term average for ROE but have had some bad years. By comparison, the average ROE for S&P 500 companies is 17%; the average in the Jensen fund is 24%. Only 110 companies out of a universe of 5,000 pass through this first screen.

Morgan Stanley Pays $50 Million To Settle SEC Action

The Securities and Exchange Commission this week announced the institution and simultaneous settlement of an enforcement action against Morgan Stanley DW Inc. for failing to provide customers important information relating to their purchases of mutual fund shares.

Stemming from the SEC's ongoing industry-wide investigation of mutual fund sales practices, this inquiry uncovered two distinct, firm-wide disclosure failures by Morgan Stanley.

'Tough Love' Approach Sought For Accounting Firms That Don’t Reform

Accounting firms should “save themselves” to restore confidence in the industry, but those that don’t clean up their practices will face tough penalties, said the head of the new accounting oversight board.
The PCAOB replaces the industry’s own regulators. It has subpoena power and the authority to discipline accountants.

Under the PCAOB’s rules, firms will be given 12 months to fix problems that show up in the board inspections. Unless the case is particularly egregious, the firm’s violations will not be made public. If the board is satisfied with the firm’s solution, no further action would be taken. If the fixes are not satisfactory, said McDonough, “Then we have to get very tough.

CNN Money Fed underscores promise of low rates. Head of San Francisco Fed says he won't argue with views that interest rates will hold for a while.

Unusually clear comments from Fed officials Tuesday helped bolster the view that the central bank will sit tight on interest rates until the middle of next year, even as the economy gathers momentum.

Even financial markets, if you look at the futures market, don't expect much in the way of upward pressure on short-term interest rates till the middle of next year.

Growth stocks on the cheap... Trolling for bargains after the market's rally -- 4 stocks to consider now.

Given the strength of the recent stock market rebound, you might expect that there would be few bargains left lying around.

There are lots of ways to evaluate stock prices, of course. And growth investors should be looking at a stock's price relative to its total return potential rather than sizing it up based on assets or breakup value.

To find such underpriced growth stocks, I like to scan blue chips, looking for companies whose total return potential (based on earnings growth and dividend yield) is actually higher than the P/E. A stock with a P/E of 13 would be cheap by this measure if its earnings growth was 12 percent and the stock paid a 2 percent dividend yield (total return potential can be gauged by adding a stock's projected earnings growth rate to its dividend yield).

Cincinnati Business Courier reports that P & G to sell $1 B of notes. This relates to our class discussion on bonds.

The notes are expected to be split between five- and 12-year maturities. Goldman Sachs, JP Morgan and Merrill Lynch are managing the sale, Reuters reported. The notes will be rated "Aa3" by Moody's, a rating that indicates a high-quality investment. Standard & Poor's is expected to rate the notes "AA-," which also is a high-quality rating.

This article in Business Week reviews the star rating changes for 7 companies. YUM, (which is Taco bell/Pepsi) Prudential, Home depot, Career Education, Advanced Micro devices, Agilent Technologies and MedImmune. The S&P star rating change is associated with analysts' opinions to either, buy, hold, or accumulate stock. The analysts are basing their opinions on the predicted P/E ratios in comparison to peers within the industries as well estimated future (2003 & 2004) revenues as well as estimated future earnings.

This article titled Tax Break for Leasehold Improvements gives some more definition to an item we covered briefly in class and discusses a new tax incentive for businesses to perform leasehold improvements. The article gives a good example to help explain how the tax break works.

The new rules allow 30 percent of the cost of leasehold improvements made to commercial real estate to be deducted in the first year. In addition to this bonus depreciation, taxpayers can deduct regular depreciation on the improvements. Either the lessor or the lessee may make the improvements and take advantage of the tax benefits.

This Fortune magazine article reveals the methods by which Enron was able to fabricate operating cash flow and profits.

"The device they used was called a prepay; in essence it was a loan that Enron booked as operating cash flow." Basically, Enron would agree to deliver natural gas or oil to an offshore entity that was set up by one of a number of banks that dealt with Enron. The offshore entity would pay Enron upfront for the promise of future deliveries and then turn around and promise to deliver natural gas or oil to the bank. Then the lender would agree to deliver the same natural gas or oil back to Enron. This all looked like separate transactions in the financial statements, but the trades of natural gas or oil cancelled each other out, basically leaving Enron with a loan with interest.

This CNN Money article relates to our recent discussion on bonds and the effect of fluctuating interest rates.

Together, the comments by the two officials today added to a recent chorus of Fed speakers who have tried to calm market nerves that recent rapid economic growth will lead in short order to an increase in U.S. rates.

This MSN Money artice, MSN Money - Breaking News, reports the sale of one of Enron's companies as a result of it seeking bankruptcy protection two years ago.

"The price being paid by Oregon Electric will also include debt, the amount of which is yet to be decided based on its financial performance in 2003.

The positive point of the deal is that Enron has been able to sell the asset in one piece rather than breaking it up as some had feared it might have to do given the delay that was occurring in finding a buyer for the asset.

``Enron and its official unsecured creditors committee believe this transaction is the best option to deliver maximum value to our economic stakeholders,'' said Stephen Cooper, Enron's chief restructuring officer.

This article discusses the role KPMG played to promote "dubious charitable deductions and complicated transactions to generate phony paper losses for clients". These tax shelters were offered between 1998-2001 and are no longer being offered. Wonder if Enron and other wrongdoings at the time scared them straight.

This article discusses the probe into Freddie Mac for their recent accounting scandal. The investigators are "examining whether Wall Street firms aided the U.S. mortgage finance company’s misdeeds by arranging deals that allowed Freddie to hide big gains and smooth out its earnings...". In addition, "An independent report this summer said Freddie Mac’s senior management ignored accounting rules to push earnings into the future to make it easier to meet profit targets. "

Interesting that corporate fraud is still going strong.

Description here

Nov. 18, 2003 (Associated Press) — The accounting industry is getting a chance to reform itself, but firms that don't do it willingly will be punished harshly, the head of an independent oversight board says.

This article discusses the type of role the auditors of publicly held companies need to play to increase consumer confidence. It also talks about the oversight committee that was formed and its functions.

This MSNBC article gives an interesting commentary into the thinking of the central bank when it comes to interest rates. Even though it is believe that the economy is on the turnaround, the US central bank has decided to keep interest rates at 40 year lows while other countries such as Australia and Britain have already raised their rates.

"Fed Chairman Alan Greenspan and his cohorts believe they can take their time before raising rates. Despite investors' skepticism, Fed insiders believe the U.S. is in a unique period where inflation is so low ? and the economy still boasts so much slack ? that they can relax and let things rip. "In these circumstances," Greenspan said on Nov. 6, "monetary policy is able to be more patient."

EMH assumes that investors are competent, well informed, well funded, make continuous evaluations, and receive a regular stream of information. With "Fee based" 'independent' research firms, its hard to believe that the conditions required for an efficient market are possible.

Eliot Spitzer has engineered a reform plan that aims to end the "scandalous relationship between research analysts and the investment banking clients of the firms that employ them". The reform "requires ten big firms to collectively spend $450 million on independent research in the next five years. However in "Son of Grubman" in November 24, 2003 of Forbes, Emily Lambert identifies how "fee based" research firms that qualify as independent are lobbying to take advantage of the opportunity.

These firms are often compensated by the very corporations that they are evaluating. Often requiring compensation to come in the form of cash payments or restricted stock. I think Louis Thompson of the National Investor Relations Institute puts it best with "For [fee-based analysts] to say they're independent is just nonsense". Only time will tell....

This article "Labor Sharpens its Pension Sword" appearing in Nov. 24, 2003 Business Week combines concepts relating to stocks and company control with pension funds and labor unions. It emphasizes the stockholder power of the unions via their pension funds.

The article cites how "...unions have begun using the power of their $350 billion in pension funds to become shareholder activists...." "Labor has become one of the country's strongest voices for corporate reform, demanding independent boards of directors, mutual fund accountability, and curbs on runaway CEO pay. But now unions are upping the ante, using their pension holdings to pressure companies on bread-and-butter labor issues as well. Combining old fashioned tactics such as picketing with their clout in the boardroom, unions are attacking employers on everything from health-care benefits to job outsourcing."

This CNN Money article talks about how investors appear to be ignoring both bad and good news on all fronts. Events which typically have had a detrimental effect on the market, like terrorist attacks and the on-going issues in Iraq, are not following the usual trends. The next question is how stores will fare during the upcoming holiday season, taking into consideration weak October sales and cautious comments from giants Wal-Mart and Target.

This article from Washingtonpost.com discusses an alleged scheme by Gateway computer executives to artificially inflate the personal computer maker's revenue and profit in 2000. Investigators claim that Gateway failed to disclose significant company trends such as: Declining personal computer sales growth, the fact that only a small percentage of net income came from PC sales, and the fact that revenue and earnings included various one-time transactions. The allegations also state that Gateway contacted individuals whose credit applications had previously been denied by the company, and offered them pre-approved financing to facilitate sales.

This BusinessWeek article talks about Kodak's business strategy given the changing market of digital and their decision to cut stockholder dividends from $1.80 to 50 cents. We discussed in class that reducing dividends is often a sign to shareholders (or anyone for that matter) that a company may be struggling to effectively manage itself. This article presents Kodak's explanation in response to pointed questions on the issue posed by BusinessWeek editors.

"On Nov. 11, BusinessWeek editors met with Eastman Kodak CEO Daniel Carp and President Antonio Perez to discuss its prospects in a world in which digital imaging is rapidly replacing the film-based photography that made Kodak (EK ) an American icon. They also discussed shareholder reaction to their controversial Sept. 25 strategic plan, which cut Kodak's high dividend by 72% to help fund acquistions and invesments in digital-imaging technologies.

This article continues the growing investigation into the mutual fund industry's alleged wrongdoings. It speculates on intense pressures to manage earnings, as discussed in the Duncan article for class. It also describes the borderline-illegal practices of "market timing" and "late trading" which mutual funds allegedly allowed for preferred customers.

Lawmakers probing mutual fund industryreports that

"lawmakers and regulators are digging into a slew of other questionable practices by fund managers and brokers". The question asked is "are mutual fund fees excessive".

Putnam Reaches Settlement of SEC Charges

Interesting discussion on how the SEC sends down sanctions on different companies, but how state and federal authorities feel more punishment is needed.

How to Rip Off Investors

This article compares the current mutual fund scandal with Enron. It implies that the same type of practices occurred, but that terminology used to describe the wrong-doing is hiding much of fault. It is an interesting perspective on the current scandal and how insiders were able to rip off thousands of dollars from investors without getting into as much trouble as Enron Execs did.

Annah McDowell

Affects of a Rising Canadian Dollar

Canadian companies rely on exports to the United States. 40% of the C$1.1 trillion Canadian economy is made up of exports. Since the Canadian dollar is rising as compared to the US dollar, they get fewer Canadian dollars on the sale to cover their expenses at home. This is affecting the Canadian economy.

Laura Luchsinger
11/13/2003

From this morning NYTimes - a very fine article covering debt, bonds, and market (S&P) ratings. Good too is the presentation of the downgrading becoming near junk status. - Don't get me wrong: I do hope Ford can come back.

The anticipation of a downgrade in Ford's rating has weighed heavily on the bond market since Standard & Poor's put Ford on a credit watch last month. The market reacted positively to Wednesday's news, because investors were relieved that Ford was not downgraded to high yield, or junk status.

This is a great article on long-lived asset impairment and disposal. It discusses when impairment should be considered, testing the assets for recoverability, estimating fair value, disclosing the impairment losses, how to report them when they are sold and reporting discontinued operations.

FASB: Stock Option Expensing Required in 2005
The Financial Accounting Standards Board, in a meeting to discuss the details of its stock-option proposal due early next year, agreed to require the expensing of options beginning in 2005, despite requests from the high-tech sector to delay such a requirement.

Most companies do not expense stock options because of concerns on how it may affect company profits. However, proponents of mandatory expensing have gained momentum from recent corporate governance reforms and the forthcoming final rule on mandatory expensing from the International Accounting Standards Board. Proponents say mandatory expensing gives investors a clearer financial picture of a company.

Final rules on stock-option expensing are scheduled for release in the second half of 2004.

Inflated Earnings leads to inflated taxable income. A recent study looked into this issue and found that companies that inflate their earnings pay additional taxes.

[the authors] studied firms that restated their financial statements in conjunction with a Securities and Exchange Commission (SEC) allegation of accounting fraud during the period 1996 to 2002. For the 27 firms in the study, the authors estimate that the average firm paid $11.84 million to the Internal Revenue Service on overstated earnings, which is the equivalent of $0.11 in additional income taxes per $1 of inflated pre-tax earnings. This implies that some managers believe that $1 of overstated accounting earnings is more valuable than $0.11 of cash.

This article describes several companies, including McAfee, the maker of debugging software, and how they've had to restate their revenue numbers as far back as 1998. The reason for this restatement is that they improperly recorded revenue to distributors and resellers even though though they had generous return policies with these customers.

CFO.com This is an interesting article in which the author describes how it's important for accountants to understand and apply GAAP, but to also be in touch with the needs of the company. This case tells the story of sending the accounting staff out to the factory floor once a week to help them apply their experiences to their daily job function and "lean accounting".

Prosecutors Drop Kmart Fraud Case - Accounting- CFO.com

This is a good article that demonstrates the revenue recognition principle and how it can be manipulated to underestimate losses. Fortunately for Kmart the charges were dropped.

According to the indictment, Montini and Hofmeister negotiated a multiyear contract with one of Kmart's vendors — American Greetings Corp. — for $42.3 million. The two individuals lied to Kmart accounting personnel and concealed a side letter that called for the repayment of the money under certain circumstances, the indictment notes.

As a result of the scheme, Kmart improperly recognized the entire amount in the quarter ended August 1, 2001, instead of over a period of time, according to the SEC's complaint. The alleged deceptions also caused Kmart to understate losses.

Cablevision will restate their 2003 earnings due to accounting errors. “THE RESTATEMENT will include the effect of $15 million in expenses that were improperly booked in 2002 and earlier, the cable company said.” After an internal investigation, Cablevision fired 14 employees for improper accounting of expenses and fabricated invoices. -K.C. Ho

Rosie O'Donnell scores a victory in magazine trial

This article describes how the publishers of the "Rosie" magazine manipulated their financial statements to lower the loss in order to keep Rosie O'Donnell in the venture.

The AccountingWeb.com Is Your Cash-Value Insurance Policy in Danger? recently reported that the cash values of many insurance policies are decreasing. Many people don't realize this because they don't check their policies.

Most owners of cash value life insurance polices don't really understand what effect low interest rates have had on their policies, according to the top insurance consultants at Herz Financial.

"Customers may be losing money with a policy that was once valuable, but now with the extended drop in interest rates, it may be on a collision course to self-destruct and become worthless," said Matthew Herz, one of the country's most successful financial advisors. "Many policies were purchased based on interest rate assumptions of 8-12%, and that is just not the case anymore with rates as low as 3% at some companies."

Net income in the third quarter for J.C. Penney Co. Inc fell 35 percent. The retailer reported EPS of $0.27 for the quarter, down from $0.42 a year ago. “The results in last year’s third quarter were helped by earnings from businesses that Penney no longer operates. Without those, last year’s third-quarter profit would have been only 30 cents per share.” The CEO made a reference of a better holiday season, even with the disappointing news, the stock price rose due to future upbeat expectation from investors. -K.C. Ho

Yahoo! Finance posts this informative article on the various types of bonds (including Treasury Direct, Agency Bonds, Muni Bonds, and Corporate Bonds) and describes pros and cons of each for the beginning and mature investor. The author describes the overall performance of long term bonds and why they may or may not be a good choice. Worth a read if class discussion interested you on a personal investing note.

This paragraph from a BusinessWeek article talks about how Airbus plans to pay over $5B cash for R&D on their new A380 instead of having to borrow the money.

"Financially Airbus has weathered the worst of the squeeze caused by the plane's development. Reassuring investors, the company has kept its promise to finance its $5.1 billion share of research and development costs from cash flow without commercial borrowing. Most analysts figure Airbus will enjoy a nice bounce in operating earnings, starting at the end of next year as R&D spending tapers."

Do accountants follow the numbers?

In the following article three major US food companies, Kraft, Dean Foods and Frito Lay, have said that they may face civil action from the US Securities & Exchange Commission over allegations that some of their staff helped US food distributor Fleming inflate its revenue

The article talking about Cisco EnterprisesCNBC reports that its third quarter earnings will surpass analyst's predictions. The announcement led to an increase in stock prices. Analysts are still hesitant however, waiting until the final payroll numbers come out to see how much of the revenue remains profits for the company.

This article talks about how a recent $1.4 billion settlement will require 10 of Wall Street's largest brokerage firms to offer small investors free independent stock research alongside their own. The debate continues whether or not the data given to small investors will be of high quality since there is a greater financial incentive for research firms to provide the best information to their top dollar, instititutional clients.

This court case report concerns a company's initial public offering and how one of the company's executives urged employees to engage in fraudulent accounting. The fraudulent accounting gave the public incorrect info on COGS, net sales, revenue, assets, etc.

This article pertains to the new goodwill rules and SEC auditing of Worldcom. Since the value of its goodwill has declined, they are willing to take a 15 to 20 Billion dollar hit. The SEC may force them to take more. Good article that applies to class discussions

Fluctuating Tax Rates This Accounting Web article talks about how companies are taking advantage of fluctuating tax rates to increase their reported earnings. This process is perfectly legal however, there is question as to whether or not it is ethical to give the perception of an increase in actual earnings.

Kimberly-Clark, Boston Scientific and International Paper are among the companies taking advantage of fluctuating tax rates to enhance their bottom lines. Most are taxed at 35 percent but don’t end up paying that much when they take advantage of various breaks afforded them by doing business in states with lower tax rates and by making good investments.

Overall third quarter earnings reports were the best in three years and many companies reported that steps taken to lower their tax rates helped the most.

While reducing tax rates isn’t illegal, it does raise some red flags on the ethical side.

Bonds vs. Bond Funds This Smart Money article discusses the different risks invloved in investing in bonds vs. bond funds. Typically investors expect bond funds to be less risky because they are diversified but this is not always the case because there is no fixed yield or obligation of returning the principle. With bond funds the risk-return ration is contantly changing. Depending on what investors are expecting in return there are several questions they should ask themselves before choosing to invest in bonds or bond funds.

Bond funds can be even trickier than bonds themselves because -- unlike the implication in their name -- they are not really fixed-income investments. Even when a mutual fund's portfolio is composed entirely of bonds, the fund itself has neither a fixed yield nor a contractual obligation to give investors back their principal at some later maturity date -- the two key fixed characteristics of individual bonds.

In addition, because fund managers constantly trade their positions, the risk-return profile of a bond-fund investment is continually changing: Unlike an actual bond, whose risk level declines the longer it is held by an investor, a fund can increase or decrease its risk exposure at the whim of the manager. In this way a bond fund is closer in character to equities than it is to individual bonds.

Bond funds may be appropriate for investors who know exactly why they are going into these funds and what they expect to get out of them.

The following Internal GE Article provides advice on Cash Flow for personal finance and for large corporations such as General Electric.

GE has 13 businesses that together generated more than $15 billion of cash in 2002 (excluding progress collections). Each of them has “paychecks” coming in and bills going out. "The ability to predict your cash on hand over a period of time, or cash flow, is vital to your personal finances and critical for the health of a multi-billion dollar organization."
Cash flow measures how much cash the company will have at its disposal at any given time after it pays expenses such as payrolls, bills, property taxes and supplier invoices. Items such as inventory, accounts receivable and property may be converted to cash at some point, but it takes cash on hand to pay suppliers, pay the rent, and meet the payroll. A positive cash flow (when cash coming into the business is more than the cash going out) is critical for the long-term vitality of any organization because it fuels growth through investments in new products and technologies, R&D and acquisitions.

According to Jeff Immelt, “cash allows for investment and value creation today…and tomorrow. Without cash, [GE] would be missing out on opportunities to grow and to fund our strategic growth initiatives, such as acquisitions and research & development investment.” Jeff adds that cash is sign of a vibrant, strong company; an attribute that many investors consider to be almost as important as earnings per share.

Through focus on higher Returns on Total Capital (ROTC) and reduced inventories, cash flow can grow and allow the company to further expand technology investments to come up with the next great idea in products and services.

Joseph Thodiyil

These two articles tie in with the Efficient Market Hypothesis. Bubble theory appears to be an ongoing argument against EMH.

An older article in the Economist (5/18/2002) entitled "Bubble Trouble" focuses on how the Fed chairman, Alan Greenspan was responsible for the late 90's / early 2000 financial bubble. Andrew Smithers and Stephen Wright argue that Greenspan could of avoided the bubble by raising interest rates by enough to bring down the 'Irrational Exuberance' and also lower share prices with the change. They blame Greenspans lack of action on two ideas. One is his belief in "Efficient Market Hypothesis". The article proceeds to explain that,

In efficient markets, prices are assumed to reflect fundamental values and to incorporate all relevant information. When ill-informed investors move prices away from their true value, informed investors will arbitrage them back to the right level, so there is no chance of a financial bubble, as defined by Peter Garber in his book "Famous First Bubbles" as a high price "at odds with any reasonable economic explanation"..... If a price goes to a level for which there is no obvious economic explanation, the believer will simply conclude that there is a non-obvious economic explanation- such as the coming of a more productive "new economy". What he will not conclude is that there is a bubble.

The article proceeds to argue that one weakness in EMH theory is the assumption that arbitrage (the simultaneous purchase and sale of the same securities, commodities, or foreign exchange in different markets to profit from unequal prices) by the informed against the uninformed is riskless and costless. The article explains that "Shorting shares involves borrowing a share and selling it now in the hope of buying it back later at a lower price to return to the lender. But borrowing a share can be costly, especially if the price continues to rise for a while before it falls. The further it goes above the price at which it was sold, the more nervous the lender will get and the more collateral he will want the borrower to post as Security." - higher risk.

In a more recent article "Professor Bubble" in Forbes , Vernon Smith, a nobel prize winning economist and expert in experimental economics conducted trading simulations using grad students for different time periods (in controlled academic environments). What he found was that once students ran the price of the security past the fair value, many kept buying. As soon as enough traders decided to stop paying a premium for the security the market crashed. When Smith ran the experiment a second time with the same group, another bubble formed, although smaller. The third time around, the investors were wiser and trading hovered around the security's value.

Smith repeated his experiments numerous times sometimes using students and sometimes using finance professionals. The financial types, he noted, made bigger bubbles. He claimed that people are "myopic. If the price is going up, they think it will keep going up."

His conclusion was that "New bubble danger comes down the road when a new generation of investors joins the market".

Thus, in an attempt to understand these concepts - I conclude that the markets greatest threat to efficient operation and potential argument to EMH is the routine influx of ignorant new investors entering the arena. The more new investors enter the market, the more likely the formation of a "Bubble" that disrupts Efficient Market Theory. However, one can take comfort that the investor learns with time. 2005? (?)

The New York Times reports that the S.E.C. and Eliot Spitzer (NY-AG) are considering legal action against Alliance Capital Management for suspected improper trading in mutual funds. Alliance, which managed a whopping $438 billion as of the end of September, has said that it is cooperating with regulators.

It is important to have the SEC and a great champion like Eliot Spitzer remind everyone that in the final analysis, illegal activities such as insider trading and accounting fraud cannot replace the fundamentals: strong future earnings and reduced risk perception for sustained growth in the stock market, and hence the mutual funds industry.

Joseph Thodiyil.

This is a CFO.com article about corporate debt. I thought it was quite appropriate given our last two classes. It relates the current improvements in the market to corporate debt and questions the abilities of these corporations to pay the debt in the future.

Contingent Liabilities. August 21, 2003 | Merrill Upgrades Monsanto to 'Buy'

Here is an old, but good, article that describes how contingent liabilities can affect a companies ability to pay back maturing bonds and pension funds.

Carson thinks the settlement greatly improves the potential that chemicals-maker Solutia will be able to refinance its credit facility and address upcoming bond maturities and pension funding obligations. He thinks this settlement is favorable for Solutia as Monsanto's other contingent liabilities associated with Solutia should be covered by Solutia's cash flow from operations.

Betting On Terror Why futures markets in terror and assassinations are a good idea. Libertarian magazine Reason argues that last summer's Pentagon proposal to create a futures market aimed at predicting events in the Middle East was a good idea, despite the political uproar it caused.

To illustrate how PAM might work, Senator Wyden offered a scenario in which a bidder thinks early on that Prime Minister X is going to be assassinated. So she buys the futures contracts for 5 cents each. As more people begin to think the person's going to be assassinated, the cost of the contract could go up, to 50 cents.

"The payoff if he's assassinated is $1 per future," noted Wyden. "So if it comes to pass, those who bought at 5 cents make 95 cents. Those who bought at 50 cents make 50 cents." Of course, those who bet the other way, lose their money. What Wyden is ignoring is that while market participants are making and losing money, it's possible that our intelligence agencies have gained some valuable information to help our leaders formulate appropriate policies such as what to do if Prime Minister X is assassinated.

So why not harness the predictive power of markets for intelligence purposes? Markets have demonstrated time and time again that people have a lot of dispersed and hidden information that the prospect of profit can lure into the open.

Here is an article on how Tyco is trying to get out from under Kozlowski's ignominious shadow. Basically cleaning up their balance sheet and returning to actual profitibility.

Richard Scrushy was indicted on federal charges related to the massive accounting fraud at HealthSouth. The former chairman pleaded not guilty to an 85-count indictment that includes securities fraud and false certification of corporate statements.

This Businessweek article highlights some of Dell's business strategies and speaks of their success and continued efficiency. Their ability to choose wisely in which new markets to enter and their ability to manage well has kept them extremely profitable. This reinforces the Dell article that we read for class.

Dell is the master at selling direct, bypassing middlemen to deliver PCs cheaper than any of its rivals. And few would quarrel that it's the model of efficiency, with a far-flung supply chain knitted together so tightly that it's like one electrical wire, humming 24/7. Yet all this has been true for more than a decade. And although the entire computer industry has tried to replicate Dell's tactics, none can hold a candle to the company's results.

This Business Standard article is from an Indian publication and provides some good examples of how companies can use management estimates in their Balance Sheet numbers to make their financial position look better than it actually is...

GDS' analysis points out that accounting for ESOPs, deferred tax liabilities, valuation of goodwill, valuation of impaired assets and the treatment of contingent liabilities, while being perfectly legal and according to the accounting standards, may be more of a statement of opinion than of fact.

Changes in the accounting treatment of these issues could result in profits being very different from the published figures,
in spite of the fact that there's no difference in the amount of cash flowing in or out of a company. "

GDSIL's report also points to several other areas where their interpretation of accounts is different from the published figures, after taking into consideration adjustments for diminution in value of investments, capitalisation of interest and other intangible expenses, exposure to subsidiaries and many other issues.

They have then re-calculated profits after making these adjustments, and have found that there was a difference of 15 per cent or more in the profits of 70 companies.

The key takeaway from the GDSIL study is that there's no alternative to go deep behind the published net profit figures if the investor wants to make an informed decision.

Alternatively, he could discard profit and concentrate on cash generated. As they say, "Cash is fact. Everything else is an opinion."

Redback submits proposal to re-buy stock to stay on active stock exchange as part of bankrupcy filing. Since they did not get enough stockholders to vote on their plan, they were forced to file CH 11 today. Redback feels they can return to a profit state by the end of FY04 or certainly by mid FY05. Redback is a minor rival of Cisco.

Yahoo News has a interesting piece on how some HealthSouth executives just can help themselves in ripping off the company even after they have charged with accounting fraud.

Those executives helped carry out nearly $3 billion in accounting fraud on orders from the company's founder and former chairman, Richard M. Scrushy, according to securities regulators and court documents.

The Efficient Market Hypothesis on Trial compares the EMH and Keynes philosophies as they pertain to the stock market.

"EMH assumes investors are rational. The Keynesian theory says that investors are guided by short run speculative motives. S. Mitchell"

MCI WorldCom overcame one of many hurdles they face as they emerge from Chapter 11. One of the biggest hurdles they still face will be to regain customer confidence.

Putnam's parent company, Marsh & McLennan Cos. , announced the replacement of their CEO. This action comes a week after civil fraud allegations were brought against Putnam, an investment firm.

This article although a little dated (March of 2001), discusses the pro forma method of reporting earnings. Once banned, it now is commonplace. Pro Forma allows wider liberties on when expenses are deducted. The author contends companies are shifting to stressing cash flow versus net income.

Roy Reinertsen