The financial numbers game detecting creative accounting practices phần 7 doc

235 34. Cendant Corp., 10-K annual report to the Securities and Exchange Commission, December 1997, p. F-16. 35. Statement of Financial Accounting Standards No. 2, Accounting for Research and Develop- ment Costs (Norwalk, CT: Financial Accounting Standards Board, October 1974). 36. Accounting and Auditing Enforcement Release No. 751, In the Matter of William F. Moody, Jr. (Washington, DC: Securities and Exchange Commission, January 11, 1996). 37. Accounting and Auditing Enforcement Release No. 895, In the Matter of Merle S. Finkel, CPA, Respondent (Washington, DC: Securities and Exchange Commission, March 12, 1997). 38. Brooktrout, Inc., annual report, December 1999. Information obtained from Disclosure, Inc., Compact D/SEC, December 2000. 39. Accounting and Auditing Enforcement Release No. 786, Securities and Exchange Commis- sion v. Comparator Systems Corporation, Robert Reed Rogers, Scott Hitt and Gregory Armijo (Washington, DC: Securities and Exchange Commission, May 31, 1996). 40. Accounting and Auditing Enforcement Release No. 764, In the Matter of Richard A. Knight, CPA (Washington, DC: Securities and Exchange Commission, February 27, 1996). 41. Accounting and Auditing Enforcement Release No. 778, In the Matter of Sulcus Computer Corp., Jeffrey S. Ratner, and John Picardi, CPA (Washington, DC: Securities and Exchange Commission, May 2, 1996), §III. B. 3. a. s. 42. BCE, Inc., annual report, December 1999. Information obtained from Disclosure, Inc., Com- pact D/SEC, March 2001. 43. Sciquest.Com, Inc., annual report, December 1999. Information obtained from Disclosure, Inc., Compact D/SEC, March 2001. 44. Sciquest.Com, Inc., Form 10-Q quarterly report to the Securities and Exchange Commission (September 2000), p. 3. 45. Pre-Paid Legal Services, Inc., annual report, December 1999. Information obtained from Disclosure, Inc., Compact D/SEC, March 2001. 46. The Wall Street Journal, February 22, 2000, p. A3. 47. Ibid., March 10, 1998, p. C1. 48. Accounting and Auditing Enforcement Release No. 938, In the Matter of Ponder Industries, Inc., Mack Ponder, Charles E. Greenwood, and Michael A. Dupre, Respondents (Washing- ton, DC: Securities and Exchange Commission, July 22, 1997). 49. Accounting and Auditing Enforcement Release No. 1110, In the Matter of Sunrise Medical, Inc. (Washington, DC: Securities and Exchange Commission, not dated). 50. Harrah’s Entertainment, Inc., annual report, December 1999. Information obtained from Disclosure, Inc., Compact D/SEC, March 2001. 51. A. Schulman, Inc., annual report, August 2000. Information obtained from Disclosure, Inc., Compact D/SEC, March 2001. 52. Engelhard Corp., annual report, December 1999. Information obtained from Disclosure, Inc., Compact D/SEC, March 2001. 53. Cypress Semiconductor Corp., annual report, January 2000. Information obtained from Dis- closure, Inc., Compact D/SEC, March 2001. 54. Dallas Semiconductor Corp., annual report, December 2000. Information obtained from Dis- closure, Inc., Compact D/SEC, March 2001. Aggressive Capitalization and Extended Amortization Policies 236 55. Diodes, Inc., annual report, December 1999. Information obtained from Disclosure, Inc., Compact D/SEC, March 2001. 56. Vitesse Semiconductor Corp., annual report, September 2000. Information obtained from Disclosure, Inc., Compact D/SEC, March 2001. 57. Analog Devices, Inc., annual report, October 2000. Information obtained from Disclosure, Inc., Compact D/SEC, March 2001. 58. LSI Logic Corp., annual report, December 1999. Information obtained from Disclosure, Inc., Compact D/SEC, March 2001. 59. Vitesse Semiconductor Corp., annual report, September 2000. Information obtained from Disclosure, Inc., Compact D/SEC, March 2001. 60. Statement of Financial Accounting Standards No. 121, Accounting for the Impairment of Long-Lived Assets (Norwalk, CT: Financial Accounting Standards Board, March 1995). 61. The Wall Street Journal, September 30, 1996, p. B5 and May 18, 1998, p. B2, respectively. 62. Eastman Kodak Co., annual report, December 1999. Information obtained from Disclosure, Inc., Compact D/SEC, March 2001. 63. The Wall Street Journal, February 6, 1998, p. A6. 64. Ibid., January 7, 1998, p. B12. 65. Unisys Corp., annual report, December 1995. Information obtained from Disclosure, Inc., Compact D/SEC, September 1996. 66. Waste Management, Inc. annual report, December 1997. Information obtained from Disclo- sure, Inc., Compact D/SEC, September 1996. 67. Market capitalization includes the market value of equity plus the book value of the current portion and noncurrent portion of long-term debt. T HE F INANCIAL N UMBERS G AME 237 CHAPTER EIGHT Misreported Assets and Liabilities Xerox Corp. said the Securities and Exchange Commission has begun an investigation into accounting problems at its Mexico unit, where the Company recently disclosed an internal probe involving issues of unpaid bills. 1 Perry Drug Stores, Inc.’s valuation of physical inventory counts during the year generated results that were approximately $20 million less than the inventory carried on Perry’s books Had Perry followed its normal procedure of expensing inventory shrinkage to cost of sales, Perry would have reported a net loss of close to $6 million . . . instead of the net income of $8.3 million it originally reported. 2 [A Division Controller at Guilford Mills, Inc.] made a series of false journal entries to decrease a trade accounts payable account in a round-dollar amount ranging from $500,000, to $1,800,000, and credit a purchase account (cost of sales) in the same amount, which increased earnings. 3 The claimed assets, which included up to 5,000,000 acres of undeveloped land, a $328,000 note and $3.4 million in artwork constituted between 78% and 96% of ANW, Inc.’s total holdings. These false and misleading financial statements were included in ANW, Inc.’s reports 4 The valuation of assets and liabilities reported on the balance sheet provide a convenient method for playing the financial numbers game. As noted in the opening quotes, the assets and liabilities misstated might be common operating-related items such as accounts receivable, inventory, or accounts payable. Alternatively, the accounts mis- stated might be something a bit more unusual, such as undeveloped land or artwork. The net result is the same, however: a misstatement of earning power and financial position. 238 In most instances, assets are overvalued and/or liabilities are undervalued in an effort to communicate higher earning power and a stronger financial position. There is an exception, however, when, as part of a concerted effort to manage earnings, the balance sheet is reported in a conservative manner in an effort to store earnings for future years. Such tactics were discussed in Chapters 2 and 3. LINK WITH REPORTED EARNINGS As was seen in Chapter 7, a direct link exists between earnings and amounts reported as assets. When costs are capitalized, expenditures incurred are reported as assets on the balance sheet as opposed to expenses on the income statement. Current-period earnings are correspondingly higher. A similar link exists between earnings and assets that are not subject to amortization, including such items as accounts receivable, inventory, and investments. When these assets are valued at amounts higher than can be realized through operations or sale, expenses or losses are postponed, inflating earnings. For example, in 1992 Diagnostek, Inc., reported a $1.5 million receivable from United Parcel Service, Inc. (UPS), for lost or damaged shipments. Interestingly, this receivable was reported without having submitted a claim to UPS that would have helped to verify the amount due. Ultimately Diagnostek recovered only approximately $50,000 on the $1.5 million claim. By then a significant charge was needed to write down the UPS receivable. Earnings in prior years had been overstated. 5 As another example, it is not difficult to see that special charges will be needed to address questions of collectibility concerning accounts receivable at Xerox Corp.’s Mex- ico unit, as noted in the opening quotes to this chapter. 6 Also, as noted in the opening quotes, consider Perry Drug Stores, Inc. The company did not record a $20 million shrinkage in inventory identified when a physical count was made. Instead, the company carried the missing inventory in a suspense account known simply as “Store 100” inven- tory and included it within its consolidated inventory. The net result was the postpone- ment of an after-tax charge of approximately $14.3 million. 7 As another example that demonstrates how an overvaluation of assets will postpone expenses and losses and overstate earnings, consider Presidential Life Corp. The com- pany carried at cost its investments in the debt securities of several below-investment- grade issuers. Because of financial difficulties, the market value of these securities had declined precipitously and was not expected to recover. Presidential Life, however, con- tinued to carry the investments at cost. By postponing a write-down, the company effec- tively reported the unrealized losses on its investments as assets. 8 An undervaluation of liabilities also will inflate earnings temporarily. Liabilities of particular concern are obligations arising from operations, including accounts payable, accrued expenses payable, tax-related obligations, and contingent obligations such as lia- bilities for environmental and litigation problems. These amounts might be undervalued until true amounts owed are acknowledged and recorded. For example, at Material Sciences Corp. not only was finished goods inventory ficti- tiously increased, reducing cost of goods sold, but false entries also were used to reduce T HE F INANCIAL N UMBERS G AME 239 accounts payable and lower cost of goods sold. By reducing cost of goods sold as inven- tory was increased and accounts payable were reduced, the company’s earnings were correspondingly increased. 9 In a similar scheme, as noted in the opening quotes, a division controller at Guilford Mills, Inc., would routinely adjust accounts payable and cost of goods sold downward by round amounts ranging from $500,000 to $1,800,000. Across three quarters, the net result was an overstatement of operating income by a cumulative $3,134,000. 10 To overstate income, employees at Micro Warehouse, Inc. employed a slight variation on the same scheme. When inventory was received that had not yet been invoiced, the proper accounting procedure was to increase inventory and a corresponding liability account, referred to as accrued inventory, for amounts ultimately due. For some ship- ments, however, rather than increasing the liability account, cost of goods sold was reduced instead. The net effect was a direct increase in earnings. 11 While Material Sciences, Guilford Mills, and Micro Warehouse all boosted earnings by openly reducing a liability and an expense account, earnings also can be boosted by neglecting to accrue a liability for expenses incurred. For example, as one of its many accounting irregularities, Miniscribe, Inc., did not sufficiently accrue obligations for outstanding warranties. Reported accrued liabilities for warranties declined even as sales grew. Related warranty expense was correspondingly understated. 12 Also overstating earnings by understating a liability was Lee Pharmaceuticals, Inc. Although it learned as early as 1987 that it had contributed to high levels of contamina- tion in the soil and groundwater beneath and surrounding its facilities, and that it had an estimable obligation to effect a cleanup, as late as 1996 the company had not accrued a liability for estimated amounts due. 13 Autodesk, Inc., and Tesoro Petroleum Corp. show clearly the link between accrued liabilities and income. In its fiscal 1999 annual report, Autodesk made the following disclosure: Autodesk reversed $18.6 million of accruals associated with litigation matters. Of the amount, $18.2 million related to final adjudication of a claim involving a trade-secret mis- appropriation brought by Vermont Microsystems, Inc. 14 In a similar disclosure in 1988, Tesoro Petroleum Corp. announced the “receipt” of $21 million in pretax income that “was held as a contingency reserve for potential litigation. . . . [the Company] said the contingency reserve is no longer needed.” 15 In both cases, Autodesk and Tesoro Petroleum had accrued a contingent liability for litigation that ultimately did not result in loss. As a result, the companies were in a position to reverse, or add to, income amounts that had been accrued previously. BOOSTING SHAREHOLDERS’ EQUITY As seen here, an overstatement of assets or understatement of liabilities can be directly linked to an increase in earnings. As earnings are increased, so are retained earnings, leading to a direct increment to shareholders’ equity. Misreported Assets and Liabilities TEAMFLY Team-Fly ® TEAMFLY Team-Fly ® 240 On some occasions, companies that play the financial numbers game will overstate the value of assets received for the issue of stock. While bypassing the income statement, the net effect is still an increase in shareholders’ equity. The company appears to be more financially sound. Only when the overvalued asset is written down or sold for a loss will the fictitious increase in shareholders’ equity be reversed. For example, in 1989 Members Service Corp. issued stock to acquire certain oil and gas properties. A valuation of approximately $3.3 million was assigned to the stock and interests acquired. Unfortunately, the properties acquired were nearly worthless. Worse, in 1991, even after losing its ownership interest in the properties through litigation, Members Service Corp. reported a $2.1 million valuation for these same oil and gas interests. 16 As another example, in 1992 Bion Environmental Technologies, Inc., issued 250,000 shares of company stock in exchange for a note receivable. The valuation assigned to the stock issued was $748,798. This was a wildly optimistic valuation and had no relation to the market value of the company’s stock, which at the time was hardly worth even one cent per share. Even worse was the company’s chosen method of accounting for the note received in the transaction. When stock is issued for a note to be paid at a later date, gen- erally accepted accounting principles call for the note to be subtracted from sharehold- ers’ equity rather than being reported separately as an asset. The net effect is no change in assets or shareholders’ equity. However, in an effort to boost assets and shareholders’ equity, Bion Environmental did, in fact, report the note receivable as an asset. As a result, the company’s shareholders’ equity increased from less than $10,000 to over $750,000. 17 Finally, as noted in the opening quotes, up to 96% of ANW, Inc., assets and share- holders’ equity were overstated. Among its reported assets were up to 5,000,000 acres of undeveloped land, a $328,000 note receivable, and $3.4 million in artwork. According to the SEC, the amounts reported were false and misleading. 18 Having demonstrated the link between earnings and shareholders’ equity of misstated assets and liabilities, attention now turns to a more careful examination of selected accounts. The overvaluation of assets that are not subject to periodic amortization—in particular, accounts receivable, inventory, and investments—is examined first. A detailed look at undervalued liabilities—in particular, accounts payable, accrued expenses payable, tax-related obligations, and contingent liabilities—follows. OVERVALUED ASSETS Accounts Receivable As seen in Chapter 6, accounts receivable play a key role in detecting premature or fic- titious revenue. Such improperly recognized revenue leads to an uncollectible buildup in accounts receivable. As a result, the account grows faster than revenue, and accounts receivable days (A/R days), the number of days it would take to collect the ending bal- ance in accounts receivable at the year’s average rate of revenue per day, increase to a level that is higher than normal for the company and above that of competitors and the T HE F INANCIAL N UMBERS G AME 241 company’s industry in general. However, even when revenue is recognized properly, earnings can be boosted, at least temporarily, by improperly valuing accounts receivable. Accounts receivable are reported at net realizable value, the net amount expected to be received on collection. An estimate of uncollectible accounts, also known as the allowance or reserve for doubtful accounts, is subtracted from the total amount due to derive net realizable value. The allowance or reserve for doubtful accounts arises with the recording of an expense, the provision for doubtful accounts. When facts indicate that some or all of a particular account receivable is uncollectible, the uncollectible por- tion is charged against the allowance for doubtful accounts. That is, the actual loss, when it is known, is charged against the balance-sheet account, the allowance or reserve for doubtful accounts. The expense effect of the loss, the provision for doubtful accounts, was recorded earlier as an estimate. A company that chooses to boost earnings temporarily can do so by minimizing the expense recorded as the provision for doubtful accounts. This, in turn, will understate the allowance or reserve for doubtful accounts and overstate the net realizable value of accounts receivable. Only later, often in subsequent years, when the allowance or reserve for doubtful accounts proves inadequate to handle actual uncollectible accounts, will the problem surface. Then an additional provision or expense must be recorded to accom- modate the additional uncollectible accounts. Worse, the problem may not come to light for even longer periods if actual uncollectible accounts are not written off and instead are carried as collectible claims. Either way, the net realizable value of accounts receivable will be overstated. While there is no reason to expect a conscious decision to minimize the provision for doubtful accounts in prior periods, in 1999 Advocat, Inc., found its allowance or reserve for doubtful accounts to be inadequate. As a result, an additional provision was needed, as reported in this disclosure: The provision for doubtful accounts was $7.0 million in 1999 as compared with $2.4 mil- lion in 1998, an increase of $4.6 million. The increase in the provision for doubtful accounts in 1999 was the result of additional deterioration of past due amounts, increased write-offs for denied claims and additional reserves for potential uncollectible accounts receivable. 19 As is the case when earnings are boosted with premature or fictitious revenue, when accounts receivable are overvalued by consciously minimizing estimates of uncollectible accounts, accounts receivable, net of the allowance for doubtful accounts, can be expected to increase faster than revenue. Also, A/R days will increase to a level that is historically high for the company and above the levels of competitors and other compa- nies in the industry. A key difference, however, is that revenue typically is rising when a company reports premature or fictitious revenue. While revenue also may be increas- ing when a company consciously reports overstated accounts receivable, a financial statement reader should be particularly on guard for overvalued accounts receivable in the presence of flat to declining revenue. Declining revenue indicates declining demand for a company’s products and services and possible inroads by competitors. There also may be overall economic or industry-specific weakness that is affecting not only the company but its customers, affecting their ability to pay. In addition, the company may Misreported Assets and Liabilities 242 be selling to less creditworthy customers in an attempt to maintain previous revenue lev- els. All such factors lead to the reduced collectibility of accounts receivable and to a heightened risk that they are overvalued. Many of these problems were being experienced by Springs Industries in 1998. An earnings shortfall in the second quarter of that year was blamed “on a larger-than- expected provision for bad debts and ‘disappointing’ sales of bedding.” 20 One analyst saw the company’s earnings warning as a sign that “Springs was losing market share in bedding to WestPoint Stevens, Inc., Dan River, Inc. and Pillowtex Corp.” 22 Clearly, sales problems were showing up not only in declining revenue but in collection problems as well. Collection problems also pestered Ikon Office Solutions, Inc., in 1998. In the com- pany’s quarter ended June 1998, a pretax charge of $94 million was recorded, largely to reflect “increased reserves for customer defaults.” 22 Sales that quarter were slightly higher, rising 6 percent over the same quarter in 1997. Simply because a company records a special provision or charge for uncollectible accounts receivable does not necessarily mean that a conscious effort had been made in prior periods to boost earnings artificially. Even a best estimate of uncollectible accounts can prove inadequate as circumstances change. Nonetheless, the impact of a special charge to adjust for a large unexpected increase in uncollectible accounts will have the same effect on earnings—a precipitous decline. Moreover, the company’s earning power implied by reported profits in prior years was, whether consciously or not, overstated. Accordingly, a financial statement reader must be attuned to the risk of overvalued accounts receivable, whether the overvaluation is a purposeful act or not. Consider, for example, the cases of Planetcad, Inc., and Earthgrains Co. Planetcad, Inc. In its 1999 annual report, Planetcad, Inc., a software firm, made this disclosure about problem receivables: General and administrative expense increased 14% to $2.4 million in 1999 from $2.1 mil- lion reported in 1998. Increased general and administrative expense for 1999 versus 1998 was primarily due to increased bad debt expense. Bad debt expense in 1999 was $569,000 as compared to $85,000 in 1998, as the Company recognized the expense related to a few large balance accounts. The Company believes future charges will not be at the level incurred in 1999. 23 According to its note, in 1999 the company recorded an outsize increase to bad debt expense, or provision for doubtful accounts as it is referred to here, to account for a few questionable receivables. While the company had been profitable in 1998, reporting pre- tax income of $598,000 on revenue of $14,350,000, the additional provision for doubtful accounts, along with other problems, pushed the company into a loss position in 1999. That year the company reported a pretax loss of $2,754,000 on revenue of $14,900,000. It is instructive to look at the company’s revenue and accounts receivable balances in the years leading up to the special charge for uncollectible accounts in 1999. Amounts for the years 1996 through 1999 are reported in Exhibit 8.1. T HE F INANCIAL N UMBERS G AME 243 In examining the exhibit, it is clear that over the course of the period reviewed, the company had a chronic and worsening collection problem. Across the period, accounts receivable, net of the allowance for doubtful accounts, continued to increase at rates higher than that of revenue. As a result, the company’s A/R days continued to grow. By 1999, A/R days were up to 101.8 days. By then it was taking nearly twice as long as it did in 1996 to collect amounts due. In reviewing the data in the exhibit, it can be seen that evidence of collection problems and an impending write-down were available well before the actual event in 1999. In the periods preceding 1999, the company’s estimate of its uncollectible accounts was opti- mistic and unrealistically low. Expectations of earning power formed over those years would likely have been optimistic as well. Earthgrains Co. In its fiscal year ended March 2000, Earthgrains Co. also recorded a special charge for problem accounts receivable. In this instance, however, the problem was attributed to a single customer, as relayed in this disclosure: Marketing, distribution and administrative expenses increased in 2000 to 39.4% from 38.0% on a percentage-of-sales basis. The increase is a result of the one-time, $5.4 million accounts receivable write-off related to a customer bankruptcy filing, increased goodwill amortization, and inflationary cost pressures, including increases in employee-related costs, and other expenses, including fuel. 24 While the company attributed the collection problem to a single customer, the allowance for doubtful accounts should have been large enough to handle that customer’s prob- lems. The company’s revenue and receivable figures for the years leading up to 2000 provide some insight into the problem. Consider the figures reported in Exhibit 8.2. Misreported Assets and Liabilities Exhibit 8.1 Revenue and Accounts Receivable with Related Statistics: Planetcad, Inc., Years Ending December 31, 1996–1999 (thousands of dollars, except percentages and A/R days) 1996 1997 1998 1999 Revenue $10,630 $10,884 $14,350 $14,900 Percent increase from prior year — 2.4% 31.8% 3.8% Accounts receivable, net $1,542 $2,732 $3,981 $4,156 Percent increase from prior year — 77.2% 45.7% 4.4% A/R days a 52.9 91.6 101.3 101.8 a A/R days calculated by dividing accounts receivable by revenue per day, where revenue per day is revenue divided by 365. Source: Data obtained from Disclosure, Inc., Compact D/SEC: Corporate Information on Public Companies Filing with the SEC (Bethesda, MD: Disclosure, Inc., March 2001). 244 As can be seen in the exhibit, accounts receivable at Earthgrains Co. increased faster than revenue for each of the years 1998, 1999, and 2000. The year 2000 was particularly troublesome, with accounts receivable increasing 41.6% on a 5.9% increase in revenue. As a result, A/R days increased to 46.8 days in 2000 from 35.0 days in 1999 and 31.1 days in 1997. This information indicates that the company appeared to be experiencing collection problems. A review of quarterly statistics for the fourth quarter of the company’s year ending March 2000 and for the first three quarters of the year ended March 2001 indicate that the company was beginning to gain control of its problems. Data are provided in Exhibit 8.3. In reviewing this exhibit, it can be seen that using quarterly revenue figures, A/R days were nearly 50 days in the quarter ended March 28, 2000, the last quarter of the fiscal year. In the quarters that followed, however, both through write-offs and increased col- lection efforts, the company’s A/R days gradually declined, returning to 30.3 days in the quarter ended January 2, 2001. At both Planetcad and Earthgrains Co., accounts receivable were overvalued. It can- not be known for sure whether this overvaluation was the result of a conscious effort to report higher earnings in prior years or simply due to a miscalculation of the collectibil- ity of accounts receivable. Either way, however, earnings were temporarily overstated and subject to decline as each company came to grips with its collection problems. Inventory Inventory represents the cost of unsold goods on the balance sheet. When those goods are in fact sold, their cost is transferred to the income statement and reported as cost of T HE F INANCIAL N UMBERS G AME Exhibit 8.2 Revenue and Accounts Receivable with Related Statistics: Earthgrains Co., Years Ending March 25, 1997, March 31, 1998, March 30, 1999, and March 28, 2000 (thousands of dollars, except percentages and A/R days) 1997 1998 1999 2000 Revenue $1,662,600 $1,719,000 $1,925,200 $2,039,300 Percent increase from prior year — 3.4% 12.0% 5.9% Accounts receivable, net $141,500 $156,500 $184,500 $261,300 Percent increase from prior year — 10.6% 17.9% 41.6% A/R days a 31.1 33.2 35.0 46.8 a A/R days calculated by dividing accounts receivable by revenue per day, where revenue per day is revenue divided by 365. Source: Data obtained from Disclosure, Inc., Compact D/SEC: Corporate Information on Public Companies Filing with the SEC (Bethesda, MD: Disclosure, Inc., March 2001). [...]... 19 97, June 29, 19 97, September 28, 19 97, and December 28, 19 97 (thousands of dollars, except percentages) Dec ’96 Revenue Cost of goods sold Gross profit Gross profit margin Inventory Percent increase (decrease) from prior quarter Other current liabilitiesa Percent increase (decrease) from prior quarter Mar ’ 97 June ’ 97 Sept ’ 97 Dec ’ 97 $210,863 173 ,014 37, 849 17. 9% 144 ,73 6 $219,144 178 ,0 97 41,0 47 18 .7% ... losses from these ventures is included in the consolidated statements of operations.46 255 THE FINANCIAL NUMBERS GAME Creative Accounting Practices and Investments in Debt and Equity Securities Creative accounting practices employed in the reporting for investments in debt and equity securities may come in the classification of an investment as trading, held to maturity, or available for sale, in the determination... 41,0 47 18 .7% 148,251 $238,358 1 87, 248 51,110 21.4% 144,052 $226,344 174 ,78 4 51,560 22.8% 141,898 $213, 377 173 ,066 40,311 18.9% 159,095 — 2.4% (2.8%) (1.5%) 12.1% 110,942 100,354 1 07, 279 115,424 97, 786 — (9.5%) 6.9% 7. 6% (15.3%) a Accounts payable plus accrued expenses payable Source: Data obtained from Disclosure, Inc., Compact D/SEC: Corporate Information on Public Companies Filing with the SEC (Bethesda,... though inventory increased to $159,095,000 from $144 ,73 6,000 at the end of the same quarter in the previous year In addition, while gross margin declined to 18.9% in the December 19 97 quarter from 22.8% in the September 19 97 quarter, gross margin was still higher in the December 19 97 quarter than the 17. 9% reported in the December 1996 quarter While these statistics do not point unequivocally to improper... between them that is only temporary 263 THE FINANCIAL NUMBERS GAME Cumulative depreciation expense reported on the tax return and on the income statement will be the same over a depreciated asset’s useful life It is different, however, in each of the intervening years In the early years of the asset’s life, depreciation expense on the tax return exceeds that reported on the income statement Then, in... inflation used in the calculation of LIFO inventory to the actual rate experienced by the Company of 1.1% to 0.3%.38 In other words, early in the year the company estimated the year’s inflation rate to be 1.1% for 1999, and by the end of the year the actual rate of inflation was a more moderate 0.3% Interestingly, in 2000 the company’s estimate was very close to the actual inflation rate That year the company’s... 2000 $16,649 25,233 ———– 41,882 ———– $46,983 24,063 ———– 71 ,046 ———– $14, 679 29,861 ———– 44,540 ———– 3,385 2,3 47 ———– (3,4 67) 4 ,77 9 ———– 6,613 1,186 ———– 5 ,73 2 ———– $ 47, 614 ———– ———– 1,312 ———– $72 ,358 ———– ———– 7, 799 ———– $52,339 ———– ———– Source: The Lubrizol Corp., Annual Report, December 2000, p 32 For example, in calculating taxable income, the Internal Revenue Code permits use of accelerated depreciation... forecasts for the quarter by two cents per share.53 As with IBM, the timing of the sale was presumably a function of factors other than making Wall Street’s estimates Nonetheless, the sale and the method by which it originally was reported raises questions about the real motivation Detecting Investment-Related Creative Accounting Practices It is important to know, or have a general appreciation for, the fair... the income statement Consider the case of The Lubrizol Corp For the years ended December 1998, 1999, and 2000, the company reported on its income statement an income tax provision of $ 47, 614,000, $72 ,358,000, and $52,339,000, respectively, on pretax income of $118,814,000, $195,350,000, and $ 170 ,348,000 The components of the tax provision for each of the three years were provided in a footnote to the. .. (Bethesda, MD: Disclosure, Inc., June 1998) 261 THE FINANCIAL NUMBERS GAME inventory grew by 12.1% in the December 19 97 quarter, other current liabilities, including accounts payable, actually declined by 15.3% At that point, other current liabilities had declined to an amount that was well below the $110,942,000 amount where it stood at the end of the same quarter in the previous year This decline occurred . occasions, companies that play the financial numbers game will overstate the value of assets received for the issue of stock. While bypassing the income statement, the net effect is still an increase. to the actual rate experienced by the Company of 1.1% to 0.3%. 38 In other words, early in the year the company estimated the year’s inflation rate to be 1.1% for 1999, and by the end of the. companies used the LIFO method for at least part of their inventories while about 44% of them used the FIFO method. For companies that do not wish to select one extreme or the other, the average-cost