Stock Options. Let the games begin! On Wednesday FASB published the exposure draft of its proposed standard for how companies should account for stock options that they pay to employees as compensation.

The proposal has two main elements: that publicly traded companies be required to use a fair-value method of valuing options from the date they granted to employees, and that the value be subtracted as a business expense on companies' income statements. At present, the cost of stock options must be estimated only in footnotes that append federal filings, where employers are allowed to use a much simpler technique than fair value to reckon the cost.

Bonds. TheStreet.com reports that deal-seeking bond investers typically receive the lowest prices on high yield bonds when shopping early in the year. Those who waited until later in the year found themselves facing investors who were running from their 10-year Treasurey note. Some analysts believe that high-yield bonds, or sometimes called junk bonds because the corporate debt is considered to be a higher credit risk, are "priced to perfection". Currently, the difference between high-yield bonds and treasurey bonds is 4.39%. This asks the question of whether investors are willing to take the extra risk for such a small percentage.

Market Efficiency. In class we briefly looked at the Iowa Electronic market that covered the democratic nomination process. Now, the Instapundit is linking to the Iowa Electronic Market that represents the Kerry vs. Bush presidential election and notes that despite a bad week for Bush, his stock price is edging higher.

Market Efficiency. Anomalies in the Efficient Market Hypothysis Good article talking about the anomalies in EMH.

Despite strong evidence that the stock market is highly efficient, there have been scores of studies that have documented long-term historical anomalies in the stock market that seem to contradict the efficient market hypothesis. While the existence of these anomalies is well accepted, the question of whether investors can exploit them to earn superior returns in the future is subject to debate. Investors evaluating anomalies should keep in mind that although they have existed historically, there is no guarantee they will persist in the future.

[Rod Buxton]

CFO.com The author of this article believes the difference in accounting practices as directed by the FASB and the international counterpart, IASB, are minimal. As a result, international standards for accounting may soon become standard practice. [Ted Leithart]

Merger aids Millennium Stock. Reuters reports that Lyondell Chemical Company will purchase Millennium Chemicals Inc. "for $1 billion in stock, creating the No. 3 North American chemicals producer as the industry appears poised to rebound from a five-year downturn." The merger is the result of a failed merger, Equistar Chemicals LP. Lyondell will assume about $1.3 billion of Millennium net debt.

"Millennium has undergone its share of problems, including a suspension of its dividends, job cuts, a restatement of results stemming from accounting errors and noncompliance with some of its financial covenants.

With news of debt relief, and hopes of accounting errors in their past, stockholders are investing with hopes of future cash flows and dividends.

Restatements. Forbes.com reports that Key Energy (a Midland, Texas based oil well services company) is planning on restating last years results to correct mistakes regarding writedowns causing shares of Key to drop.

Key Energy said it believes $5 million of goodwill and other intangible assets from a 2003 acquisition by the company's South Texas division should have been charged to earnings. It said the value of the acquired business was misrepresented by employees involved in illegal activities at the unit.

The company also said it began civil litigation against the former employees and some third parties in an effort to recover its losses.

Stock-Option Accounting. The Star Ledger argues that incredible inaccuracies would result from companies being forced to deduct stock-option costs from earnings.

Companies now don't have to record the cost of options as an expense on their income statements. Instead, they must include the potential cost in a footnote. The Financial Accounting Standards Board, the U.S. accounting rulemaker, tried a decade ago to mandate expensing from earnings, but it eventually backed down to pressure from Congress and the technology industry. Now, because of all the recent corporate scandals, the FASB is taking on the issue again and is expected next week to release a draft of its new rules.

Disclosure. Money.cnn reports that the SEC is investagating two former Putnam managers, who were charged with civil fraud during the fund scandal, due to their lavish compensation in 2000. They are also considering new regulations that would require additional disclosures of information, such as how pay is tied to fund management.

Robin Thurston, global research director at fund-tracker Lipper Inc., said that the disclosure -- among the first in what could be many in various court proceedings in the mutual-fund scandals -- could spur calls for more disclosures of fund-manager pay. The SEC is now considering rules that would require more information, such as how pay is tied to fund performance, but not dollar amounts. The agency argues that overall management fees paid to a mutual fund represents enough dollar disclosure. For the most part, the industry agrees.

Financial Fraud. Bloomberg.com reports that irregularities found in Mayflower Corp.'s accounting records have caused the share price to plummet.

Shares of Mayflower Corp. Plc, the U.K.'s biggest busmaker, plunged 32 percent after accounting irregularities were found at the TransBus International division and Chief Executive John Simpson and Finance Director David Donnelly quit.

The irregularities relate to "delays in passing on payments from customers to one of the group's finance providers'' and will raise the company's net debt "less than'' 20 million pounds ($36 million), Mayflower said. PricewaterhouseCoopers LLP is carrying out an investigation.

An article in TIME this week reports on the changes due to the new Sarbanes-Oxley act passed in 2002. The Act has given accountants real clout and has increased their revenues due to audit fees 38%. The Act also created a new agency called the Public Company Accounting Oversight Board, which checks the accounting firms' work. It also prohibits auditing firms from selling lucrative strategic consulting services to the entities it audits, eliminating the age-old conflict-of-interest.

The Accounting Web Reports Treasury Issues Accounting Method Change Procedure.

The Treasury Department and IRS issued a revenue procedure that sets forth the exclusive administrative procedures that taxpayers must use to obtain automatic consent to change to their methods of accounting under the recently issued regulations on capilatlizing costs incurred in acquiring or creating intangible assets. Several companies switched following the January 2002 issuance of advance notice of proposed rulemaking and did so without the Commissioners consent. Those taxpayers will not be eligible to use these procedures until their ammend their prior federal income tax returns to correct their unauthorized charges.

Posion Pills. The so called poison pills are generally used to make a hostile acquisition more expensive, either by triggering the issuance of new shares or by allowing investors to sell shares at a premium. However, recently many shareholders are rejecting the idea of poison pills because most believe that this gives too much power to boards as they have the ultimate right to trigger a pill without shareholder approval. A few years ago, Disney announced a decision to abolish the poison pill and many companies are following suit.

Since January, several companies have moved to abolish their poison pills, including Raytheon, Circuit City Stores, FirstEnergy, PG&E and Goodyear. However, John Keefer, partner at corporate law firm King & Spalding, believes it would be a mistake for companies with poison pills in place to scrap them. "Although there has never been a case where a poison pill has been triggered, they can deter someone from making a creeping takeover without paying a premium."

Off-Balance Sheet Financing. Accountingweb reported that SEC will closely scrutinize Off-Balance-Sheet Disclosures after it was once abused by Enron to hide debt and overstate profits.

In the past, companies have not been required to report how their current or future financial conditions might be affected by off-balance-sheet arrangements, which often involve entities formed to diversify risk and issue securities, leasing arrangements and other contractual obligations, the Journal reported.

Companies are beginning to report on their connection to an unconsolidated entity, including nature, size and amount of risk in SEC filings, but studies have shown that not all companies are embracing the requirements.

Auditing. Behind wave of corporate fraud: A change in how auditors work. Auditors have to reassess how they perform audits. How deep do they look for errors or crooks. They asses this by how honest they think management is in that particular year. This is what got them in trouble at WorldCom, Health South and Tyco. Some hid the dishonesty in many little low dollar entries while others just made big last minute additions to the books. The bottom line is how to catch dishonest people without spending a fortune on the audit process.

"just because an accounting firm says it has audited a companies numbers doesn't mean it actually has checked them."

"The sole documentation for one $239,000,000 journal entry, recorded after the close of the 1999 fourth quarter, was a sticky note bearing the number"$239,000,000" according to the WorldCom audit committee's report. Sometimes the "top side" adjustments boosted earnings by reversing liabilities. Other times they reclassified ordinary expenses as assets, which delayed recognition of costs. Other unsupported journal entries included one for precisely $334 million in July 2000, three weeks after the quarters books were closed. Another was for exactly $560 million in July 2001.

The Cincinnati Enquirer reports that Fifth Third Bank is now able to acquire other banks and branches. They haven't been able to for the last year due to federal regulations. It also goes into detail about what Fifth Third had to do to maintain compliance, including accounting procedures.

The agreement called for Fifth Third to solve internal accounting errors and improve risk-management processes, and forced it to take a $54 million charge in 2002.

Disclosure. MSN's Slate magazine describes the beginning of 'annual report season' and the impact that recent corporate scandals are having on companies' disclosures.

American investors are about to be buried in paper. Annual report season is officially underway and this year is shaping up to be a contest of big, bigger, biggest. The encyclopedic reports are corporate America's showy response to the recent spate of business scandals. Their girth declares: Look how honest we are! But what's amazing in the new round of reports is that they often reveal the seamy, self-dealing, overpaying practices that created the scandals to begin with.

Stock Options. Shareholders want tech firm to change accounting. Recently, shareholders voted that Hewlett- Packard start subtracting the cost of employee stock options from its reported profits. This is one of the biggest losses experienced by a technology company in the growing war over expense options. While other industries are suffering comparable defeats, tech industries are taking the biggest hit because of their widespread use of options.

H-P, the second-biggest computer maker after IBM, would have reported extra costs of $2.3 billion over the past three years if it had been required to expense options, according to footnotes to its accounts. That would have left it with combined profits over the same period of only $212 million, rather than the $2.5 billion it actually reported. Calling on shareholders before the meeting to reject the proposal, H-P said that it already gave enough information in the footnotes to its accounts to assess the cost of options.

EU proposes crackdown on auditorsWith the recent corporate scandals involving European firms Parmalat (Italian food giant) and Royal Ahold, European Commission is considering stricter standards for auditing firms. This proposal which may be adopted by the EU Parliament by mid 2005, will not only comply with the current U.S. laws but will also have stronger impact on auditing firm's criteria and directive. For example, group auditor will be completely reponsible for the consolidated accounts.

Auditors are our major line of defense against crooks who want to cook the books," said EU Internal Market Commissioner Frits Bolkestein. "Parmalat was a reminder of what happens when that defense fails." While "no one is naive enough to think any directive will stop accounting fraud at a stroke," Bolkestein said the rules would "inject more rigor and a stronger dose of ethics into the audit process."

Contingent Liabilities. MSNBC provides a good example of a contingent liability Microsoft must disclose on their 2004 annual report. The fine amount could have a significant impact on their future value if their appeal is unsuccessful.

"The European Union declared Microsoft Corp. guilty Wednesday of abusing its "near monopoly" with Windows to squeeze competitors in other markets and levied a record fine of $613 million (497.2 million euros)."

The SEC Charges CMS Energy Corp. and Three Former CMS Executives with Fraud in Connection with Over $5 Billion in Round-Trip Energy Trades.

The Securities and Exchange Commission announced a settled fraud enforcement action against CMS Energy Corporation (CMS), a Michigan-based energy company, in connection with over $5 billion in deceptive round-trip energy trades - massive pre-arranged trades that, despite lacking economic substance, grossly inflated CMS's reported revenues and propelled the company into the upper echelon of the energy-trading volume rankings.

Restatements and Audit Fees. Sarbanes-Oxley made it illegal for accounting firms to provide both auditing services and consulting services to the same company. The lawmakers' concern was that auditors may be reluctant to question management's accounting for risk of losing the lucrative consulting jobs. If these arrangements led to subpar audits, then perhaps we'd see a connection between non-audit fees and companies having to restate their financial statements. Yet, a recent study found this was not the case...

In comparing companies that restated their financials with matched controls that did not, the authors found no correlation between restating financials and paying nonaudit fees. Neither the volume of nonaudit fees, nor the ratio of audit-to-nonaudit fees, nor the total of all fees paid to the auditor by the company shows any relationship to restating financial reports.

Stock Options. The San Jose Mercury News recently reported that change is on the horizon for the stock option reporting structure.

Any day now, accounting rule-makers will propose that companies must subtract the cost of stock options from their profits, a change that would force technology companies across America to erase billions of dollars in profits. No place would feel the impact more than Silicon Valley, where companies dish out generous stock options to executives and rank-and-file employees alike.

Business Week reported on February 10, 2004 that 3M's dividends increased, and that according to Standard and Poor's there were expectation about its future cash flows, which is reflected in the stock price.

3M raised its quarterly dividend to 36 cents from 33 cents. S&P notes this is the 46th straight year of dividend increases by the company, and that this 9.1% hike brings the 10-year growth rate for 3M's dividends to an above-average 4.6%, compared with 2.4% for the S&P 500. S&P continues to believe that the company will post strong free-cash flow growth and returns on equity, given its focus on cost control and balance sheet maintenance. S&P is maintaining the $83, discounted cash-flow-based 12-month target price.

Wall Street Journal reports that top executives at Putnam Investment Group knew of improper trading in 2000 and did not report it.

The report, whose results are expected to be released Tuesday, also found that the extent of improper trading at Putnam was broader than previously disclosed. About 40 current and former Putnam Investments employees were issued warnings about rapid trading in the company's own funds between 2001 and 2003, the report said. John Hill, chairman of the Putnam funds board of trustees, said the 40 employees who engaged in rapid trading represented a very small number of the 12,700 current and former workers whose records were examined over the past five years.

Unearned Revenue. The Cincinnati Enquirer reported that the Maisonette might move out of downtown, which sucks for us folks who bought houses near downtown. Sorry for the op/ed there. :) Although it doesn't state the accounting piece of it explicitly, I found an accounting practice at work in real life: "He's [the owner] even turned to his own customers for help by asking they pay thousands of dollars upfront for future meals to help fund an expansion that would include a concert hall and a bistro. But after collecting more than $1 million from customers, he scrapped that plan. Customers can still collect their meals." This would be counted as Unearned Revenue and would be done for Cash Flow reasons.

A Market for Terrorism? Per discussion in class, The Wired News reported the idea for the terrorism futures market that made headlines last summer. It makes implicit references to the Efficiency principle and even mentions the Iowa Futures Market. Joyce Berg, a University of Iowa professor who helped organize the political trading floors, says that exchanges "tend to predict events really well when no one person knows the answer -- when information is distributed among many people with different knowledge bases.... Markets have been shown to be really good at aggregating that information."

See also, this article from Reason magazine which argues that these markets would have provided useful information

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.

Business Week reports that on June 30, 2003 Kodak had a debt mounting up to $2.99 billion, which has to be cut down to reduce risk.

On Sept. 25, 2003, Standard & Poor's Ratings Services lowered its long-term and short-term corporate credit ratings on Eastman Kodak (EK ) to 'BBB–' and 'A-3' from 'BBB' and 'A-2', respectively, and removed them from CreditWatch. The current outlook is stable. The Rochester, N.Y.-based photography company had $2.99 billion in debt on June 30, 2003.

The downgrades reflect concern about Kodak's earnings and business profile due to declining prospects for its core conventional imaging businesses as these markets transition to digital technologies; doubts about the profit potential of digital imaging relative to conventional photography; and the need to reduce debt which remains elevated given Kodak's rising business risk and investment strategies.

Forbes reports on a new book by Chris Zook which notes howto evaluate stocks with the right growth strategies. Considering the evaluation concepts we are undergoing in class at this time, I thought Mr. Zook's insight may offer some additional advice on a healthy investment strategy.
[Ted Leithart]

Forbes says that Shell is denying reports that its auditor has refused to sign off on their accounts due to quality of information given. Shell states that the delay has come from the revision of their reserve data. Shell has cut their reserves by 250 million barrels in 2002 and 220 million in 2003. These are significant blows to investor confidence as Shell has cut their reserve inventory twice this year.

Big Four Accounting Firms support the FASB. PricewaterhouseCoopers (PwC) along with other "Big Four" accounting firms sent a joint letter to Congress that supported preserving the independence of the FASB in its ability to establish accounting standards.

The firms issued the letter in response to the bills proposed in Congress that reccomendded legislation for the accounting of stock options. in looking at a copy of the letter in its entirety, PwC and the other signatories reaffirmed thier support of the mandatory expensing of all employee stock options whose fair market value would be detemined in a manner suitable to the reporting company. The companiies assert that the independence of the FASB and Congress' history of not imposing its judgements on the FASB 's standards have been critical to the effective operation of capital markets. They maintain in thier letter that the FASB's standard-setting process include seeking the perspective of all participants in the capital market- individual investors, institutional investors, the SEC, etc... and that this process should continue without the interference of Congress.

Intangibles. "You're Fired" could become Trump trademark. This article shows the significance of intangible assets such as trademarks.

"Donald Trump is hardly the first boss to utter the dreaded words, “You’re fired!” But he just might be the first to realize the commercial potential of the expression."

Trump has made a career out of using his image to sell high-end real estate, plastering his name on luxury hotels, casinos and condominium towers. In Manhattan alone, well-heeled and status-conscious buyers can find shelter at Trump Tower, Trump World Tower, Trump International Hotel & Tower, Trump Park Avenue and others. If Trump wins the trademarks, he would have a tool to block others from marketing clothing with the phrase “You’re fired,” just as Nike has done with its trademarked advertising phrase “Just do it,” Kayden said.

Novartis considers bid for Aventis. This article presents a unique case of two significant pharmaceuticals players potentially bidding for a merger with Aventis and its impact on market shares.

Booty currently estimates there is a 10 percent chance of Aventis remaining as a standalone company, a 30 percent chance of a white knight bidder taking it over and a 60 percent chance of Sanofi prevailing with a higher offer.

There were market rumors in Paris, Zurich and London on Thursday it was considering offering 0.9 of its shares plus 35 euros in cash for each Aventis share, or roughly 67 euros per share. Sanofi's stock-and-cash bid, which has been rejected by Aventis, is currently worth around 47.3 billion euros ($58.16 billion), or 59 euros per Aventis share. That combination would create the world's third-largest drug firm. Novartis investors nervous Initial reaction to Novartis's statement was negative, amid concern over the price of a potential deal and the risk overall sales growth might slow, and the group's shares fell 0.5 percent to 54.10 Swiss francs, following heavy losses on Thursday.

This CFO.com article says that finding new ways for companies to increase revenues is becoming harder. Chris Zook, director of the global strategy practice at Boston-based consulting giant Bain & Co provides imput.

Zook, who advised companies to perfect their knitting in his previous book, Profit from the Core, explains how to expand into new markets in his new book, Beyond the Core. He says a company can combine high growth and low risk by moving systematically into "adjacencies"—products, services, geographies, or customer segments that are highly related, or adjacent, to the company's core business.

Thus, by retaining core competencies, companies can leverage their strengths and drive revenue growth. [Ryan Rebholz]

Tax Me If You Can The link takes you to a program called FRONTLINE on PBS. The topic of this one was accounting and the use of tax shelters. From this site you can read the transcript, watch the program online, and find links to related readings.

The huge firm KPMG is a big focus in the program and it mainly pertains to unethical use of tax shelters in accounting for corporations. Some instances companies were showing huge losses, while in reality they were very profitable.

Veritas Restates Three Years of Results Veritas Software Corp. announced that it will restate its financials for the past three years as a result of an internal investigation, reported Reuters.

The probe uncovered accounting practices not in compliance with generally accepted accounting principles during 2002, 2001, and prior periods. According to the Associated Press, these practices — which included the incorrect deferral of professional services revenue and the unsubstantiated accrual of certain expenses — produced inaccuracies "that also spilled over into 2003."

Stock Options. CFO.com reports that a new valuation model could dampen the controversy over expensing employee stock options.

The continuing brouhaha over a new accounting rule that would require expensing of employee stock options could amount to a tempest in a teacup, if a new valuation model is embraced by regulators and proves to be as accurate as advertised.

CFO.com reports that Bristol-Myers Restates Last Five Years. Drug maker Bristol-Myers Squibb Co. announced that it revised its fourth-quarter 2003 earnings upward, from $429 million to $506 million, and raised revenues, from $5.6 billion to $5.7 billion, to correct accounting errors.

This article talks about how during the Iraq war, inventory was being accounted for using a "just in time" or "urgent operational requirement" method and this made the actual supplies getting to the soldiers harder to track. If you read the link, you'll see that this all came about because a British Soldier was shot when he had to give up his body armor to another soldier viewed to be in more danger. The shortages ranged from clothing to ammunition.

Big Four accounting firm PwC has dropped Gateway Computer as an audit client. Possible reasons for dropping Gateway are questions about fees. Or, questions about management's integrity or ability to produce accurate financial statements.

In April 2003, the company had to delay its 2002 annual report because it needed to restate 2000 and 2001 revenue and costs of goods sold.

However, in a press release issued after the close, Gateway denied that it disagreed with PwC "on any matter of accounting principles or practices, financial statement disclosure, or auditing scope or procedure."

CFO.com reports that the SEC has proposed ammendments encouraging companies to switch their accounting to the International Financial Reporting Standards.

The proposed amendments would apply to companies that publish IFRS financial statements for the first time for any financial year beginning no later than January 1, 2007. Any company that adopted IFRS would be required to show how previous disclosures differed from the international standard and how the company reconciled its previous system of accounting to IFRS.

Business Week reports that tech companies have continued to invest unprecedented amounts in research and development even though demand has been stagnant until recently.

COST IS KEY. The payoff could be big for both chip companies and their consumer-electronics customers. To help them lower prices and spur sales, companies such as Sony (SNE ) are counting on the traditional price reductions of about 25% a year for most chips -- and bargaining hard with suppliers when they don't get more.

The New York Times reports that Britian's top market regulator is joining the US's SEC and Dutch regulators in an informal investigation of the restatement of Royal/Dutch Shell Group's proven reserves of oil and petroleom in January

The pressure on Shell and on its board and executives is unlikely to let up any time soon. On Friday, the company is to publish its annual report, which will disclose the amount paid to the former chairman, Sir Philip Watts, and the head of exploration and production, Walter van de Vijver. If either were given performance-related bonuses or raises in 2003, investors are expected to be highly critical.

The two executives were asked to leave on March 3, after a preliminary board investigation into the reasons Shell decreased its estimates by 20 percent. A series of internal memorandums obtained by The New York Times shows that Shell executives knew of the reserve discrepancy as early as 2002, but opted not to disclose the problem to investors.

Look for Shell's stock to fall throughout the investigation due to increased risk to investors.(Ryan Rebholz)

Cincinnati Business Courier discusses how reverse mortgages make the largest financial investment for most people pay off for retirees.
submitted by Ted Leithart

This CFO.com article discusses the process of having to go back and re-state or re-work a company's financial statements. The article details the effect that such changes can have on past statements as well as the SEC implications that can be involved.

As a result of this work, Nortel is reviewing accruals and provisions of prior periods, which will likely require it to revise its results for the 2003 calendar year, several of its 2003 quarterly reports, and financial results for prior periods, according to the company. Given the volume and complexity of the work involved, company management can't predict when the review will be completed, Nortel stated.

The Falling Dollar. The NY Times notes that the falling value of the dollar is responsible for a significant portion of some companies' increased revenue numbers.

The Ingersoll-Rand Company, the equipment maker, had an 11 percent increase in revenue in 2003; over one-third of that gain resulted from currency translation. And at Caterpillar Inc., half of the 8 percent growth in machinery sales volume and more than half the increase in engines sales volume were currency-related.

The author suggests this may explain why U.S. companies aren't expanding their workforces as much as would be expected to support such increases in sales.

CFO.com reports that the Securities and Exchange Commission (SEC) said a former CFO and a former chief accounting officer were responsible for a fraudulent scheme to overstate earnings by "hundreds of millions of dollars" at a former subsidiary of Conseco.

Wall Street Journal wsj.com Friday March 12,2004:MCI to state fraud was $11 billion
The total accounting fraud will reach over $11 billion because the company has reversed many of its past accounting practices. Current expenses booked as capital spending.

"The telecommunications titan is expected to provide audited financial results for 2000,2001 and 2002 that will reveal the full extent of the largest accounting fraud in U.S. history"

"Mr. Sullivan,facing a possible sentence of as much as 165 years, pleaded guilty last week to illegally manipulating the books. Much of the fraud was committed by moving routine expenses, which are deducted immediately from earnings, into capital spending, which is deducted in stages over long periods."

" Aside from the accounting fraud,MCI has said it plans to write off nearly $80 billion of the $107 billion in assets it had on the books when it entered chapter 11 protection. The value of the assets was inflated by the over heated market for telecommunications, which put to high a value on the company's network and encouraged WorldCom to overpay for many of its nearly 70 acquisitions."

Revising the Books Dogs U.S. Companies - This article from Reuters discusses the increase in the number of companies restating their earning due to tougher questioning by internal auditors and increased regulatory pressures.

"Financial restatements and earnings revisions continue to dog Corporate America and experts say the trend will continue as executives and their accountants rush to clean up past messes. There have been at least 60 instances this year where companies have had to either restate their earnings or have been summoned by regulators to clarify published numbers, according to Reuters Research. Last year, 70 companies restated their earnings in the first quarter of 2003, up from 56 for the same period in the previous two years, a study by Huron Consulting, which tracks restatements of half-yearly and annual results, showed. The reasons for restating earnings statements have more or less remained the same -- varying from overly aggressive accounting, to changes in internal policies, to miscounting."

Forbes has this article that states the debate over expensing options has not focused on the right issue.

The granting of share options "became popular when there was a general feeling that you should align the interest of management and the performance of the firm," said George Perry, a senior fellow in economic studies at the Brookings Institution, a Washington, D.C.-based think tank.

But, he added, "the question is whether you provide the wrong incentives to companies and the people who receive the options."

In the WorldCom and Enron scandals, Perry noted, executives misled investors about their companies' financial performance to buttress the company's stock price -- and by extension the value of their own options.

The article also discusses the two most popular methods of calculating the value of stock options in financial statements.

CFO.com Reports that Goodyear Disciplines Managers in Europe

The tire maker also expects to restate its financials for the third time in six months, largely as a result of an understatement of four years of workers' compensation claims. The world's largest tire company also found added accounting problems in its U.S. operations that will probably result company's third restatement in six months. The company expects to adjust its operating earnings downward by $16 million over five years and a cut in shareholders' equity as of September 30, 2003, of about $23 million, according to a Goodyear release.

CFO,com Repots that the Public Company Accounting Oversight Board (PCAOB) has approved new Sarbanes-Oxley Act rules governing how accounting firms will audit their clients' internal controls when reviewing their financial statements.

Under Section 404 of Sarbox, the management of a public company must assess the effectiveness of the company's internal controls over financial reporting. The section also directed the PCAOB to produce professional standards governing independent auditors' testing of and reporting on managements' 404 assessments.

The economist reports the economic recovery is nothing more than a manipulation of the money supply by the Federal Reserve and questions not the way in which the Fed creates money (by fiat), but is concerned on the vast expansion of the money supply in the last few years. With no external auditors or accounting regulations to control the Federal Reserve, they have increased the money supply so rapidly that the interest rates have plummeted.
My personal concern is not the quick expansion of the money supply, but that very few seem concerned over the lack of any fiscal or considerate restraint.

CFO.com reports that cleaning up year-end cash flow balance sheets can cause problems.

Reducing payable, receivable and inventory accounts is a simple way to reduce working capital and, in-turn, have the cash-flow statement seem more desirable to investors. Even though companies are praised for having a consistantly low capital, a study by CFO magazine reports that working capital drops in the last quarter of the fiscal year and drastically rises once the annual report is released.

This drastic change can be very misleading, considering that most investors consider cash-flow to be very reliable resource. This year end scramble to improve final quarter reports suggests that companies could do a better job managing cash-flow year round.

Goodwill. A CFO.com article discusses goodwill impairment charges and investor reactions.

The impairment exam is a two-step process that first tests to see if existing goodwill is impaired and then determines the size of the impairment. One indication that a company's goodwill may be impaired is that the intangibles on the company's books greatly exceeds its market capitalization.

CFO.com reports that the SEC is increasing its focus on large companies, in an effort to bring financial fraud to the surface.

Susan Markel, SEC Enforcement Division chief accountant, said over the weekend that the regulatory agency is bringing more financial fraud cases against big-name, Fortune 500 companies. For example, last year the SEC brought 199 financial cases, and 34 of them involved Fortune 500 companies, or 17 percent of the total. That compares favorably with the total of 79 financial fraud cases in 1998. Only four of those cases — just 5 percent — involved the 500 largest companies, according to the report.

The AccountingWeb reports that U.S. Multinationals Make Sweeping Changes in Corporate Governance.

The relationship between management and boards of directors at U.S. multinational companies has been changed dramatically through an array of corporate governance initiatives begun in response to corporate scandals, the Sarbanes-Oxley Act, and other requirements.

''Boards and audit committees at large corporations have responded actively to the call for change and have accomplished a lot,'' said Garrett Stauffer, of PricewaterhouseCoopers' U.S. corporate governance practice. "We expect the increased attention and focus on governance will continue."

An agency problem reported in USA Today between a legendary investor Warren Buffett, CEO of Berkshire Hathaway and his mutual fund directors.

Buffett chastised fund directors, who also were his targets in Berkshire's 2002 shareholder letter. Mutual fund directors are supposed to look out for shareholders' best interests. They also hire the companies that manage a fund's assets. So far, no fund's board of directors has terminated management contracts with any of the companies caught in the mutual fund trading scandal, he says.

Buffett offered a suggestion to make fund governance stronger: He would require directors to affirm that they have looked at other management companies to run the fund and that their current choice is one of the better ones available. He'd also ask directors to affirm that they have negotiated management fees comparable to similar funds.

The Street reports that even though Cablevision had gains last year, now it is going through a loss. One of the aspects explaining this situation is that the last year gains considered the sale of one of the company assets, the Bravo Network, which is not related to the operating activities.

Cablevision Tuesday reported a fourth-quarter loss and missed analysts' expectations. The company had a net loss of $197.4 million, or 69 cents a share, compared with a profit of $529.8 million, or $1.66 a share a year ago, which reflected a $2.15 a share gain from discontinued operations, including the sale of its Bravo TV network. Analysts had forecast a loss of 45 cents a share, according to Thomson One Analytics. Revenue rose to $1.23 billion from $1.09 billion a year ago. Operating income fell to a $46.2 million loss from a $70.6 million gain in the year-ago quarter, primarily because of "costs associated with the company's direct broadcast satellite service.

Former Chairman at Shell was told of issues [link not working]

"A memo, circurlated to Sir Phillip Watts and other senior executives in early 2002, warned that the companies method of booking oil and natural gas reserves appeared to be inconsistent with U.S. Securities and Exchange Commission guidelines, these two people said."
"On Jan. 9, the worlds third-largest publicly traded oil company by market value announced it would cut its oil and gas reserves by about 20%, or 3.9 billion barrels of oil equivalent."
" Just taking the oil portion, the reclassified reserves represent $67.5 billion of potential future revenue, assuming moderate oil prices of $25 a barrel.
The reserves serve as a key gauge of an oil companies future value and are watched closely by analysts and investors. U.S. accounting rules provide specific guidance when companies can book "proved" reserves.

Forbes.com reports that several banks have taken significant charges for impairment of their mortgage-servicing rights. Countrywide Financial Corp profit nearly tripled in 2003 to $2.4 billion on $8.5 billion in revenue.

Key to the profit figure was Countrywide's ability to count future mortgage-servicing income as income today. Countrywide's 2003 earnings release shows $6.1 billion in gains from the sale of loans and securities.

These gains, by and large, do not take the form of cold, hard cash. Instead they represent mostly prospective future profits from servicing mortgage portfolios. Counting future servicing revenue is perfectly legal in the mortgage industry, but it involves a certain amount of guesswork, and sometimes those guesses prove to be too optimistic.

FASB stock option rules subject to House rules www.accountingweb.com Should RSA Security Inc. be required to record 80% of their stock options their reported profits would be drastically overstated for 2003. Their reported profit of 14 million dollars would have to be restated as a 21 million dollar loss.
New rules proposals require options to be shone as an expense verses a footnote in their financial reports.

The Accounting Web reports that Merril Lynch cites some parameters to be considered when analizing corporate earnings. Furthermore, the article mentions that a high financial leverage ratio increases risk.

Four of the six measures can be calculated from historical financial statements prepared in accordance with generally accepted accounting principles (GAAP). The two remaining measures require input from Standard & Poor's. The six measures are:Pretax return on capital, Cash realization, Productive asset reinvestment, Tax rate, Common stock ranking, and Credit rating.As explained in the report, the six metrics reflect what Professor Hawkins and Merrill Lynch consider to be the six key characteristics of high quality earnings, (i.e., earnings that are earned by superior returns on total capital, close to being realized in cash, repeatable because of the level of capital invested in assets, not dependent on transitory tax rates, and not at risk because of high financial leverage and dividend obligations.)

Phar-Mor and Inventory Overstatements. In the early 1990s, Phar-Mor management inflated the company's reported earnings for several years.

Generating phony profits over an entire decade was no easy feat. Phar-Mor’s CFO said the company was losing serious money because it was selling goods for less than it had paid for them. But Monus argued that through Phar-Mor’s power buying it would get so large that it could sell its way out of trouble. Eventually, the CFO caved in—under extreme pressure from Monus—and for the next several years, he and some of his staff kept two sets of books—the ones they showed the auditors and the ones that reflected the awful truth.

They dumped the losses into the “bucket account” and then reallocated the sums to one of the company’s hundreds of stores in the form of increases in inventory costs. They issued fake invoices for merchandise purchases, made phony journal entries to increase inventory and decrease cost of sales, recognized inventory purchases but failed to accrue a liability and over-counted and double-counted merchandise. The finance department was able to conceal the inventory shortages because the auditors observed inventory in only four stores out of 300, and they informed Phar-Mor, months in advance, which stores they would visit. Phar-Mor executives fully stocked the four selected stores but allocated the phony inventory increases to the other 296 stores.

Scrubbing the Numbers - CFO Magazine - March Issue 2004 - CFO.com: "Scrubbing the Numbers. Cleaning up the balance sheet boosts year-end cash flow, but it can leave some messy problems.

The holiday season is not a happy time for many finance executives. While others attend parties and eat turkey, finance departments in companies with a calendar year-end often spend the two months between Halloween "- Girish

Extension of Compliance Dates Regarding Internal Control Over Financial Reporting Requirements

The Commission has extended the compliance dates for amendments to its rules under the Securities Exchange Act of 1934 that were adopted on June 5, 2003, pursuant to Section 404 of the Sarbanes-Oxley Act. The amendments require a company to include in annual reports a report by management on the company's internal control over financial reporting and the accompanying auditor's report.

Newswise cites research from the University of Washington that indicates companies are pumping up accruals to make them look better before a public stock offering. The swells then revert back to normal levels soon thereafter.

Our research shows that accruals are unusually large before a sale," said University of Washington accounting professor Steve Sefcik, who conducted the study with Business School colleagues Paul Malatesta and Larry DuCharme. Accruals reflect the difference between reported earnings and cash flows, and generally accepted accounting principles (GAAP) allow firms some discretion. Under GAAP, earnings numbers that corporations report to investors can differ in both magnitude and timing from the actual net cash flows that companies experience.

"Firms that manipulate their earnings prior to stock offerings deceive investors, who in turn form overly-optimistic expectations regarding future post-issue earnings," said Malatesta. "These findings strongly suggest that investors should consider the quality of reported earnings and not just their magnitude. They should read the footnotes to the financial statements, and pay attention to cash flows as well as earnings."

Earnings Morningstar.com discusses Earnings Quality.

It's important to distinguish between earnings manipulation, which is done with intent to deceive, and earnings generation from low-quality sources, which won't cause a blowup, but which is still unsustainable"

The three big areas to watch are tax rates, cost-cutting, and share repurchases. Paying less in taxes to Uncle Sam is nice and does result in more money left over for shareholders at the end of the day--but what the tax code giveth, the tax code can taketh away. Tax breaks can expire or be rescinded, and there's a limit to how low a firm's tax rate can go.

Cost-cutting is similar. All else equal, I'd rather own a more efficient firm than a less efficient one, but cost-cutting has limits. At some point, all the low-hanging fruit will be plucked, margin expansion will slow, and so will earnings growth.

Finally, we have share repurchases, which, contrary to popular wisdom, are not an unadulterated positive. Firms can keep earnings per share rising at the same time they're destroying economic value by pursuing buybacks when the shares are trading at a rich valuation. In this case, the firm is overpaying for each share, which destroys value because the future return on the investment is likely to be lower than the firm's cost of capital. Since the overall share count is decreasing, however, earnings per share keep moving up.

(Posted by P. Timmerding)

CFO.com reports that the United States IRS wants the U.K.-based pharmaceutical giant GlaxoSmithKline to cough up more than $5 billion in taxes, penalties, and interest, more than half of operating cash flow.

"The dispute involves transfer pricing—specifically, the rate Glaxo charged for marketing services supplied by its U.S. affiliate from 1989 to 1996. The IRS maintains that the rate was far too low, and thus vastly understated Glaxo's income subject to U.S. tax during that period. New rules would radically change how the U.S. tax authority treats services supplied to parent companies by affiliates in other tax jurisdictions."

"Some worry that the new rules could subject multinational companies to huge increases in U.S. taxes. Under current tax rules, transfer pricing of services can be reported at cost as long as those services are deemed not integral to the business. The proposed new rules do away with the safe harbor for nonintegral services. Instead, they require those services to be priced, for starters, at cost-plus (called the simplified cost-based method)."

An article posted on NYSSCPA.ORG from the Wall Street Journal states the U.S. is examining Coca-Cola Co.'s dealings with Japan's Takasago International Corporation.

Federal investigators in the U.S. are examining Coca-Cola Co.'s dealings with a Japanese company in connection with allegations the Atlanta beverage company overstated financial results for several years by shipping excessive beverage concentrate to Japan, The Wall Street Journal reported Monday citing people familiar with the investigation.

The Decembrist (Mark Schmitt) respondes to the article from the New York Times below by questioning the small sample size used in the study

The study does note that of the 6,000 stock transactions he tallied in the six-year period, more than half were accounted for by only four Senators: the late Claiborne Pell of Rhode Island, John Danforth of Missouri, John Warner of Virginia, and Barbara Boxer of California.

and

Ziobrowski concludes based on this method that "trading with an informational advantage is common among Senators." Yet in the first years of the study, which is when the advantage appears, only 25-27 of the hundred Senators traded stocks at all. So it is not "common," since it is actually not common for Senators to trade stocks at all.

I'm still undecided about this. If the study was on anything else I'd probably ignore it, but it is always good to have an excuse to bash US Senators!

Insider trading?

US senators' personal stock portfolios outperformed the market by an average of 12 per cent a year in the five years to 1998, according to a new study.

"The results clearly support the notion that members of the Senate trade with a substantial informational advantage over ordinary investors," says the author of the report, Professor Alan Ziobrowski of the Robinson College of Business at Georgia State University.

There was no difference in performance between Democrats and Republicans.

A separate study in 2000, covering 66,465 US households from 1991 to 1996 showed that the average household's portfolio underperformed the market by 1.44 per cent a year, on average. Corporate insiders (defined as senior executives) usually outperform by about 5 per cent.

CFO.Com has an interesting article on how companies should account for equity based compensation on their financial statements. The Financial Accounting Standard Board is being pressured to cooperate with the international views on equity based compensation, especially now that the international accounting standards board wants anyone who uses their standards to expense stock options starting in January 2005. This would upset small start up companies in the states.

"John Palafoutas, a domestic policy and congressional affairs lobbyist for the American Electronics Association, the nation's largest high-tech trade association, told TheDeal.com. We are not obligated to do what the Europeans do. They use stock options differently than we do, and we're going to keep fighting against it."