Financial Accounting Blog

Wednesday, January 28, 2004

Super Bowl and Stocks. Would a SuperBowl victory by the New England Patriots signal an end to the current bull market? Maybe. Forbes says that the outcome of the SuperBowl has correlated with the rest-of-the-year stock market direction 81% of the time.
Since the first Super Bowl in 1967, when Vince Lombardi's Green Bay Packers whipped the Kansas City Chiefs, 35-10, the Super Bowl Stock Market Predictor has been an astonishingly accurate--albeit somewhat silly--indicator of stock market direction for the rest of the year. The theory holds that when a team from the original National Football League wins the championship, stocks rise. When a team from the now-defunct American Football League wins, that's bearish. The two leagues merged in 1971, with most original NFL teams in the league's National Conference and AFL teams in the American Conference.

Using the Dow Jones Industrial Average, the S&P 500 Index and the NYSE Composite as market proxies, the prophecy of the pigskin has correctly called the direction of at least two of the three 30 times, while it blew the call seven times. A four-year skid of bum results ran from 1998 to 2001, but the predictor was back on track the last two years. The victory by the AFC's Patriots in 2002 preceded a double-digit drop in the Dow, and last January's 48-21 rout of the AFC's Oakland Raiders by the NFC's Tampa Bay Buccaneers came less than two months before the market staged its dramatic bullish turnaround in March of 2003.

This FASB information site provides project updates for proposed changes to the Revenue Recognition principle from December 2003 meetings. The objective of the project is stated below.
The planned comprehensive revenue recognition Statement will (a) eliminate the inconsistencies in the existing authoritative literature and accepted practices, (b) fill the voids that have emerged in revenue recognition guidance in recent years, and (c) provide guidance for addressing issues that arise in the future.

John Quiggin at Crooked Timber points out that after a year of profitable business at last has a P/E Ratio.

Having finally managed positive earnings over a full year, Amazon shares have now acquired that most basic measurement of value, a price-earnings ratio. With shares at $53 and earnings of 17 cents per share, it's a bit over 300 to 1, which suggests that perhaps the New Economy is not dead after all. With revenues growing at 20 to 30 cent per year, and slowing, it's hard to see how Amazon can deliver the four or five successive doublings in profit that would be needed to justify this price.

Tuesday, January 27, 2004

This Quicken article provides excellent insight on stock selection and valuation from one of the world's great investors, Warren Buffett.
There is a quick test that can be used to judge not only the economic attractiveness of a business but how well management has accomplished its goal of creating shareholder value. If a company has been able to achieve above average returns on retained earnings, that success will be reflected in an increased stock price. In Buffett's quick test, the increase should, at the very least, match the amount of retained earnings, dollar for dollar.

Article from Charitable Lead Trusts: Goodwill, good returns

How's this for a way to do good for yourself and others: make regular donations to a charity for a set period of time, get a huge tax deduction, then get all of your money back and then some? Do some fancy tax planning and you could even earn a lot more on the money you gave away than you actually gave away.
The way to this win-win situation is through Charitable Lead Trusts -- and they are gaining in popularity, according to Needham, Mass.-based Tower Group, a research firm.


Monday, January 26, 2004

Store Gift Cards: This article at reports on how the growing use of store gift cards is making it harder for retailers to accurately report their Christmas sales.
While gift cards still represent a sale for retailers, companies aren't able to register those sales until the gift cards are spent by their recipients. Since that often doesn't happen until weeks after the end of the holiday season, the effect is that recognized holiday sales are depressed.

PE Ratio. This article says that there are currently only 10 stocks in the S&P 500 with PE ratios less than 10. They calculate PEs using analysts' expectations of 2004 EPS rather than the EPS numbers reported for 2003.
The report cited several companies whose stocks have comparatively low price-earnings ratios, largely in the home building sector, including homebuilders Centex Corp. (NYSE:CTX), Pulte Homes Inc. (NYSE:PHM) and KB Home (NYSE:KBH).

This article at YahooNews refrences another probable manipulation of financial statements. The SEC called for the restatement of Tyco's financial results over the past 5.5 years. Tyco's former auditor, PwC, had previously examined and approved the company's financial results. The partner in charge of Tyco's audits now faces a lifetime cease and desist order because PwC executives allegedly twisted the accounting books to furnish excessive personal spending without restraint. One example given is the expenditure of $6,000 on a shower curtain. Although no criminal litigation is likely to arise, PwC partner Richard Scalzo is permanently banned from preparing financial statements, PwC will no longer preform auditing services for Tyco, and the accounting firm's reputation has been tarnished.
Another blow against the accounting firm's work came in August when the SEC slapped the PwC partner who had overseen Tyco's audits with a lifetime ban. The SEC found that PwC partner Richard Scalzo was "reckless" and stood idle as the conglomerate's top executives manipulated accounting entries to conceal their lavish spending and pay.

How to Spot Financial Fraud. MSN Money highlights indicators that should be observed which may help spot firms with accounting fallacies.
Spotting accounting fiddles isn’t easy. After all, if the auditors are taken in, how can we do any better?

Well, you can learn how to spot the danger signs. While accountants have their nose to the numbers, investors can stand a little further back and take a different view. If, for example, a company appears to be doing fantastically well compared with the industry it operates in, if it is led by a charismatic chief executive, if its business is too complex to be easily understood, and if it has a history of frantic acquisition (especially funded by shares), then many of your alarm bells should be ringing.

Sunday, January 25, 2004

COMPENSATION AND CASH FLOW. reports why many companies are using metrics from the cash flow statement, and not just the income statement, to measure performance and award bonuses. Cash flow, working capital, return on invested capital are now as important as revenues or earnings.

In addition to personal performance, annual bonuses are traditionally tied to metrics reflected on the income statement, such as revenue or net earnings. These targets "focus managers on driving income-statement results without a lot of regard to the balance sheet," says Cheryl Beebe, treasurer and vice president of finance at Corn Products International. That was the case at her company, too, quips Beebe, before management decided to "put skin in the game."

In 2001, Corn Products tied annual bonuses to cash flow. Now in its third year, the program links 20 percent of yearly bonuses to total working capital (current assets minus current liabilities, excluding short-term debt). The rest of the bonus is determined by operating income and personal performance. Beebe maintains that the working-capital program has cut down on dysfunctional behavior because executives are less likely to manage for top-line sales and revenue numbers. The Corn Products plan links bonuses "to what it takes to earn a profit on sales," asserts Beebe. "It's great to make a sale, but if it takes 120 days to collect the money, profit margins won't be very sturdy, and that's not the business model we want to encourage."

PE Ratio.'s article titled "10 Things You Should Know Before You Buy A Stock" touches on P/E ratios as a means of valuation.
It's wonderful to find a company such as eBay (EBAY:Nasdaq - commentary - research) whose earnings are growing exponentially. But the other side of the equation is the value the market pays for that growth and the prospect of future growth. There are several basic methods of determining a company's valuation: Price to earnings, price to sales, etc. These numbers can be easily found on Yahoo!, Morningstar and a slew of other Web sites. While price-to-earnings multiples, or P/E multiples, aren't the perfect gauge, investors need to consider how much they are paying for a stock.
Rod B. 1/25/04

The New American website has this article called "Mishandling The People's Money".

PE Ratio. The New York Times reports that a study has been conducted concluding that high P/E companies cannot possibly grow as quickly as they need to in order to justify thier high valuations.

As part of their research, the professors checked a database of all publicly traded domestic companies for those whose earnings at any time from 1951 to 1998 grew at more than the median annual rate for five consecutive years. That may seem a modest prerequisite, since that median over those 48 years was around 6 percent. But very few companies met that condition, and those that did were rarely those that investors had valued at the high end of the spectrum. The professors concluded that very high P/E ratios were hardly ever justified.

One company that has a P/E ratio around 102 based on earnings for 2003 is Ebay. Ebay is currently trading at $69.35 and if we assume that it's stock price grows just 8% annualized over the next 5 years to $102, its EPS would have to grow 30% annually to justify today's valuation. reports that MCI will recoup $9.5 million paid to Goldman Sachs for advice just prior to filing for bankruptcy in the wake of a massive accounting fraud at the company.
Goldman was hired in 2002 to help with raising capital, arranging financing, discussing mergers and selling company assets, the Associated Press reported.

The company is paying its own bankruptcy law firm as much as $3 million a month, but it is also required to pay for its creditors' lawyers and financial advisers, paying $150 million in fees during the past year. More than $40 million of that paid for the company’s investigation into the massive accounting scandal that led to the biggest bankruptcy case on record.

Saturday, January 24, 2004

Off-Balance Sheet Financing. reports that the SEC and FASB will implement stricter standards regarding off-balance sheet arrangements.
The new MD&A final rule lowers the disclosure threshold for reporting off-balance-sheet arrangements, contractual obligations, and contingent liabilities in annual reports. Disclosure is currently required only when there is a "reasonable likelihood" that an off-balance-sheet transaction has a current effect on the company's financial expenditures or capital resources, or will have such an effect in the future. Under the new standard, disclosure is required if there is so much as a "remote" chance that the transaction will have such an effect.

Friday, January 23, 2004

The Power of Markets. A topic that we'll get to later in the semester is about the ability of stock markets to aggregate the wisdom that's spread across thousands of investors and then reflect that wisdom in one number: the stock price. As part of their research agenda the U. of Iowa runs stock markets that allow people to invest in presidential candidates.

Click here to see the latest graph of the democratic candidates' stock prices. Crooked Timber website suggests that the graph is evidence that markets aren't good at predicting outcomes.

Thursday, January 22, 2004

Company Life Insurance This article/video discusses how companies are now taking out Life Insurance policies on its employees. While originally meant for top-level executives, companies are now using this as a tax-free way to fund other employee benefits.
When Joel St. John died, his wife learned that the grocery store chain where he worked as a butcher was the beneficiary of his life insurance policy, not his family. The company made off with $100,000 of his money and the family only received $17,500.

Currently 25 percent of Fortune 500 companies have such policies, including Disney (DIS), Dow Chemical (DOW) and the parent company of the Fox News Channel, News Corporation (NWS). One firm is even making 12 percent of its bottom line from employee death benefits.

But advocates of the company-owned life insurance policies say politicians and lawyers are vilifying the practice, and the money is often used to fund other employee benefits.

Super Bowl Costs. reports that...
Water-cooler chatter about this year's Super Bowl could cost employers $821 million or more, according to estimates by outplacement firm Challenger, Gray & Christmas.

Challenger, Gray & Christmas calculated the employer loss by dividing the average hourly wage, $15.52, by six to determine the average amount earned every 10 minutes, or $2.59. It then multiplied the $2.59 by 52,870,000, or the estimated number of employed Super Bowl viewers.

The Debate Over Expensing Stock Options Continues reports that SEC commissioner, Paul Atkins, has thrown himself into the debate over the expensing of stock options and is questioning the expected ruling from FASB.
Speaking at an American Enterprise Institute conference on expensing stock options, commissioner Paul Atkins said he feared the Financial Accounting Standards Board (FASB) was moving toward a proposed rule for political reasons, not accounting ones, according to Reuters.

"I'm not sure that the presented fix doesn't create more problems than it actually solves," Atkins reportedly said, emphasizing that he was speaking personally and not on behalf of the SEC.

This article details the recent surrender of former Enron accounting chief, Richard Causey, to the FBI. He faces five counts of securities fraud and one count of conspiracy to commit securities fraud. The text goes on to explain some of the measures Causey and other executives allegedly took in an attempt to produce reports that showed earnings greater than what anylists had predicted. The article then alludes to the disguise of a loan from Merrill Lynch as a sale of Nigerian barges. The Enron scam reaffirms the importance of accurate financial statements to both lending institutions and the investing public.
Causey, with other Enron executives and senior managers, "engaged in a wide-ranging scheme, through a variety of devices, to deceive the investing public about the true performance and profitability of Enron's businesses by manipulating Enron's publicly reported financial results and making false and misleading public representations about Enron's financial results and the performance of its various business units," the indictment said.

The document noted Causey reported to Enron's chairman and chief executive but did not name former Enron chairman Kenneth Lay or former CEO Jeffrey Skilling. Neither of them has been charged with any crime.

According to the indictment, the scheme's objectives, among other things, were to produce earnings that grew by 15 to 20 percent annually and meet or exceed "without fail" the published expectations of industry analysts forecasting Enron's financial results while avoiding public reporting of large write-downs or losses.

The intention was to "deceive lenders, rating agencies, and the investing public about the true magnitude of Enron's debt and other obligations and the true condition of Enron's cash flow," the indictment said.

Fraud. BW Online reports that there is a new movement of software that "crunches" data to determine if financial numbers are fabricated and if accounting fraud has occurred.
Benford's Law provides just one small example of the way in which technology used to uncover accounting fraud has been growing in both sophistication and popularity. The growth hasn't really been stimulated by technological innovation, which has mostly amounted to fine-tuning sleuthing programs so that they issue fewer false alarms, customizing such programs for use with new industries, and upping raw computing power so the programs can crunch more data. Instead, the boom is being fueled by accounting scandals, terrorism threats, and new regulations such as the Sarbanes-Oxley financial-disclosure law and the Patriot Act, which both require companies to be more vigilant about avoiding financial fraud and about keeping employees honest.

(posted by B. Piening)

Wednesday, January 21, 2004 Clearly, financial accounting is relevant to both Wall Street analysts and business executives or managers. However, as the article suggests, sometimes differences arise between both factions concerning disclosure from analysts, or a potential lack of awareness of the long term effects of company actions from executives. This article suggests that despite any differences, both analysts and executives are looking to obtain, or supply, information that lies beyond the scope of traditional GAAP guidelines and seek to gather a more indepth and representative picture of the results of business operations.
Both analysts and executives are relying less on financial results that are reported according to Generally Accepted Accounting Principles (GAAP). Instead, they are turning to economic income or economic profit.

Why the switch? GAAP-reported results contain enough adjustments that sifting through them to find a company's true operating results becomes nearly impossible. It is also difficult to compare performance across firms. One example: Pension profits are included in GAAP-reported profits, even though they are usually not sustainable and are not related to operations, says Glenn Welling, an Irvine, Calif.-based managing director with Holt Value Associates, a financial consulting firm headquartered in Chicago. "There are a tremendous number of distortions in accounting data."

Measures of economic income or profit try to eliminate the distortions and indicate just how effectively firms are using their assets to generate returns above their cost of capital. "What's important is not just what you make, but what you spend to make it," notes Neal Cannon, senior vice president with Financial Relations Board Inc., a Chicago-based investor relations firm.

Tuesday, January 20, 2004

Restatements. A new report says that Reserve Accounting Leading Cause of Restatements in 2003. A restatement is when a company declares that previously released financial statements contain material errors and then states how the numbers should have been reported.
Reserves and contingencies may be among the most judgmental accounts in a company's financial statements as they are subject to an estimation process. These restatements, however, do not simply reflect changes in estimates, but rather reflect flawed judgments due to the oversight or misuse of facts, fraud, or a misapplication of Generally Accepted Accounting Principals (GAAP).

PE Ratio. The Motley Fool website discusses a situation with regards to the Price/Earnings ratio of Pfizer that is similar to that discussed in our text. They’ve stated that, at the time of the article, Phizer’s P/E was 50. They go on to state that
it can’t possibly grow its earnings fast enough to justify paying 50 times every dollar earned in the last 12 months, can it?
They go on to state the reason for this high P/E ratio:
the stated earnings under generally accepted accounting principles (GAAP) include a non-cash writedown of impaired goodwill to the tune of $4 billion. Back this amount out, and Pfizer's P/E drops to a much more reasonable 19. But an investor just looking at the number would come away with a singular determination: Pfizer is insanely expensive.
They sum up by stating that
much of the market treats the P/E as the be-all and end-all in measures of how expensive a stock is means that those who wish to dig a little deeper could find values in unexpected places.

(Posted by P. Timmerding)

Monday, January 19, 2004

Revenue Recognition. The New York Times[link no longer working] reports that Computer Associates is the subject of a Securities and Exchange Commission investigation into the software company's recent history of apparent improper accounting practices. [Update]
For two years, federal prosecutors and commission lawyers have investigated whether Computer Associates used accounting tactics to inflate its reported sales and profits in the late 1990's.

In October, Computer Associates said that an internal investigation by its audit committee had found that during its fiscal year ended in March 2000, it had recognized sales from contracts that had not yet been signed. As a result of the inquiry, the company forced Ira Zar, its chief financial officer, and two other executives in its finance department to resign.

But many former employees of Computer Associates have said that the company's accounting problems run far beyond backdating contracts in its 2000 fiscal year. The employees say that throughout the late 1990's, the company used a variety of accounting tactics to inflate its sales and profits and to convince Wall Street that it was growing as a result of new product sales instead of contracts it had acquired when it bought other companies.

Sunday, January 18, 2004

The BBC has a story from Zimbabwe showing that the United States is not alone in having accounting firms caught up in financial scandals and fraud.

A commentary in (The Herald) called on accounting firms and the Reserve Bank of Zimbabwe (RBZ) to accept some responsibility for allowing corruption to flourish for too long.

"Accounting firms must take some flak for the mess in the financial sector... Accountants are 'wilfully blind' to the fraudulent nature of transactions that go on... and should not be left out in the crackdown by the Reserve Bank of Zimbabwe," the writer, Sifelani Tsiko, said.

"The RBZ should shoulder the blame for failing to monitor and regulate the financial sector in the country. The mess in the sector should have been detected a long time ago and wiped squeaky clean to enhance the image and performance of the sector," he added.

Saturday, January 17, 2004

Financial Auditing in Iraq. GULF DAILY NEWS discusses the new additions to a new KPMG office in Baghdad. It is very interesting to me how easy it is to forget that Iraq has businesses that function not only locally, but in the global economy. I wish these five new auditors nothing but the best in their rebuilding process.
FIVE Iraqis have a new start in life, after being brought to Bahrain for training at a financial advisory firm. KPMG has opened an office in Baghdad and began recruiting for auditors three months ago....

"They have been caged by the world and Saddam for the last 18 years and we feel it is our duty to try to give them the opportunity to increase their understanding of the financial and accounting world."...

Mr Al Adhamy said that two managers had already been selected for the Iraq office and the company was aiming to employ 20 more Iraqis by June. The company also hopes to create jobs for 150 Iraqis within the next two years.

Thursday, January 15, 2004

Intangible Assets. This is a article from Dec 30, 2003 discussing CFO's addressing intangible assets; in this case intellectual property.
Hidden Treasures - Even with new accounting treatments, financial systems don't allow companies to say much about their intangible assets. Finance chiefs are finding ways to address this conundrum....

The frustration now is that even after new international financial reporting standards (IFRS) go into effect next year, HIT's financial statements still won't be able to convey the value of its biggest assets—the brand ownership of Bob the Builder, Barney the Dinosaur, Angelina Ballerina and a host of other characters popular among pre-school children around the world....

But can finance chiefs rise to the challenge to bring intangibles into sharper focus? The jury is out, amid plenty of debate within finance circles on how—and even whether—it can be done.

USA Today reports although strong quarterly earnings were reported from Intel, Yahoo, and Apple from their financial statements Wednesday — their stocks tumbled in after-hours trading on the news due to an anticipated tech rebound.
"Yahoo said it earned $75 million, or 11 cents a share, compared with $46.2 million, or 8 cents, a year earlier — exceeding analysts' predictions by a penny.

Revenue more than doubled to $664 million, including some revenue sharing with partners. Helping it: online ad sales from its acquisition of Web advertising-driven search engine Overture Services and fee-based subscriptions. Yahoo has 5 million paying customers, compared with less than 500,000 two years ago. Yahoo and Sina, China's largest Internet portal, also announced an agreement Wednesday to create an auction service.

Yahoo expects revenue of $2.12 billion to $2.25 billion this year — in line with analyst forecasts, according to Thomson First Call. Shares of Yahoo dipped 4% to $46.55 in after-hours trading."

Wednesday, January 14, 2004 has a great article on some "tricks" that companies can use to make their financial statements look better to potential investors.
There are more than a few ways to make financial statements look pristine when earnings season comes around. In this article we're going to take a look at two things that always seem to catch investors: "one-time charges" and "investment gains."

Rod B.

Cost Principle. Soccernet from the UK's Daily Mail newspaper has an interesting article about the finances of German soccer club Borussia Dortmund. In particular it points out the problem with historical cost accounting. Dortmund paid a huge amounts of money for players that are still listed as assets at the price they were bought. However, since the collapse of the price European TV companies are willing (and able) to pay for soccer the price of these player's contracts has fallen through the floor.

...Moreover, while Dortmund claimed they are in no financial trouble, they did not challenge any of the figures brought forth. And on the next day, an analyst for the Deutsche Bank, whose job is to evaluate Borussia's shares, declared that while the situation was 'serious' it was 'not dramatic' because 'the squad is worth 150m euros and if Dortmund need money, they can sell a few players'.

Excuse me, but which planet is this analyst on? First, who told him that the squad is worth 150m euros? (The club, that's who.) Second, who's going to pay any real money for a bunch of underperforming players, half of whom are currently down with serious knee injuries? gives a report on the evolution of accounting fraud and the changing technology used to fool auditors.
Back in the 1960's the fraudulent growth story destined to get the most attention was that of Equity Funding. It was a Wall Street darling with a concept that seemed ever so clever: It sold mutual fund shares to investors, and then allowed them to borrow against the value of the funds to purchase life insurance.......By the early 1980's, it was ZZZZ Best that showed how easy fraud could be. That carpet cleaning company was started by a 16-year old who wound up with stock worth more than $100 million after his company went public.........Then a copier was used to produce documents good enough to fool the trusting auditors. They sent requests for confirmation to the addresses listed on the statements...........Is it too much to ask that the auditing firms come up with a foolproof way to assure that bank accounts are real?

MSNBC reports former Enron finance chief Andrew S. Fastow and his wife have agreed to plead guilty for their roles in a massive accounting scandal in 2001.
Andrew Fastow, who was indicted in October 2002, is charged with 98 counts of insider trading, fraud, money laundering, tax violations and others for allegedly running a complicated web of partnerships and financing methods that hid debt, inflated profits and funneled millions of dollars to him, his family, friends and colleagues.

His wife is charged with six counts of conspiracy and filing false tax forms. She is accused of helping her husband make one partnership appear independent of Enron so the company would continue receiving related tax benefits.

Tuesday, January 13, 2004

The New York Times reports that Adecco has some accounting internal control issues and is wary to be compared to Parmalat. Parmalat is currently being investigated for accounting fraud.
An Adecco analyst in London said he had also been in touch with company executives.

"The main focus (Adecco) are pointing people to is that the issue is with their controls not with anything they have reported,'' the analyst said. Dresdner Kleinwort Wassterstein (DrKW) analysts upgraded the stock to "buy'' from "sell'' after Adecco's discussions with brokers.

The "suggestion is that auditors imposed more stringent criteria for 2003 vs. 2002 and Adecco internal controls were not able to provide the requisite information,'' DrKW said in a note.

BusinessWeek Online details the possible effect that the potential activation of new International Fiancial Reporting Standards in 2005 will have on businesses, primarily within Europe. Perhaps this article relates inpart to the concept recently discussed in class which was identified as the "cost principle," which is the idea that assets shown on a balance sheet should reflect their expense to the company, not their current value.
The new rules are part of a decade-long international effort to harmonize financial reporting around the world. They're meant to prevent Enron-style scams by requiring companies to incorporate in their own books the financial results of entities that they control. But unlike in the U.S., the new rules make no distinction between large multinationals with operating subsidiaries and private-equity funds -- financial companies that invest in startups or leveraged buyouts with the idea of selling out later at a profit. "If you control it, you consolidate it -- no ifs, ands, or buts," says Wayne Upton, research director for the London-based International Accounting Standards Board (IASB), the group writing the new standards. The European Union is committed to adopting IASB rules, and eventually they're supposed to converge with America's Generally Accepted Accounting Principles.

Problem is, conglomerates and private-equity firms are different types of businesses. If the accounting rules stick, experts say, financial reports from private fund managers will simply lump together all the losses and all the debts of the companies in the fund, rather than telling investors how much their stakes are estimated to be worth at the moment. The new rules "remove the very information investors most want to see," says Les Gabb, a partner with Advent Venture Partners in London. "It makes them practically useless."

The Cincinnati Enquirer reports although gift card receipts are higher this year than ever before, the sales cannot reflect earnings.
Retailers can't book gift-card sales until the cards are actually used, under generally accepted accounting principles, which means most cards that were purchased as gifts before Christmas haven't shown up as sales.

"Approximately 85 percent of all gift-card usage occurs within the two weeks following Christmas,'' said Mike Brewer, a spokesman for Louisville-based Stored Value Systems Inc., one of the nation's leading providers of gift cards and gift-card services.