Federal Government's Financial Condition The Journal of Accountancy provides the text of an address delivered by Comptroller General of the United States David Walker, before the National Press Club in Washington, September 2003. Walker describes the issue of transparency and how the American people are given an incomplete and inaccurate picture of the government's current financial condition. Walker outlines several specific "calls to action," including the restructuring of certain entitlement programs and the streamlining of the government's organizational structure to improve efficiency and accountability.

More important, although we know that we are in a financial hole, we don't really have a very good picture of how deep it is. Several very significant items are not currently included as liabilities in the federal government's financial statements. These items include several trillion dollars in nonmarketable government securities in the so-called "trust funds." In the case of the Social Security and Medicare trust funds, the federal government took in taxpayer money, spent it on other items and replaced it with an IOU.

The bottom line is that, in my view, the federal government's current financial statements and annual reports do not give policy makers and the American people an adequate picture of our government's overall performance and true financial condition.

The article also contains an interesting epilogue that describes a recent interview with Walker since he gave the address.

Bonds and Rising Interest Rates. The NY Times gives a good explanation as to how a change in interest rates can affect the bond market.

The Federal Reserve is poised to start raising interest rates at the end of the month. Yields on the 10-year Treasury bond are climbing steadily, and bond prices, which move in the opposite direction, have been falling since March. So far this quarter, fixed income funds are down an average of 2.5 percent, according to industry tracker Lipper Inc.

The article offers advice on actions that should be taken by those who aggressively manage their portfolios.

``If you're someone who really does truly actively trade, if you reallocate once a quarter, it's probably a good time to be entirely short, or not in bonds at all,'' said Andrew Clark, a senior research analyst with Lipper. ``But if you're a passive, long-term investor, as long as you're diversified, you can ride this out.''

The author also suggests that if you are invested in a bond fund that the managers of the fund are probably already making adjustments to keep pace with rising interest rates.

Executive Compensation. CFO.com has an excellent article from 2003 that addresses various reasons why companies are changing the way they are compensating employees. The article's principle focus is on how these changes affect executive compensation. Part of this article focuses on the logic behind reducing the use of stock options as compensation in an effort to encourage executives to focus on results rather than stock price. The second part of the article says that companies are adopting this model because stock options may soon been viewed as an expense for all employees (as proposed by FASB).

Granted, CFO bonuses may have surged because companies booked more profit last year. But the rise in short-term incentive pay could also mean that the interests of corporate executives and shareholders are finally synching up.

Either way, CFO compensation is likely to be less dependent on stock options in coming years — even if the stock market hits a good stretch. Recent financial scandals have tainted the granting of lavish stock options to senior managers, and powerful institutional investors are now demanding that companies devise different ways to provide incentives to managers.

Asset Retirement Obligations AccountingWeb.com reports that FASB has published an exposure draft concerning conditional asset retirement obligations and is an interpretation of Statement 143. The exposure draft proposes that

"to provide more consistent recognition of liabilities relating to asset retirement obligations and more information about future cash outflows relating to these obligations."

This proposal has come from an onset of accounting practices associated with the "timing of liability recognition for conditional asset retirement obligations."

For-Profit Blogging. Blogger was purchased by Google last year. Google provides the blogging software and hosts this blog on its own servers at no cost to the blog's authors/creators. If they're giving it away, then How does Blogger make any money?

Vivendi Arrested. AP reports that former CEO of Vivendi Universal has turned himself into Paris police.

Authorities are probing a massive share buyback in which Vivendi allegedly spent over $1.2 billion to prop up its own share price in the weeks following the Sept. 11 terror attacks. Messier and his top team are suspected of buying back Vivendi shares well above the authorized volumes even while the company was presenting its financial results --a practice strictly forbidden by stock market rules.

Stock Options. The Financial Accounting Standards Board found some friends in Washington. A few key government officials spoke on behalf of FASB's proposal that companies expense the fair market value of stock options and against some recent efforts to legislate accounting rules.

The chairman of the Senate Banking Committee lashed out at Congress for undermining efforts by the accounting standard setter to require that companies expense the value of stock options....

Following a committee hearing on bond market regulation, Shelby [R-Ala.] reportedly told members of the press that the House legislation is "certainly not going anywhere in the Banking Committee."

Sarbanes-Oxley. CFO.com reports that the SEC has approved a new auditing standard proposed by the PCAOB (Public Company Accounting Oversight Board) related to Section 404 of SOX.

The auditor's report on internal control over financial reporting will express two opinions — an opinion on whether management's assessment of the effectiveness of internal control over financial reporting as of the end of the most recent fiscal year is fairly stated, and an opinion on whether the company has maintained effective internal control over financial reporting as of that date.

Earnings management. The 2003 Medicare Reform act doesn't come into effect until 2006. However, companies are able to take advantage of it already in estimating future retirement healthcare benefits.

Long-range estimates of drug subsidies also provide firms with an opportunity to engage in a bit of earnings management. That's because the forecasts add gray areas to the task of figuring out a company's future overall retiree health-care liabilities. Predicting the eventual size of the subsidies, after all, involves forecasting such big unknowns as the future of retiree prescription-drug use, the prospects for pharmaceutical innovation, and the future cost of the drugs.
. . .
By providing companies with the chance to lowball their liability estimates — and, ultimately, cut reported expenses — the subsidies offer new leeway in using OPEB [other postretirement employee benefits] numbers to hit earnings targets, says Georgia Tech accounting professor Charles Mulford.

Accounting for environmental liabilities. At this time thereis not a uniform way of accounting for environmental liabilities. This report by The Rose Foundation for Communities and the Environment, The Environmental Fiduciary: The case for incorporating environmental factors into investment management policies, offers suggestions on how companies can account for such liabilities.

Debt Financing. What happens to a company when they are unable to pay the interest on their bonds? Donald Trump found out the answer to this question in May when his casino company didn't have the necessary cash to pay the interest on its bonds. The result was less control in the company for Donald Trump, who now has a diminished ownership percentage in the company. See this post from February about the agreement between Trump and the investment bankers.

United Parent Seeks Investors


September 11,2001 brought an onset of several problems for the United States, more specifically in the airline industry. Americans had a fear of flying, which caused the airline industry earnings to plummet. As a result many airlines went under. United Airlines, the number two airline, was no exception. It filed for bankruptcy, Chapter 11, in December of 2002. Today, Money.cnn.com has reported that United Airlines is seeking $500 million in new equity in United's bankrupt company, UAL Corp. {UALAQ), which they believe will reduce the size of the federal guarantee.

The $2 billion that United sought from the federal government as financial backing, was vital in United's "restructuring". However, things don't seem to be looking good, since the Air Transportation Stabilization Board rejected United's proposal for a loan guarantee. Not to mention this was the second time for the rejection.

The plan is that,

"United would seek funds from private equity investors, possibly augmented by the issuance of UAL subordinated debt."

This article gives an analysis of debt versus equity financing. Debt and equity financing provide different opportunities for raising funds. As this article entails, a commercially acceptable ratio between debt and equity financing should be maintained. From the lenders' perspective, the debt-to-equity ratio measures the amount of available assets or "cushion" available for repayment of a debt in the case of default.

Not So Fast FASB. Just when it looked like FASB had solved the expensing of stock options issue, several bills are now in the works to change all that. This topic has become such a hot-button issue that the Securities and Exchange Commission took the liberty of inviting public comment, which is rather unusual. See our previous posts on these bills here, here, here, and here.

Recognizing the significance of any potential change to the proxy voting process, the SEC took the unusual step a year ago of announcing its intention to examine the matter and invited public comment.

Then, while normally the next public act would have been to issue a proposal and invite public comment, the SEC published the staff report which would serve as a basis for the five commissioners to decide what to do.

The proposed rule was issued in the fall with an invitation for public comment, and then a hearing was held in March, followed by yet another round of public comment.

Several Milacron Execs Turn In Stock Earlier Than Expected Milacron CEO Ron Brown was among a handful of company officials that were forced to prematurely turn in restricted shares of company stock in order to appease income tax requirements.

The moves were made necessary be the recent change in control of the corporation. The change of control was effective last week when Milacron completed a financial restructuring after shareholders approved a series of measures at the annual meeting.

The restructuring left majority control of the company in the hands of two foreign investment firms that kicked in $100 million to pay off debt coming due. The change in control in turn caused certain restricted shares held by Milacron executives to vest immediately, triggering a need to withhold income taxes on the value of those shares.

SEC warns audit firms. Bloomberg News reports a recent SEC warning to accounting firms that they cannot provide both savings based tax consulting services (those with a contingent fee) and financial statement audit services to the same client. The two services seem to pose a confict of interest. This type of tax work rewards the audit firm for client taxes saved. Financial auditors could be tempted to overlook financial statement irregularities that lower client taxes, thereby increasing tax consulting fees.

SEC Chief Accountant Donald Nicolaisen said he ordered the seven biggest firms in a private meeting last week to fully disclose any such arrangements to the company audit committees that oversee their work. He also warned the firms they may face SEC enforcement investigations over the contingency fees, payments that are based on a percentage of tax savings.

In January 2003, the SEC passed rules prohibiting accounting firms from performing a number of consulting services for audit clients. The rules let firms provide tax advice to audit clients as long as it is pre-approved by the audit committee. Firms can enter into contingency fee agreements with non-audit clients for tax work.

FASB and Legislation. The Financial Accounting Foundation's Board of Trustees has issued a statement opposing legislation that they believe would jeopardize FASB's ability to function as an independent standard setting body. This foundation appoints and funds FASB and the members are concerned about accounting rules being legislated rather than determined by FASB.

The Financial Accounting Standards Board (FASB), after extensive analysis and with careful public due process, issued a proposal on March 31, 2004 regarding accounting for employee stock options and other equity-based compensation. As Trustees of the Financial Accounting Foundation (FAF) we do not take positions on the FASB’s standards-setting proposals; we leave the complex task of accounting standards setting to the experts who comprise the FASB. However, we care deeply about the integrity and independence of the standards-setting process, which we believe is threatened by current legislative proposals.

We, therefore, strongly oppose any current or proposed legislation that would undermine the independence of the FASB by preempting, overriding, or delaying the FASB’s ongoing effort to improve accounting for equity-based compensation. We believe that once Congress starts setting accounting standards through its political process, the integrity of U.S. accounting standard setting and the credibility of U.S. financial reporting will be dangerously compromised.

HealthSouth. HealthSouth has settled it's dispute [noted previously here] with bondholders. You can read about the premium they are giving to the bondholders of 7.625% notes. After HealthSouth failed to issue audited financial statements the bondholders called due the principal of the bonds. Healthsouth has been negotiating with the bondholders to avoid having to come up with the full principal payment. The company has enough cash to pay the interest and a premium (consent fee) but the principal might force them into bankruptcy.

HealthSouth Corp. today announced that more than a majority in principal amount of the holders of its 7.625% Senior Notes due 2012 have delivered consents to approve proposed amendments to, and waivers under, the indenture governing such notes.

Stock Options. The chairman of the Cato Institute explains why he thinks FASB is wrong about expensing the cost of stock options. This is in response to FASB's recent exposure draft of a new accounting rule that would require that all forms of share-based compensation be accounted as a cost in the period they are granted. The author argues that:

A stock option in not like "other forms of compensation." Stock option are incentive for future performance; they are not, like a bonus, a reward for prior performance.

Stock options and other forms of equity-based compensation dilute the outstanding shares only when they are exercised, not when they are granted. And the accounted value of these forms of compensation should be based on their market value when exercised, not on some non-objective formula when granted.

The Columbus Business First journal has an opinion piece on why Ohioans should care about the stock options debate. FASB currently calls for "one size fits all" accounting standard for stock options.

Up until now, standard practice with regard to accounting for stock options involved acknowledging their issue and then later incorporating their impact once employees cashed them in. The standards board's plan is to require companies record options at the time of issue.

Placing an accurate value on options before they are exercised is problematic at best, however, and newly established businesses likely will not have the upfront capital to afford such a measure.

Financial Statement Accounting Fraud. The New York Times reports that Prabhat Goyal, former CFO of Network Associates, will face criminal charges in connection with a scam to dupe investors. Essentially, the scam entailed recording revenue for product shipped to distributors before the product was sold to consumers. Distributors were paid "excess inventory fees" for the returned products.

The alleged chicanery began in 1998 when the government says Goyal decided Network Associates should book revenue based on the amount of product sold to distributors instead of on the amount of inventory that ended up being bought by consumers and businesses. Network Associates changed its accounting method in 2001 after Goyal stepped down as CFO.

Even though this controversy is overshadowing Network Associates, their stock has held its value. This suggests that investors have not changed their views on the company's ability to produce cash flow in the future.

APR vs. APY. The Motely Fool website explains the difference between APR (annual percentage rate) and APY (annual percentage yield).

"You'll typically see one (APR) cited in relation to mortgage loans and the other (APY) in regard to interest-bearing accounts."

InvestorWords.com defines APR as

"the yearly cost of a mortgage, including interest, mortgage insurance, and the origination fee (points), expressed as a percentage", and APY as "the effective annual return".

The article states that the APY is helpful in that it provides information as to what should be expected from the interest rate, taking into account how often interest is applied. In the end, the more compounded interest the more money you'll get back.

Accounting gets bigger and smaller. The Atlanta Business Chronicle says that the requirements of Sarbanes-Oxley are causing changes in the size of accounting firms.

Under Sarbanes-Oxley,
-The lead audit partner and audit review partner working with a publicly traded company must be rotated every five years
-The Big Four accounting firms cannot mix the services they provided pre-Enron. As a result, the accounting firms are now back to their core duty, the actual audit.

These new requirements have resulted in mergers of smaller accounting firms because firms need more partners so that they can meet the required partner rotations on their publically traded audit clients.

The increased size of the Super Regional Firms allows more stature and they become more likely to grab some good business from the Big Four, especially as the economy comes back over the next few years.

"We're getting a lot of opportunities from the national firms because there is so much work to be done because of Sarbanes-Oxley," said John Davis, co-leader of the Dixon Hughes Atlanta office. " The national firms don't have enough people to do that work, so it's sending work our way. It's the typical work that CPA firms would do -- internal auditing and internal control assessments."

Fraud. Shareholders Sue Alliance Gaming claiming the corporation took advantage of its artificially inflated stock price at the expense of investors. According to the complaint, Alliance issued a series of materially false statements that artificially inflated its share price and then allowed certain executives to sell $3.6 million in shares. Then on June 8th, the company lowered earnings due to various reasons estimating a drop in earnings of ~$.08 a share. Since this report the stock price has dropped 25%.

"The defendants actively concealed from the public that the company was experiencing massive problems [and] delays associated with the company's wide area progressive games in Nevada due to regulatory hold-ups," said Lerach Coughlin Stoia & Robbins, in a statement, calling the company's previous earnings guidance "grossly inflated."

Conflicts of Interest? Can shareholders trust the Institutional Shareholder Services (ISS), or are there potential conflicts of interest? The ISS provides proxy voting and corporate governance services. Its core business is analyzing proxies and issuing informed research and objective vote recommendations to more than 20,000 shareholders each year.

However, the SEC has questioned whether there exists conflicts of interest between ISS and the shareholders who use their service. ISS's business is reporting to big shareholders on how to vote their proxies. Yet, ISS accepts payments for these services from the very companies whose business it is reviewing and ranking.

A recent opinion letter from the Securities and Exchange Commission has encouraged institutional investors, who often follow ISS advice on company referendums, to take a closer look at ISS' relationship with its corporate clients.

According to Gustitus [spokeswoman for ISS], about 15% of ISS' revenue comes from its 400 corporate clients, with the remaining 85% coming from institutional investors. Considering that the firm analyzes some 8,600 proxies, reflecting virtually all U.S. public companies, during the regular proxy season, ISS likely issues investor reports on the proxies of nearly all its corporate clients, she said.

The Mercury News [registration required] reports that the House Financial Services Committee has voted favorably on a measure that would block FASB's proposed rule for expensing the cost of stock options. However, the Senate Banking Committee is poised to block the blocking measure:

Under the House bill, only options going to the top five executives of a company must be expensed.

Supporters hope the bipartisan 45-13 vote Tuesday ... will help propel it past some tough opposition in the Senate...Among the biggest obstacles to the legislation is Sen. Richard Shelby, R-Ala., chair of the Senate Banking Committee, [who is] unlikely to be swayed by strong action in the House. ...[He] believes that the preservation of FASB's independence is fundamental to maintaining transparent, competitive and liquid markets,... and he opposes holding hearings on it.

The question that once again seems to be posed by this legislative activity is who is responsible for "...deciding what should be accounted for and how it should be accounted".

Fraud. The SEC has filed civil fraud charges against Network Associates' ex-CFO Prabhat K. Goyal. He faces

charges in connection with accounting transgressions, [including charges] that he overstated the company's revenue and earnings from the second quarter of fiscal 1998 to the fourth quarter of fiscal 2000 [and] that [he] has sold stock while possessing material non-public information regarding the financial fraud at Network Associates.

The charges against Goyal include using a subsidiary to repurchase products from distributors and making secret payments to distributors to induce them to hold inventory and buy more products. The SEC is seeking disgorgement of gains in the form of salary, bonuses and sales of stock as well as civil money penalties.

It would appear that there will be a continuous stream of "EX-CFO"s charged with accounting transgressions for the foreseeable future. Interestingly, on both sides of all these scandals, the litigation practitioners continue to prosper.

Market Efficiency. In The Efficient Market Hypothesis on Trial professors Phillip Russell and Violet Torbey re-examine EMH and conclude that a refinement is in order. Their premise states:

The hitherto dominant paradigm in financial market research, the Efficient Market Hypothesis (EMH), has been put on trial recently and subjected to critical re-examination. The preliminary evidence indicates that the initial confidence in the Efficient Market Hypothesis might have been misplaced. It is observed that financial equilibrium models based on EMH fail to depict trading operations in the real world. Various anomalies and inconsistent results call for refinement of the existing paradigm. It is proposed in this article that a more coherent theory of stock market behavior can be developed by incorporating Keynesian ideologies on the speculative behavior of investors.

Warren Buffet is more concise: "I'd be a bum in the street with a tin cup if the markets were efficient."

Market Efficiency. The website Investor Home presented an insight into the motives of the"non-believers" of the Efficient Market Hypothesis. Specifically referring to active managers the essay states,

Faced with the inference that they cannot add value, many active managers argue that the markets are not efficient (otherwise their jobs can be viewed as nothing more than speculation). Similarly, the investment media is generally considered to be ambivalent toward the efficient market hypothesis because they make money supplying information to investors who believe that the information has value (beyond the time when it initially becomes public). If the information is rapidly reflected in prices, there is no reason for investors to seek (or purchase) information about securities and markets.

Global Accounting Standards. Four European Nations have rejected the latest version of the international accounting rule on derivatives. With a target of January to pass a full package of accounting standards starting to look doubtful, four European Nations rejected the compromise rule that would require investments in derivative securities to be measured by their market value as opposed to their historical cost which is likely to cause volatility in financial statements.

The derivatives rule is part of a set of global accounting standards, called International Financial Reporting Standards, being promoted by the International Accounting Standards Board. The separate accounting rules of each European country are set to be replaced in 2005. The idea behind uniform, stricter standards is to avoid the corporate corruption scandals seen in the U.S., and to harmonize U.S. and European rules.

Sarbanes-Oxley and Private Companies. A recent survey found that although they are not subject to the provisions of Sarbanes-Oxley, many privately-held companies have changed their business practices in reaction to the law. Nearly half of the companies that responded to the survey said that they had adjusted their accounting / reporting processes.

Among those who cited a specific area of change, their top responses were:

Payroll/benefits, 44 percent
Expenditure/purchasing, 37 percent
Accounts receivable/sales, 31 percent
Capital assets, 31 percent
Conversion/inventory, 31 percent
Credit management/collections, 29 percent
Disbursements, 25 percent
Financial close, 22 percent

Computer Associates revised company financial information for the first three quarters of the current fiscal year, as reported on CFO.com . CA is currently under investigation by the Securities and Exchange Commission and the Justice Department for previous errors in its financial statements. This filing is another example of improper accounting practices, dating back to 2000, that have been reported by Computer Associates.

This latest restatement reflects a change in the way Computer Associates booked subscription revenue, spokesman Robert Gordon told Bloomberg. "This is unrelated to our historical accounting issues in relation to our old business model," he added. Or, as the wire service put it, the restatement is due to a new, tighter accounting policy and unrelated to the company's recently uncovered fraud.

FASB is in the news again. CFO.com reports that the Financial Services Committee of the House of Representatives has voted to restrict an option-expensing standard recently proposed by the FASB.

H.R. 3574, the Stock Option Accounting Reform Act — which was approved last month in subcommittee — would demand an economic impact study before FASB is permitted to implement its proposed rule. In addition, the bill would require companies to expense only stock options granted to the top five officers. Small businesses would be entirely exempt from FASB's rule; newly public companies could forgo expensing for three years.

Global Accounting Standards. J. Edward Ketz writes an opinion piece about the work of both the Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB) towards global harmonization of financial accounting rules. Although he admires the work they've done he argues that the benefits of global harmonization will not amount to much until enforcement efforts across the globe match that of the SEC.

Power of Markets. A new book by James Surowiecki called The Wisdom of Crowds:Why the Many Are Smarter Than the Few and How Collective Wisdom Shapes Business, Economies, Societies and Nations examines the power of capturing the collective wisdom of groups rather than relying on individual experts. One area where this is applied is markets. Markets are a method of collecting the wisdom that is spread across a group of people and summarizing that wisdom into one number such as a stock price or point-spread.

Click here to read a short review of the book.

"If you ask a large enough group," [Surowiecki] says, "to make a prediction or estimate a probability," the errors they make cancel each other out. "Subtract the error, and you're left with the information." In this fashion, the TV studio audience of "Who Wants to Be a Millionaire," guessed the right answer to questions 91 percent of the time, torching the "experts," who guessed the right answer only 65 percent of the time.

What should Microsoft do with its $56bil nest egg? The Economist reports that Microsoft is sitting on $56 billion in short term investments and cash equivalents. While Bill Gates wants to sit on enough money to make up for a year with no income, there is still $28 billion left. So what should Microsoft do with its retained earnings? Some say to re-invest the money; buy a company like SAP and expand into service contracts with large corporations. The analysts warn against that, it would alienate other businesses it works with. Instead they suggest a dividend payment.

Hostile Takeovers. The Economist says that hostile takeovers are on the rise again and that they remain unpopular with investors and government regulators.

...hostile bids are, in fact, just as unpopular in America these days which is what makes Oracle's recent unfriendly bid for PeopleSoft, a rival software firm, stand out. Despite the efficiency of its capital markets, America's market for corporate control is very far from free. A slew of hostile takeovers during the 1980's led many states to legislate to allow firms to implement anti-takeover measures, and these have been backed by the Supreme Court.

Some companies have instituted "poison pill" polices to prevent hostile takeovers.

PeopleSoft has the option of using a so-called "poison pills" the ability to issue masses of shares that would dilute its value in the event of a takeover. It also has a staggered board, where directors are elected in different years, making it impossible to take control of the company in a short space of time. In theory, these measures are meant to forestall a "rush to judgment" in the event of a hostile bid. In practice, they protect incumbent managers against any threat to their position.

Carly Fiorina, CEO of Hewlett Packard, urged investors to re-evaluate HP's stock price especially in comparison to IBM and Dell. Her argument revolves around analysts believing HP's stock is riskier than it actually is, and that IBM and Dell are actually riskier investments in the long run.

Fiorina does have some grounds for complaining about HP's stock market performance. Over the past year, HP has managed to turn around its PC and server businesses from big losers to mild gainers, while its imaging and printing unit continued to pile up cash. In addition, HP has not lost the drastic amounts of share to rivals that some predicted following its acquisition of Compaq. But, in the past 52 weeks, investors have not rewarded HP at all, keeping its shares flat, while Dell and IBM shares are up more than 10 percent.

Dell Joins debates over Expensing Stock Options. CFO.com reports that Dell Inc. has joined Apple Computer Inc., Hewlett-Packard Co., and Intel Corp. in the dilemma of whether or not to expense the value of stock options. Dell's position is that until FASB sets its final standard regarding expensing of options, any potential benefit of reporting the expense does not measure up to the investor confusion that could result from the expense. Intel's CFO, Andy Bryant, told reporters "I've said time and time again, it's not an expense, it's an equity transfer."

Computer Associates' Sanjay Kumar steps down. In a follow-up to the "How Executive Greed Cost Shareholders $675 Million" article presented in supplemental class readings from the chapter on stock options, this article notes that Sanjay Kumar [one of the three people who received the combined $1.1 Billion in stock] is leaving the company.

"It has become increasingly clear to me in the past few days that my continued role at CA is not helping the company's efforts to move forward," added Kumar in a statement.

Omnivision Technologies, Inc. Proposed Earnings Restatements cause investor confidence to falter. This article notes that investor confidence in Omnivision Technologies, Inc. has declined after the company issued a public announcement that it might be restating some of its 2004 and possibly some of its 2003 quarterly reports. Investor uncertainty increased further with news that 2004 fourth quarter and annual reports were to be delayed until June 23.

Cisco Employees Flood FASB with Letters. After issuing a proposed rule that would require companies to expense stock options on their income statements, FASB received a plethora of complaint letters, most of which came from Cisco Systems.

About 1,800 Cisco employees, or 7.5 percent of the company's domestic workforce, have submitted comments on the proposed rule; in a CFO.com sampling of 25 letters, all of them opposed it. According to a Cisco source, the comment letters may have been inspired by a memo signed by chief financial officer Dennis Powell. That message alerted employees to FASB's 90-day public comment period and invited employees to visit Cisco's internal government-affairs Web site to learn how their opinions could be heard.

Revenue Recognition for Software. i2 technologies has settled with the SEC over revenue recognition issues.

Over a nearly five-year period ending in 2002, the company allegedly misstated about $1 billion of license revenues, including over $125 million it should never have recognized.

Had the Dallas-based developer and marketer of enterprise supply chain software provided accurate financial reports during these periods, it would have disclosed increasingly negative results, the commission asserted.

According to the SEC, i2 favored up-front recognition of software license revenue, which is accepted under generally accepted accounting principals (GAAP). However, i2 knew or should have known that immediate recognition of revenue was unsuitable for a number of i2's software licenses because they required long and involved implementation and customer customization, the commission added.

Qwest fails after overstatment of revenue was revealed Forbes.com reports that after the collapse of telecommunications company Qwest was overstating its revenues. By overstating revenues, Qwest appeared to be profitable, though it was not.

All four defendants and four other Qwest executives have been sued by the Securities and Exchange Commission, which says they inflated revenues by about $144 million in 2000 and 2001 to meet promises of double-digit revenue growth. That lawsuit has been put on hold pending the criminal trial. The company also faces several shareholder lawsuits...
The case is the first to come out of investigations that prompted Qwest chief executive Joseph Nacchio to quit in 2002 and ultimately led the Denver-based company to erase $2.5 billion in revenue.

How Options Fueled the Enron collapse: A 2002 episode of the PBS series Frontline argued that the failure to expense the cost of stock options contributed to the collapse of Enron.

[Sarah Teslik, Executive director of the Council of Institutional Investors] "had FASB changed the rules and required companies to show stock options as an expense, I think Enron and a number of the other companies that have tanked through fraudulent bookkeeping would have been held back considerably, because their schemes depended on postponing public revelation of the losses. And if stock options had to show up as an expense, then a lot of the money that was quietly being siphoned off would have been publicly siphoned off, and it would have been a deterrent.

Since this Frontline aired, FASB has again proposed that all companies must expense the value of stock options paid to employees as compensation. As noted here not everyone agrees that this is the best thing to do.

Congress and FASB Decide to study effects of stock options CFO.com reports that as part of the Financial Transparency Act, Congress will begin a three year study on the effects of booking stock options as expenses. However, during that three-year period, there can be no change to the expensing rules. FASB is opposed to this bill.

But the proposed legislation would also commission a three-year study of the effects of such disclosure. During that time, new accounting standards governing options would not be recognized... The bill's sponsors argue that mandating companies to expense options would effectively eliminate the use of broad-based options plans as an incentive for rank-and-file employees. They also claim such a move would create less accurate financial information for shareholders... Not surprisingly, standards-setters at FASB, which has tentatively decided to require companies to book stock options as an expense, strongly oppose HR 1372. Beyond the proposal to stall FASB's final rule from being recognized as GAAP by the SEC, the proposed legislation calls into question the accounting rulemaking body's independence.

Proper Disclosure. The SEC used the settlement with Warnaco Group to send a message to all companies. cfo.com reports that the SEC settled charges against Warnaco and its auditors PwC stemming from the company's misleading disclosures concerning the clothing company's 1998 financial results and an inventory overstatement of $145 million. In other words, they neglected to tell shareholders that the overstatement would result in a significant restatement of the financials for the prior three years.

The SEC stated that the executive officers and auditors should have known better:

"With the action taken today, the commission has reiterated to issuers, their management, and audit firms that simply 'getting the numbers right' is not enough. An issuers filings cannot give misleading reasons for its financial results and must disclose material information to investors," said Antonia Chion, an associate director of the commission's division of enforcement.

Accounting Fraud. cfo.com reports that although Symbol has settled probes for $138 million, seven former executives have been indicted for their roles in the accounting scandal.

"This is a textbook example of a company cooking the books," U.S. Postal Service Inspector William Kezer reportedly stated at a press conference in Brooklyn. "What's significant about this case is the number of cooks in the kitchen." Symbol committed fraud in order to meet analyst projections for 32 straight quarters, inflating revenue by $230 million between 1998 and 2002, according to Bloomberg, citing U.S. Attorney Roslynn Mauskopf.

The SEC singled out a number of fraudulent schemes to align Symbol's reported financial results with market expectations. They include a process through which baseless accounting entries were made to conform the unadjusted quarterly results to management's projections; the fabrication and misuse of restructuring and other non-recurring charges to artificially reduce operating expenses; channel stuffing and other revenue recognition schemes; and the manipulation of inventory levels and accounts receivable data to conceal the adverse side effects of the revenue recognition schemes.

Ford sends not so discreet signal to analysts. Ford Motor Company announced that it has completed the first phase of its turn-around effort and still plans on making $7 billion operating profit by the middle of the decade. Even though it earned $0.96 a share in the first quarter, it revised its earnings upward by only $0.30 to $1.50 - $1.60. This should be a clear signal that it expects lower profits through the rest of the year.

Ford has been very conservative recently when offering guidance on its earnings and cost-cutting expectations, keeping with a pledge to “under-promise and over-deliver.”

Last month, the company boosted its full-year earnings guidance by 30 cents to a range of $1.50 to $1.60 a share. Some analysts say the new prediction remains conservative given that Ford earned 96 cents a share in the first quarter.

“It could put Ford in a difficult position of trying to explain to investors just why the remaining three quarters of the year should be nowhere near as profitable as the first quarter, while maintaining a position that the revitalization plan is indeed on track,” Credit Suisse First Boston analyst Chris Ceraso said in a research note this week.

Dividend Payments. A judge has given movie-theater operater Regal permission to pay a special $5 per share cash dividend to its shareholders. The Teachers Retirement System of Louisiana had petitioned the court to block the dividend payment arguing that it favored some shareholders at the expense of others. But since the dividend is paid on a per share basis, the judge ruled in favor of Regal. A writer at the Motley Fool doesn't like what this will do to Regals debt to stockholders' equity ratio...

Regal has less than $300 million on the balance sheet, and most of the payment will be financed through a restructuring of a $1.35 billion bank line of credit and the sale of $400 million in new subordinated notes. As a result of the transaction, both Moody's and Standard & Poor's have revised their credit outlook for Regal from stable to negative. After the dust settles, pro-forma debt will have risen to more than $2 billion, while equity is reduced to $94 million from $1.3 billion.

Stock Options. JDSU says that 2004 stock options worth 18% of it's revenues! The article notes that the accountants may reduce the reported expense this if they deem the volatility of the stock can be considered lower.

Technology company JDS Uniphase Corp. said on Tuesday it awarded 47 million stock options to employees in its current fiscal year, which if expensed would be equivalent to around 18 percent of its annual revenue.

Another Way to Evaluate Stocks - Voodoo. Arthur Laffer, an economist, has found a new way to evaluate stocks that may seem to be unconventional, compared to the standard P/E method, however, he uses data that is credible, which makes this approach one to consider, as one evaluates a stock. This new Voodoo approach can be considered strategic or completely unconventional - you decide.

The economist instead uses the Commerce Department's National Income & Product Accounts, a compilation of profits shown on tax returns of some 5 million public and private companies.

Laffer makes connections between the NIPA figures and fluctuating interest rates, personal tax rates and other factors. These variables inherently affect stock valuations, he says, and need to be cleansed in historic comparisons. "When interest rates are 22%," he explains, "you would expect a different P/E from an equity than when interest rates are 3.5%." Upshot: Laffer says his NIPA system would have sent a sell signal in 1999 but now indicates stocks are the cheapest they've been in three decades. That doesn't particularly help in picking individual stocks, because NIPA draws only general conclusions.

Separate Facts from Forecast In this article, the author makes a very logical point in that on financial statements, separating hard numbers from forecast and business predictions, will help everyone. It will help investors delineate between the two in an effort to make a sound decision on the future risk of the company and it will help the executives in their role by making them accountable for the facts and less liable as it relates to forecast. The outcome of this approach, will help all parties. This argument seems to be a win win situation by simply creating two columns on financial statements - one for facts and one for forecast.

Businesspeople know that financial statements are impressionistic. Because GAAP requires accountants to include forecasts in statements, some numbers are, by definition, educated guesses (quick: What's your pension liability for employees retiring in 2020?). That guesswork may not be obvious to observers, in part because financial statements often lump together hard numbers and forecasts.

That's a problem for both executives and investors. It forces CEOs and CFOs to certify the accuracy of statements that involve conjecture, opening these executives up to legal liability for sometimes unavoidable inaccuracies. And it gives investors a false confidence in the numbers, when instead they should be mindful of how uncertain the numbers can be.

In collaboration with Jonathan Glover and Pierre Jinghong Liang, we have developed a straightforward and low-cost solution to this problem: Have executives and their accountants state plainly which of the numbers on their statements are estimates.

This can be done by organizing financial statements into two separate columns, one for facts and one for forecasts. (See the exhibit "Separating Facts and Forecasts.") Prepared this way, the total of the two columns would be identical to the total arrived at on a traditional financial statement. Depreciation of a building, for example, is a forecast; it requires, among other things, estimating the building's residual value at the end of its life and the expected length of service. Cash sales, on the other hand, are facts; at the end of the quarter, there is no mistaking how much cash a company generated from the sale of its goods or services.

A key benefit of this method is that the SEC's safe harbor rules may apply to the forecasted portion of the financial statement, reducing the legal risk posed to executives certifying conventional statements. The safe harbor rules were originally enacted to protect managers and others from liability when certain forecasts made in good faith proved to be off the mark. As it stands, the forecasts combined with facts in financial statements are often invisible and so aren't eligible for protection. Because CEOs certify the entire financial statement, the burden will be on them to prove that subsequent inaccuracies, brought to light by investors, were initially reasonable based on their knowledge.

For a detailed discussion of our method, see http://littlehurt.gsia.cmu .edulgsiadoc/WP12004-E27.pdf

CFO.COM reports stocks that pay dividends are down an average 0.55 percent this year; non-dividend-paying issues are off nearly 5 percent.

Executive Compensation Changes. In this report, CFO.com says that executives are compensated with an abundant amount of stock options which may be the wrong incentive in the interest of shareholders. Furthermore, their measurable business objectives are centered around their impact on the stock itself. This creates an issue and can result in what many people call "cooking the books" in hopes that their creative adjustments to the financial statements will reduce the risk of investing in their company, resulting in an increase in share price.

Stock-option compensation has been in the crosshairs of shareholder activists and other critics. They contend that options provide too much incentive for executives to focus on the share price - and, perhaps, to cook the books.

Last year the compensation committees of corporate boards seemed to take that criticism to heart. In a reversal of a strong recent trend, the pay packages of many top-earning CFOs no longer sported whopping options components.

Start-ups and Accounting. The Cincinnati Business Courier says that owners of startups must be careful in their selection of accounting methods and form of business.

Planning a company's financial operations and preparing for quarterly taxes is something every entrepreneur must face when forming a company. Connie Weaver, an assistant professor of accounting in the McCombs School of Business at the University of Texas, has studied the different forms of business incorporation entrepreneurs take and their resulting tax burdens.

"If you're a manufacturer with the possibility of a lot of liability issues, you might be better off looking at the C corp," Weaver said. "Sure, you might end up paying more in taxes, but you probably have better liability limitations on your personal assets."

The trade-off is what you pay in your overall tax burden and when you pay it, versus what protections a particular form of incorporation might give your company.

FASB changes accounting rules for Medicare subsidy

FASB’s final guideline requires companies to record the amount of federal subsidy they expect to receive as an "actuarial gain," to be amortized into income over the average working life of their employees rather than recognizing the full effect all at once.

The guideline will take effect for fiscal periods beginning after June 15 for publicly traded companies — the third quarter for companies on a calendar year.

Black-Scholes may not be the best model for stock option expenses. CFO.com article proposes that binomial stock option value modeling may be more accurate than Black-Scholes, however, it may also be more easily manipulated by management to lower reported stock option expenses. Additional FASB usage guidelines may be needed to establish allowable assumptions for the new model.

...the traditional method for valuing options, the Black-Scholes model, seems likely to be eclipsed for purposes of expensing employee grants by an alternative known as the binomial method (also known as the Cox, Ross, Rubinstein model).

Mark Rubinstein, a finance professor at the University of California at Berkeley who helped create the binomial model. Rubinstein says the first question he gets from managers is, "Can you tell me how I can get lower numbers?"

Gross Margins. Gross margins are a closely watched measure of success in the chip business. So much so, that Intel forecasts revenues and gross margins. MSNBC reports.

Intel said it now expected revenue of $8.0 billion to $8.2 billion, with a gross profit margin of 60 percent to 61 percent for the second quarter ending June 26.

cfo.com reports that PWC has settled the Raytheon case for $50 million.

Plaintiffs were reportedly eyeing PwC's lead partner on its work for Raytheon; he's now the defense contractor's chief financial officer.

PricewaterhouseCoopers LLP agreed to pay $50 million to settle charges that it helped Raytheon Co. hide cost overruns five years ago, according to the Boston Globe

Break up the Big Four? cfo.com reports some critics want to break up the Big Four accounting firms into as many as eight different companies.

One such critic is Richard Breeden, former SEC commissioner and court-appointed monitor for MCI. "The next head of antitrust at the [Department of Justice] should just sit down with [European Union competition commissioner] Mario Monti and agree to break the Big Four firms up," he says. "The concentration is too big to be healthy."