The financial numbers game detecting creative accounting practices phần 8 doc

276 3. Accounting and Auditing Enforcement Release No. 1287, In the Matter of Guilford Mills, Inc., Respondent (Washington, DC: Securities and Exchange Commission, July 24, 2000), § A.4. 4. Accounting and Auditing Enforcement Release No. 789, Securities and Exchange Commis- sion v. ANW, Inc., et al. (Washington, DC: Securities and Exchange Commission, June 3, 1996), para. 2. 5. Accounting and Auditing Enforcement Release No. 762, In the Matter of Diagnostek, Inc., Joseph Sanginiti, and Dennis Evans, CPA (Washington, DC: Securities and Exchange Com- mission, February 23, 1996). 6. The Wall Street Journal, June 30, 2000, B6. 7. Accounting and Auditing Enforcement Release No. 1037. 8. The Wall Street Journal, March 2, 1993, p. B3. 9. Accounting and Auditing Enforcement Release No. 1176, In the Matter of Material Sciences Corp., Respondent (Washington, DC: Securities and Exchange Commission, September 28, 1999). 10. Accounting and Auditing Enforcement Release No. 1287. 11. Accounting and Auditing Enforcement Release No. 1144, In the Matter of Micro Warehouse, Inc., Respondent (Washington, DC: Securities and Exchange Commission, July 28, 1999). 12. MiniScribe Corp., annual report, December 1986. 13. Accounting and Auditing Enforcement Release No. 1023, In the Matter of Lee Pharmaceu- ticals, Henry L. Lee, Jr., Ronald G. Lee, Michael L. Agresti, CPA, Respondents, (Washing- ton, DC: Securities and Exchange Commission, April 9, 1998). 14. Autodesk, Inc., annual report, January 2000. Information obtained from Disclosure, Inc., Compact D/SEC: Corporate Information on Public Companies Filing with the SEC (Bethesda, MD: Disclosure, Inc., September 2000). 15. Tesoro Petroleum Corp., annual report, December 1998. Information obtained from Disclo- sure, Inc., Compact D/SEC: Corporate Information on Public Companies Filing with the SEC (Bethesda, MD: Disclosure, Inc., September 1999). 16. Accounting and Auditing Enforcement Release No. 983, In the Matter of George Christo- pher Bleier, CPA, Respondent (Washington, DC: Securities and Exchange Commission, November 7, 1997). 17. Accounting and Auditing Enforcement Release No. 768, In the Matter of Louis R. Weiss, CPA (Washington, DC: Securities and Exchange Commission, March 11, 1996). 18. Accounting and Auditing Enforcement Release No. 789, para. 2. 19. Advocat, Inc., annual report, December 1999. Information obtained from Disclosure, Inc., Compact D/SEC: Corporate Information on Public Companies Filing with the SEC (Bethesda, MD: Disclosure, Inc., March 2001). 20. The Wall Street Journal, June 17, 1998, p. B4. 21. Ibid. 22. Ibid., August 17, 1998, p. C22. 23. Planetcad, Inc., annual report, December 1999. Information obtained from Disclosure, Inc., Compact D/SEC, March 2001. 24. Earthgrains Co., annual report, March 2000. Information obtained from Disclosure, Inc., Compact D/SEC, March 2001. T HE F INANCIAL N UMBERS G AME 277 25. Accounting and Auditing Enforcement Release No. 883, Securities and Exchange Commis- sion v. Emanuel Pinez (Washington, DC: Securities and Exchange Commission, February 14, 1997). 26. The Wall Street Journal, February 19, 1998, p. A8. 27. Accounting and Auditing Enforcement Release No. 940, Securities and Exchange Commis- sion v. Alexandra Elizabeth Montgomery, Willia Kenneth Nestor, Frederick Burgess, and Harriet Gluck (Washington, DC: Securities and Exchange Commission, July 24, 1997), para. 2. 28. Accounting and Auditing Enforcement Release No. 1037, §B. 29. Accounting and Auditing Enforcement Release No. 885, In the Matter of Alan D. Rosskamm, Respondent (Washington, DC: Securities and Exchange Commission, February 18, 1997). 30. Accounting and Auditing Enforcement Release No. 1050, In the Matter of Owen D. Taranta, CPA, Respondent (Washington, DC: Securities and Exchange Commission, August 11, 1999). 31. Accounting and Auditing Enforcement Release No. 1326, Securities and Exchange Com- mission v. Richard I. Berger and Donna M. Richardson (Washington, DC: Securities and Exchange Commission, September 27, 2000). 32. Gross profit is revenue less cost of goods sold. 33. The Wall Street Journal, December 14, 1992, p. B4. 34. Ibid., February 23, 1993, p. A1. 35. Ibid., April 18, 2001, p. A8. 36. For a more complete treatment of the LIFO and FIFO inventory methods, refer to E. Comiskey and C. Mulford, Guide to Financial Reporting and Analysis (New York: John Wiley & Sons, 2000), chapter 4, “Topics in Revenue Recognition and Matching.” 37. Statistics obtained from Accounting Trends and Techniques: Annual Survey of Accounting Practices Followed in 600 Stockholders’ Reports (New York: American Institute of CPAs, 2000). 38. Winn-Dixie Stores, Inc. Form 10-K annual report to the Securities and Exchange Commis- sion, June 30, 1999, p. F-30. 39. Tesoro Petroleum Corp., annual report, December 1999. Information obtained from Disclo- sure, Inc., Compact D/SEC, March 2001. 40. Companies will do this in different ways. Disclosures may include the effects on cost of goods sold, on operating profit, on net income or earnings per share, or any combination of these measures. 41. The reader is referred to Comiskey and Mulford, Guide to Financial Reporting and Analy- sis. Chapter 6, “Financial Derivatives,” is devoted to the topic of recent developments in accounting for financial derivatives. 42. Statement of Financial Accounting Standards No. 115, Accounting for Certain Investments in Debt and Equity Securities (Norwalk, CT: Financial Accounting Standards Board, May 1993). 43. ABC Bancorp, annual report, December 1999. Information obtained from Disclosure, Inc., Compact D/SEC, March 2001. 44. Corning, Inc., annual report, December 1999. Information obtained from Disclosure, Inc., Compact D/SEC, March 2001. 45. In some instances, such as when an investor has sufficient representation on the investee’s Misreported Assets and Liabilities 278 board of directors, ownership positions of less than 20% may give the investor significant influence. Refer to Accounting Principles Board Opinion No. 18, The Equity Method of Accounting for Investments in Common Stock (New York: Accounting Principles Board, March, 1971). 46. Boeing Co., annual report, December 1999. Information obtained from Disclosure, Inc., Compact D/SEC, March 2001. 47. ABC Bancorp, annual report, December 1999. Information obtained from Disclosure, Inc., Compact D/SEC, March 2001. 48. AFLAC, Inc., annual report, December 1999. Information obtained from Disclosure, Inc., Compact D/SEC, March 2001. 49. The Wall Street Journal, March 28, 1997, p. A3. 50. Ibid., March 2, 1993, p. B3. 51. Ibid., April 28, 2000, p. A4. 52. Ibid., November 24, 1999, p. C1. 53. Ibid., November 22, 1999, p. A4. 54. The exception is a company, including many financial institutions, that has an established trading desk where investment gains and losses are a key part of operations. 55. Present value is the amount due on an obligation less any interest on that obligation that would be expected to accrue under market interest-rate conditions over the period prior to settlement. On an interest-bearing loan, the amount owed on the loan, the loan principal, is the present value of the loan. Interest is paid in addition to that present value amount. On a non–interest-bearing liability, the amount owed is considered to include interest. To calcu- late present value, the liability must be discounted to remove that interest. The liability amount, excluding interest, would be the non–interest-bearing liability’s present value. It should be noted, however, that because the amount of interest is considered to be immater- ial, the present value of a non–interest-bearing obligation that is due within one year is, for practical purposes, said to be equal to the total amount due. Thus, obligations such as accounts payable and accrued expenses payable are not discounted when reported on the bal- ance sheet. 56. The Wall Street Journal, March 4, 1998, p. B4. 57. Accounting and Auditing Enforcement Release No. 774, In the Matter or Charles W. Wallin, CPA (Washington, DC: Securities and Exchange Commission, April 19, 1996). 58. MiniScribe Corp., annual report, December 1986. 59. Accounting and Auditing Enforcement Release No. 1150, In the Matter of Owen D. Taranta, CPA, Respondent (Washington, DC: Securities and Exchange Commission, August 11, 1999). 60. The controller’s adjustment was actually to reduce inventory purchases, which reduced cost of goods sold. Accounting and Auditing Enforcement Release No. 1287. 61. For a careful treatment of the tax subject, refer to chapter 5, “Income Tax Reporting and Analysis,” in E. Comiskey and C. Mulford Guide to Financial Reporting and Analysis. 62. Barron’s, November 22, 1999, p. 6. 63. Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes (Nor- walk, CT: Financial Accounting Standards Board, February 1992). 64. Statement of Financial Accounting Standards No. 5, Accounting for Contingencies (Nor- walk, CT: Financial Accounting Standards Board, March 1975). T HE F INANCIAL N UMBERS G AME 279 CHAPTER NINE Getting Creative with the Income Statement: Classification and Disclosure The appropriate classification of amounts within the income statement can be as important as the appropriate measurement or recognition of such amounts. 1 Operating income is often more important to investors than net income, and widely regarded as an indicator of how well management is running the shop. 2 The top line is the bottom line for investors lately. 3 The quotes suggest some of the motivation for this chapter as well as its content. The tra- ditional prominence accorded the bottom line of the income statement is being chal- lenged by a variety of intermediate income statement subtotals. The past decade has witnessed an exceptional degree of attention being focused on the layers or subtotals that make up the income statement. With this emphasis on subtotals, as opposed to a single bottom line, the classification of items within the income statement takes on greater importance. This chapter reviews the current structure and classification of items within the income statement. The opportunistic use of income statement classification to alter apparent earnings performance is also considered. The financial numbers game is played principally by accelerating or decelerating the recognition of revenue or gains and expenses or losses. That is, earnings are shifted among different periods in the interperiod version of the game. However, an intraperiod form of the numbers game is also possible. Here alterations in the apparent financial per- formance of a firm are achieved through variations in the summarization, classification, labeling, and disclosure of items within the income statement of a single period. The TEAMFLY Team-Fly ® TEAMFLY Team-Fly ® 280 very plausible assumption underlying this approach is that earnings performance is judged by more than simply the bottom line of the conventional income statement. If earnings performance were assessed somewhat exclusively by net income—that is, the bottom line of the income statement—then simply moving items up or down within the income statement, in a form of intra–income statement creativity, would be fruitless. However, in the past decade we have seen a strong shift away from a primary emphasis on the bottom line of the income statement. In the extreme case, especially for the “new” economy companies, the “bottom line” becomes the “top line.” That is, growth in sales or total revenue is accorded a stature previously reserved for net income. Gross profit, the excess of sales or revenue over cost of goods sold, also known as cost of sales or cost of revenue, enjoys an elevated status as well. Some income statement creativity goes beyond simply moving up the income state- ment to measures such as operating income, gross profits, or sales. Selected pro-forma measures of performance are increasingly common. These measures usually are com- puted by beginning with net income and then making selected additions and subtractions to arrive at a new pro-forma measure. For example, real estate investment trusts (REITs) provide an alternative performance measure called funds from operations (FFO). This pro-forma measure starts out with net income, and then real estate–related depreciation is added back. The effects of gains and losses on the sale of real estate assets also are removed. Some firms also report pro-forma measures of earnings that remove selected noncash expenses as well as nonrecurring or nonoperating gains or losses. Recently, pay- roll taxes paid by firms upon the exercise of executive stock options have been added back to net income in arriving at pro-forma earnings. A careful consideration of these pro-forma measures is the subject of Chapter 10. Just as with interperiod techniques, which shift revenue or gains and expenses or losses among periods, intrastatement (within the income statement) creativity also can be employed to alter a financial statement reader’s impression of a firm’s financial perfor- mance. 4 Again, the effectiveness of intrastatement techniques is based on the plausible assumption that the bottom line, as a measure of financial performance, is not dominant. This chapter is organized around identifying and illustrating selected creative income statement practices. To provide essential background for the discussion, an overview of current generally accepted accounting principles (GAAP) requirements for income state- ment structure and classification is provided. It is within the framework of these require- ments that the income statement creativity of the financial numbers game is exercised. CURRENT INCOME STATEMENT REQUIREMENTS AND PRACTICES Under current practice and GAAP requirements, the income statement takes on two basic formats: single step and multistep. The single-step statement involves limited subtotals and basically provides a summary listing of all revenue and all expenses. In the simplest cases, the only intervening subtotal is income before income taxes. With the multistep format, subtotals are provided for items such as gross profit, operating income, and other income and expense. Examples of the single-step and multistep formats are provided in Exhibits 9.1 and 9.2, respectively. T HE F INANCIAL N UMBERS G AME 281 Getting Creative with the Income Statement: Classification and Disclosure Exhibit 9.1 Single-Step Income Statement Format: Callon Petroleum Co., Consolidated Statements of Operations, Years Ending December 31, 1998, 1999, and 2000 (thousands of dollars) 1998 1999 2000 Revenues: Oil and gas sales $35,624 $37,140 $56,310 Interest and other 2,094 1,853 1,767 ———– ———– ———– Total revenues 37,718 38,993 58,077 Costs and expenses: Lease operating expenses 7,817 7,536 9,339 Depreciation, depletion, and amortization 19,284 16,727 17,153 General and administrative 5,285 4,575 4,155 Interest 1,925 6,175 8,420 Accelerated vesting and retirement benefits 5,761 — — Impairment of oil and gas properties 43,500 — — ———– ———– ———– Total costs and expenses 83,572 35,013 39,067 ———– ———– ———– Income (loss) from operations (45,854) 3,980 19,010 Income tax expense (benefit) (15,100) 1,353 6,463 ———– ———– ———– Net income (loss) $(30,754) $2,627 $12,547 ———–– –———– –———– ———–– –———– –———– Source: Callon Petroleum Co., Form 10-K Annual Report to the Securities and Exchange Commission, December 2000, p. 35. Earnings per share and preferred dividend information, provided as part of the income statement, is omitted from the above. Alternative Income Statement Formats The single-step income statement of Callon Petroleum Company, in Exhibit 9.1, is pre- sented by about 28% of companies—based on an annual survey of 600 companies taken by the American Institute of Certified Public Accountants. 5 Notice that, while they are disclosed on separate line items, significant nonrecurring items of Callon Petroleum are simply listed with the other recurring expense items. The multistep income statement of Colonial Commercial Co., in Exhibit 9.2, is pre- sented by about 72% of firms, based on the AICPA survey. About one-half of firms using the multistep income statement present gross profit (sales minus cost of sales) or operating income (sales minus operating expenses), with an undisclosed number dis- closing both gross profit and operating income. 6 The Colonial Commercial income statement provides measures of both gross profit and operating profit. Gross profit margins are widely used by analysts in analyzing cur- rent and prospective firm profitability. The separation of operating from nonoperating 282 items may help to explain the dominance of the multistep format. That is, the develop- ment of the operating-income category requires companies to separate operating and nonoperating items. This is not a feature of the single-step format. The single- and multi-step income statements presented in Exhibits 9.1 and 9.2 included only a single special income statement classification, that is, the loss on dis- continued operation of Colonial Commercial. 7 Special income statement classifications are discussed and illustrated next. Special Income Statement Classifications Generally accepted accounting principles require that selected items be classified below income from continuing operations in the income statement. This standard income state- T HE F INANCIAL N UMBERS G AME Exhibit 9.2 Multistep Income Statement Format: Colonial Commercial Corp., Consolidated Statements of Income, Years Ending December 31, 1998, 1999, and 2000 (thousands of dollars) 1998 1999 2000 Sales $25,234 $42,259 $58,320 Cost of sales 18,558 30,409 42,224 ———– ———– ———– Gross profit 6,676 11,850 16,096 Selling, general and administrative expenses, net 5,769 10,070 15,352 ———– ———– ———– Operating income 907 1,780 744 Gain on sale of Monroc, Inc. stock 2,102 — — Gain on land sale 827 — — Interest income 181 173 60 Other income 114 153 221 Interest expense (200) (516) (1,204) ———– ———– ———– Income (loss) from continuing operations before income taxes $3,931 $1,590 $(179) Income taxes 79 683 910 ———– ———– ———– Income (loss) from continuing operations 3,852 907 (1,089) Discontinued operations Loss from operations of discontinued segment — — (3,212) Loss on disposal of discontinued operation — — (3,732) ———– ———– ———– Loss on discontinued operations — — (6,944) ———– ———– ———– Net income (loss) $3,852 $907 $(8,033) ———– ———– ———– ———– ———– ———– Source: Colonial Commercial Corp., Form 10-K Annual Report to the Securities and Exchange Commission, December 2000, p. 24. Earnings per share information, provided as part of the income statement, is omitted from the above as well as a note on discontinued operations. 283 ment format is presented in Exhibit 9.3. Each of the elements in the exhibit is presented net of any associated income tax effect. The categories for discontinued operations and for extraordinary gains and losses involve a degree of judgment, and its creative employment in the case of discontinued operations will be discussed later. There is less flexibility in the cases of the extraordi- nary classification and with accounting changes. Extraordinary Items To be classified as extraordinary, an item of revenue or gain and expense or loss must be judged to be both unusual and nonrecurring. Given the requirements of this test, very few items are classified as extraordinary. In recent years, the annual survey conducted by the AICPA has located, on average, only about three extraordinary items per year out of 600 companies surveyed. This excludes extraordinary gains and losses on debt retirement. Gains and losses realized on debt retirement are the single most common extraordi- nary item. This is not because these items satisfy the joint test of unusual and nonrecur- ring. Rather, Statement of Financial Accounting Standard No. 4, Reporting Gains and Losses on the Extinguishment of Debt, simply requires extraordinary classification. 8 SFAS No. 4 was issued at a time (1975) when it was increasingly common for firms to repurchase their own debt at a discount. There was concern that the associated gains were not being disclosed in a very forthright manner. Investors could misjudge the oper- ating performance of firms if they were unaware of the contribution made to earnings by these transactions. 9 While the FASB response could be seen as somewhat extreme, requiring extraordinary treatment for these gains and losses ensures that they are not overlooked by investors. Some examples of the rare breed of extraordinary items, exclu- sive of gains and losses on debt retirements, are found in Exhibit 9.4. There may not seem to be much of a pattern to the extraordinary classification decision based on the limited number of available cases. However, it is common for this classifi- cation to be applied to gains and losses resulting from natural disasters, the effects of gov- ernment regulation, and the expropriation of assets by a foreign government—usually during war or comparable disruptions. The cases of Avoca, Inc., Noble Drilling Corp., and Phillips Petroleum Co. are consistent with these conditions, that is, wars and government Getting Creative with the Income Statement: Classification and Disclosure Exhibit 9.3 Income Statement Format with Special Items Income or loss from continuing operations $XXX Income or loss from discontinued operations XXX Extraordinary gains and losses XXX Cumulative effect of accounting changes XXX —–—– Net income or loss $XXX —–—– —–—– Source: Key guidance is found in Accounting Principles Board Opinion No. 30, Reporting the Results of Operations (New York: American Institute of Certified Public Accountants, June 1973). 284 actions. While not listed in the exhibit, gains and losses associated with the 1989 earth- quake in the Bay area of San Francisco typically were classified as extraordinary. Some classification diversity can be observed by contrasting some of the extraordi- nary items in Exhibit 9.4 with comparable items that were not so classified. BellSouth Corporation (1993) did not classify as extraordinary costs associated with damages from Hurricane Andrew. In contrast, American Building Maintenance classified as extraordi- nary an insurance gain due to earthquake damage. Moreover, Sun Company (1992) did not treat as extraordinary a recovery from the government of Iran from an expropriation of properties. However, Phillips Petroleum classified the same item as extraordinary. Other high-profile cases in which the extraordinary classification was not applied include the release of toxic chemicals by Union Carbide Corp. (1984) in Bophal, India, T HE F INANCIAL N UMBERS G AME Exhibit 9.4 Some Examples of Extraordinary Items Item or Event Company Gain on insurance settlement due to American Building Maintenance, damage from the San Francisco earthquake Inc. (1989) to a building Insurance proceeds resulting from Avoca, Inc. (1995) destruction of a building by fire Loss on an interest rate swap termination; Berlitz International, Inc. (1999) swap hedged floating rate debt Settlement of a lawsuit BLC Financial Services, Inc. (1998) Costs of canceled business acquisition agreement Bria Communications Corp. (1996) Gain on sale of residential mortgage loan KeyCorp (1995) servicing operations Gains on the disposition of assets following a Kimberly-Clark Corp. (1997) pooling of interests Insurance settlement due to deprivation of use of Noble Drilling Corp. (1991) logistics and drilling equipment abandoned in Somalia due to civil unrest Gain from settlement with the government of Iran Phillips Petroleum Co. (1990) over the expropriation of Phillip’s oil production interests Write-off of unamortized balance of intrastate Schwerman Trucking Co. (1995) operating rights Gain on the sale of the company’s consumer SunTrust Banks, Inc. (1999) credit card portfolio Sources: Companies’ annual reports. The year following each company name designates the annual report from which each example was drawn. Information obtained from Disclosure, Inc., Compact D/SEC: Corporate Information on Public Companies Filing with the SEC (Bethesda, MD: Disclosure, Inc., June 2000). 285 and the oil spill by an Exxon Corp. (1989) (now Exxon Mobil Corp.) tanker in Valdez, Alaska. The position taken by Union Carbide and Exxon, respectively, must have been that the chemical release and oil spill were risks inherent in the operation of their respec- tive businesses. They may have been nonrecurring, at least in terms of magnitude, but they also could not be considered unusual. Classification as extraordinary requires that the gain or loss be both unusual and nonrecurring. To the extent that analysts are interested in identifying nonrecurring items as part of their earnings analysis, the extraordinary classification is of limited value given the rar- ity of nonrecurring items being so classified. Rather, analysts will need to review income statement details, the cash flow statement, financial statement notes, and management’s discussion and analysis in their efforts to locate nonrecurring items. Moreover, the rar- ity of extraordinary items, along with the prominence of their disclosure in the income statement, make them unlikely tools to use in the financial numbers game. Discontinued Operations A discontinued operation involves the disposition of a business segment. A business seg- ment traditionally has been held to be a complete and separate business activity and not simply a product line. The current segment reporting standard, SFAS No. 131, Disclo- sures about Segments of an Enterprise and Related Information, identifies the following three characteristics of a segment: 1. It engages in business activities from which it may earn revenues and incur expenses (including revenues and expenses relating to transactions with other components of the same enterprise). 2. Its operating results are regularly reviewed by the enterprise’s chief operating deci- sion maker to make decisions about resources to be allocated to the segment and assess its performance. 3. Discrete financial information is available. 10 Both the gain and loss from the disposition of the discontinued operation, as well as the operating results of the discontinued operation, are disclosed separately in the income statement. Separate classification of discontinued operations is designed to make the income statements of successive periods more informative. If the income statement of 2000 contained one collection of business segments and 2001 a smaller set, it would be difficult to judge the financial performance of the continuing businesses. Removing the results of a discontinued business from the results of continuing operations for 2000 pre- serves the interpretive value of the operating results of 2001 compared to 2000. A selection of discontinued operations is found in Exhibit 9.5. A careful examination of these examples suggests that making this classification decision often involves some close calls. As with many areas of judgment in financial reporting, there is a gray area when it comes to classifying discontinued operations as segments. The discontinued operation classification of A.O. Smith Corp. in the exhibit appears quite plausible in that it disposed of its storage tank and fiberglass pipe business. These businesses appear to be quite different from A.O. Smith’s remaining motors and gener- Getting Creative with the Income Statement: Classification and Disclosure [...]... changes in accounting principle are highlighted in the income statement because the cumulative effect of the change is disclosed separately in the statement The cumulative adjustment represents the effect of the new policy on the earnings of prior years However, investors also are interested in the earnings effects of the changes for the year of the change That is, what is the effect of the change... earnings for 19 98 for the remaining effect of the accounting change Moreover, in the case of a change in estimate, the prospective treatment of the change results in no cumulative-effect adjustment in the income statement in the year of the change Nevertheless, investors should be interested in the extent to which a change in earnings for the current year is a product of the change in estimate The current-year... lower if the new method had been in use Unlike the cumulative effect, which relates to prior years, the effect of the change in accounting principle on income from continuing operations for the year of the change is not set out separately in the income statement Rather, normally it is disclosed as part of the note describing the accounting change Under the retroactive restatement method, financial. .. because they do not result from the issuance of a new accounting standard by, for example, the Financial Accounting Standards Board.15 Although these changes are characterized as discretionary, this does not mean that they can simply be adopted at will in order to achieve a desired effect on net income Rather, the new accounting principle should be preferable to the old For example, the new accounting. .. modify the measure However, there is no opportunity to assess the implications of a number that is simply not included or that is included but not separately disclosed SUMMARY The income statement is the premier playground for those who engage in the financial numbers game The goal of this chapter has been to outline the key features of the GAAP-basis income statement Then, based on this foundation, the. .. recast to reflect the application of the new accounting principle.14 287 THE FINANCIAL NUMBERS GAME Examples of changes in accounting principles would be a change from accelerated to straight-line depreciation, a change from the LIFO to average-cost inventory method, or a change from the completed-contract to percentage-of-completion method of accounting for long-term contracts Each of these changes would... (catch-up) or retroactive restatement methods The accounting treatment applied to an accounting change is increasingly determined as a part of the standard-setting process The cumulative-effect method is the most common, and it includes the cumulative effect of the switch to the new method in the income statement for the year of the change This cumulative total represents the amount by which prior year results... repeatedly in the survey results reported in Chapter 5.) Analysts then will make a note to follow-up and attempt to determine the composition of the line item However, if disparate—that is, recurring and nonrecurring—items offset each other, then the absence of a line-item change will reduce the likelihood of a search for the composition of the line item The other income and expense note of The Sherwin-Williams... a numbered note that detailed the composition of this line item The ADM “Other expense” note is presented in Exhibit 9.13 Given the size of the numbers in the ADM income statement—year 2000 net income of $301 million the $26 million decrease in “Other expense, net” might not have prompted further scrutiny However, as with the case of Sherwin-Williams, the net balance is the sum of offsetting balances,... earnings or other trends 3 Whether the misstatement hides a failure to meet analysts’ consensus expectations for the enterprise 4 Whether the misstatement changes a loss into income or vice versa 5 Whether the misstatement concerns a segment or other portion of the registrant’s business that has been identified as playing a significant role in the registrant’s operations or profitability 6 Whether the misstatement . shifted among different periods in the interperiod version of the game. However, an intraperiod form of the numbers game is also possible. Here alterations in the apparent financial per- formance of. provided. It is within the framework of these require- ments that the income statement creativity of the financial numbers game is exercised. CURRENT INCOME STATEMENT REQUIREMENTS AND PRACTICES Under. method, financial statements of previous years are recast to reflect the application of the new accounting principle. 14 Getting Creative with the Income Statement: Classification and Disclosure 288 Examples