|Gross margin for fun and profit
|"Businesses come in all varieties and the gross margins generated by various businesses are no exception. Software businesses and pharmaceutical firms have high gross margins. Costco and Exxon have low gross margins."
|Chipping away at financial reporting quality
|"Chief financial officers are responsible for managing the financial reporting process. We test whether the quality of a firm's financial reports is a function of the effort expended by the CFO. Using golfing records to measure leisure consumption, we first show that CFOs consume more leisure when they have lower economic incentives to work. We show further that higher levels of CFO leisure are negatively associated with a number of indicators of financial reporting quality. The use of firm fixed effects and an instrumental variable analysis suggest that the observed relations are causal. Further tests indicate that higher leisure consumption is associated with shorter conference calls with a more uncertain tone. Finally, the effects of lower quality reporting are demonstrated by results linking CFO leisure with analysts' forecast dispersion and weaker earnings response coefficients."
|Are buybacks an oasis or a mirage?
|"The dilution rate for the U.S. equity market in 2014 was 1.8% compared to the historical dilution rate of 1.7% over the 80-year period from 1935 to 2014."
|"As investors engage in an increasingly desperate global competition for higher-yielding securities, debt issuers appear to be taking advantage of the extraordinary demand by manipulating one of Wall Street's favorite metrics of profitability."
|Apple not as cheap as it looks?
|"Thanks to an accounting- rule change for which it lobbied, Apple gets to book revenue from sales of bundled products such as iPhones -- which include hardware, software, services and upgrade rights -- more quickly than it used to. In short, one reason Apple's earnings have been so high is accounting inflation, and the market realizes this."
|Stiffen audit rules
|"Normally, repos are accounted for as borrowings, which is what they are. The borrower retains all the upside and downside of the securities in question. The lender gets an interest rate. But Lehman found a loophole in an accounting rule, and concluded that if it put up $105 in collateral for every $100 borrowed, it could claim it really was a sale. At the end of each quarter, the company would decide just how much it needed to beautify its balance sheet, and would do repos to produce the desired result. They would be reversed a few days later."
|The importance of being audited
|"When a company's auditors resign and disclose that prior financial statements "should no longer be relied upon," investors should head for the hills because there is a very good chance fraud has been discovered. Unfortunately if that company is a Chinese operation that obtained an American listing through a so-called reverse merger, then it is probably too late to salvage much if anything from the investment."
|Forensic Finance, Benford's Way
|"One of the more curious statistical anomalies of the universe has turned out to have a range of practical applications in the world of finance. It also turns out to be one of the stranger laws underpinning the stock market, although figuring out why is a painful process. Above all, Benford's Law can be used to spot financial fraudsters because of a psychological quirk that means we humans are dead useless at pretending to be random. All of this comes from a law that was discovered by one man, explained by another and named after a third. Now that's random."
|How GM made $30 Billion
|"Consider this: How could it be that one of GM's most valuable assets, listed at $30.2 billion, is the intangible asset known as goodwill, when it's been only a little more than a year since the company emerged from Chapter 11 bankruptcy protection?"
|Do financial statements tell the truth?
|"Financial statements are like fictional works 'based on a true story'. They bear some relationship to actual events, but they are interpretations with their own biases and agendas."
|"Yet you don't have to be a forensic accountant to spot trouble on a financial statement. Here are several line items on a balance sheet you should focus on to gauge a company's strength, including inventories, free cash flow, and accounts receivable."
|What's on my shoe? EBITDAPO
|"Instead GM's advisors are plumping for enterprise value as a multiple of something called EBITDAPO. That's the same as regular old earnings before interest, taxes, depreciation and amortization, but with pension costs and other post-retirement employee benefits (OPEB) - healthcare, basically - also stripped out."
|Chinese firms using back door
|"When I asked Heckmann whether he would be leery of Chinese reverse mergers, he said that he wouldn't avoid just reverse mergers, but all Chinese companies, because it's simply too hard to determine the real numbers. One reason: He says he believes, from his experience, a primary goal of Chinese companies is tax avoidance."
|Capital can't be measured
|"Bank capital cannot be measured. Think about that until you really get it. 'Large complex financial institutions' report leverage ratios and 'tier one' capital and all kinds of aromatic stuff. But those numbers are meaningless. For any large complex financial institution levered at the House-proposed limit of 15x, a reasonable confidence interval surrounding its estimate of bank capital would be greater than 100% of the reported value. In English, we cannot distinguish 'well capitalized' from insolvent banks, even in good times, and regardless of their formal statements."
|Repo 105's antecedents
|"For those that don.t know Repo 105 was a sale and repurchase agreement by which Lehman parked about 50 billion in assets (presumably assets they did not want to discuss) overnight via a repo transaction so they would not appear on the balance sheet. By now anyone who does not realize that sort of accounting legerdemain is unacceptable is (a) entirely out of touch with reality and (b) self aggrandizing on a magnificent scale. Both are signs of mental illness."
|The SEC enabled this charade
|"The issue isn't derivatives; it's all financial transactions whose objective is to deceive or to weaken financial transparency."
|Quadrophobia: rounding of EPS data
|"We hypothesize that earnings management causes quadrophobia, the under-representation of the number four in the first post-decimal digit of EPS data. We demonstrate that quadrophobia is pervasive, persistent, and follows economically rational patterns. Consistent with analyst coverage being a determinant of earnings management, quadrophobia increases (declines) when companies gain (lose) analyst coverage, and is more frequent when earnings are close to analyst forecasts. Persistent quadrophobes are more likely to restate financials and to be sued in SEC proceedings alleging accounting violations. Quadrophobia, even if itself legal, therefore appears to signal a propensity to engage in problematic accounting practices."
|The 'lost decade'
|"In sum, there has been no justice, and thus, no lessons learned or changes made. And so naturally, the theme continues to roll on with products like leveraged ETFs - long on advertised promises, and short on explanations of their inherent shortcomings. After these products lose steam, the theme will be recycled with the same conclusion, that the promise of higher returns was just too good to be true."
|The worst footnote of 2009
|"Voting for the worst footnote of 2009 ended last night and footnoted readers have chosen the disclosure by Chesapeake Energy (CHK) that it had spent $12.1 million to purchase Chairman and CEO Aubrey McClendon.s antique map collection."
|Chanos condemns 'monstrous idea'
|"Famed hedge-fund manager James Chanos in recent speeches has outlined lessons from the financial crisis. A top one: 'Accounting matters a lot.' Chanos, who has flagged numerous accounting frauds over the years including the one that ultimately brought down Enron Corp., is concerned investors will quickly forget this and other warnings from the implosion of the financial system."
|How to catch a fraud
|"One indicator was particularly telling, and it's surprisingly obvious: number of employees. For companies that didn't commit fraud, the change in revenue and the change in employees stayed within about 4% of each other. For fraudulent companies, the difference was 20%."
|Goodbye to reforms of 2002
|"Sarbanes-Oxley was passed, almost unanimously, by a Republican-controlled House and a Democratic-controlled Senate. Now a Democratic Congress is gutting it with the apparent approval of the Obama administration."
|Magic tricks on the corporate books
|"Accounting shenanigans bubble to the surface every few years. In the dot-com days the trick was to book virtual revenues. After the tech bust, tinkering with expenses was all the rage. Now forensic auditors and analysts worry that troubled companies are playing fast and loose with asset valuations and cash management."
|Honest man emerges from banking crisis
|"With so many top executives complaining they can't figure out what their companies' assets are worth, the real wonder is that more corporate directors haven't quit rather than certify financial reports they don't understand."
|Back to square one?
|"After intense pressure from lawmakers and some factions of the financial industry, the Financial Accounting Standards Board (FASB) voted on Apr. 2 to make it easier for corporate management to value assets on their balance sheets with less regard for market prices. The board, which sets U.S. accounting policy, was cheered on by the banking sector and pressured by Congress. The move may make life easier for financial institutions, letting them ride the markets' gyrations with less risk that regulators will demand they raise funds or face closure. But at the same time, it could well cloud investors' insight into how well the banks are really doing. And some observers worry the new rules will also give banks less incentive to cleanse their balance sheets by getting rid of risky assets through the Treasury's new auction program, unveiled late last month."
|Botox earnings put crooked E in P/E
|"Comprehensive income is the change in a company's shareholder equity during a given period, excluding the effects of new capital injections and dividend payments. By this measure, S&P 500 companies had combined losses in the past four quarters of about $200 billion, according to data compiled by Bloomberg and my own review of the companies' financial reports. In other words, there is no P/E ratio, because there is no E."
|All about choice
|"Experience has told us that when the economy turns bad, it's time to expect more accounting shenanigans from public companies. This can happen in three ways. Sometimes, a company has been using aggressive accounting for years, and a dismal economic picture makes it difficult to hide the old chicanery any further. Other times, a firm decides to use accounting tricks to mitigate the impact of poor operating results. And then there are the opportunists, who use financial reporting to make bad times seem even worse, knowing that when the economy turns around, they can undo some of their overly negative accounting assumptions - and look all the better moving forward. This makes it an ideal time to review some of the potential accounting misfortunes that might befall investors as the economy sours."
|Accounting standards wilt under pressure
|"World leaders have vowed to help prevent future financial meltdowns by creating international accounting standards so all companies would play by the same rules, but the effort has instead been mired in loopholes and political pressures."
|Companies win, investors lose
|"The Canadian accounting standards board announced last week that they would let companies reclassify certain assets to delay reporting losses to investors. What happened was exactly what was warned about in these pages two weeks ago. Companies are being given more leeway to manipulate net income. In short, Canadian banks and insurers will report higher income than they otherwise could have in their forthcoming year-end reports."
|SEC agrees to accounting shift
|"The Center for Audit Quality, which represents accountants, said in a letter seven days later that perpetual preferred securities should be treated as equity because the holdings do not have a maturity date and 'the investor cannot recover its investment simply by holding the investment.'"
|Pass the buck
|"Statements such as .IFRS is already being used in most of the world.s major capital markets,. are clearly deceptions. Other claims, like that IFRS is .capable of consistent interpretation and application. around the world, contrast sharply with what the audit firms tell their clients in private. One large firm summed up IFRS as follows for its clients: More choice, less detail. Clearly, the private advice to clients is at odds with the public marketing efforts to investors."
|Fair value accounting rarely fair
|"Brooks added that,while FVA attempts to value investment vehicles by interpreting today's market value, proponents of this accounting standard fail to appreciate how the market works. "Fair value accounting will show a TSX sticker price for 3,000 shares the same as 300,000 shares - but the market shows us differently," explains Brooks."
|Wall Street says -2 + -2 = 4
|"Here's how it works, according to Richard Bove, an analyst at New York-based Ladenburg Thalmann & Co. A company decides to designate $100 million of its subordinated bonds as subject to mark-to-market accounting. The price of the bonds drops to 80 cents on the dollar from 100 cents. So the firm books $20 million on the 'presumed savings that you have on your liabilities,' Bove said. 'In the real world you didn't save a dime,' he said. 'You still owe the $100 million. It's another one of these accounting rules that basically takes you further and further away from reality.'"
|Banks keep $35 billion markdown off income statements
|"Banks and securities firms, reeling from record losses resulting from the collapse of the mortgage securities market, are failing to acknowledge in their income statements at least $35 billion of additional writedowns included in their balance sheets, regulatory filings show."
|"As Canada moves toward adopting International Financial Reporting Standards (IFRS) as the accounting standard for public companies, it is preparing to turn its back on decades of progress shoring up financial reporting in this country. Any regular reader of this column will know that Canada.s current mix of loose accounting and deficient securities enforcement is wholly unacceptable for investors. The introduction of IFRS in its current form will only make the situation that much worse."
|Lenders face still more misery
|"A closer look at the books of big lenders reveals several weak spots that haven't yet shown up in the financial results. At many banks, bad loans are piling up faster than the amount of money they're setting aside to cover them. Meanwhile, housing lenders booked income on vulnerable exotic loans and mortgage securities before they collected the money - paper gains that may be reversed through writedowns. Plus the values of some troubled loans, which have been trimmed modestly so far and shown up in previous losses, could still be overstated. Why haven't these items hit lenders' bottom lines? Largely because of the ambiguity and complexities of the accounting rules. Banks have a lot of wiggle room when it comes to reporting the profits and values of complex loans and securities. For one thing, their earnings can far exceed the amount of cash coming in the door. At the same time, their losses aren't always based on hard numbers but rather on debatable judgment calls. With the housing market showing no signs of recovery anytime soon, it's becoming clear that some of their assumptions have been overly optimistic."
|Loophole lets bank rewrite the calendar
|"In its financial statements for 2007, the French bank takes the loss in that year, offsetting it against 1.5 billion euros in profit that it says was earned by a trader, Jerome Kerviel, who concealed from management the fact he was making huge bets in financial futures markets."
|Debugging Wall Street's funky math
|"In the first half of the year, most Wall Street firms awarded themselves large profits from assets that are rarely traded and difficult to price, according to numbers contained in the brokerages' recent financial statements. But, with markets seizing up since the end of June, those assets could be even harder to value, potentially prompting investors and regulators to question Wall Street's earnings."
|A book-keeping error
|"New research suggests that the increasing reach of fair-value accounting might be a mixed blessing. A paper by Guillaume Plantin of the London Business School, Haresh Sapra of the University of Chicago and Hyun Song Shin of Princeton University concludes that fair-value accounting could sometimes generate fluctuations in asset values that distort the very price information that it puts such store by."
|Wells Fargo gorges on mark-to-make-believe gains
|"The board last September approved a new, three-level hierarchy for measuring 'fair values' of assets and liabilities, under a pronouncement called FASB Statement No. 157, which Wells Fargo adopted in January. Level 1 means the values come from quoted prices in active markets. The balance-sheet changes then pass through the income statement each quarter as gains or losses. Call this mark-to- market. Level 2 values are measured using 'observable inputs,' such as recent transaction prices for similar items, where market quotes aren't available. Call this mark-to-model. Then there's Level 3. Under Statement 157, this means fair value is measured using 'unobservable inputs.' While companies can't actually see the changes in the fair values of their assets and liabilities, they're allowed to book them through earnings anyway, based on their own subjective assumptions. Call this mark-to-make-believe."
|Alcan, BCE, Nortel cited for pension deficits
|"Alcan Inc., Nortel Networks Corp. and BCE Inc. top a list of 10 companies singled out yesterday by Moody's Investors Service Inc. for their underfunded pension plans. Moody's bond raters have been studying pension liabilities at the 300 or so Canadian entities it covers because the liabilities can have an impact on corporate credit ratings. Moody's hasn't cut any ratings because of underfunded pensions, said Waylon Iserhoff, senior accounting analyst and vice-president at Moody's, Toronto. But pension deficits bear watching because costs to top them up can reduce a company's flexibility to spend in other areas, Mr. Iserhoff said."
|Where Were The Auditors?
|"It's pretty clear by now that the stock option backdating scandal is much more widespread than initially believed. More than 150 companies are either embroiled in internal probes or are now being investigated by the Securities and Exchange Commission for potential stock option backdating abuses. The deluge is growing daily, with a fresh batch of companies announcing stock option accounting problems with each passing day."
|A worm in the Apple
|"Now the investigation into possible wrongdoing at the Silicon Valley stalwart is widening to include the past four years. Apple said in a release that it had uncovered "additional evidence of irregularities" and that it will likely have to restate financial statements and take "noncash charges" for employee compensation. The company said it could not yet determine the extent of the charges or the tax implications. It advised investors not to rely on financial statements and earnings-related press releases going back to Sept. 29, 2002."
|The trial of Sarbanes-Oxley
|"The act was named after its two main sponsors, Senator Paul Sarbanes (pictured right above) and Congressman Mike Oxley (left). Sarbanes-Oxley, or SOX, as it has become known, was unpopular with business people from the start. In recent years it has been hard to find a chief executive of a public company who does not complain vehemently about the burdens imposed by the dreaded SOX. Indeed, rather than diminish as the initial shock wore off, the complaints have only got louder. The SOX-bashers have been joined by such luminaries as Alan Greenspan, the former head of the Federal Reserve and Bob Greifeld, the boss of the NASDAQ stockmarket."
|The footnote fanatic
|"By obsessing over data buried in corners of corporate financial reports, onetime auditor David Trainer has come up with some surprising calls on stock buys and sells."
|Sarbanes-Oxley 'reform' harming economy
|"Although Sarbanes-Oxley was sold as a cure for Enron-like corporate misbehavior, the law mostly fails to target the real wrongdoers and instead punishes all public companies as a class. Its costliest part, called Section 404, mandates that auditors not just sign off on a company's numbers, but also its "internal controls.""
|Wild west accounting
|"If you steal a Canadian's wallet, you could end up in jail. But if you steal a Canadian's retirement savings, little is usually said or done about it. Unlike in the United States, we are not seeing any exemplary prosecutions for securities fraud in Canada. And without any widely perceived deterrent, we are virtually encouraging the scam artists to continue taking advantage of Canadian investors."
|Investing in the dark
|"One of my chief complaints about the trusts is that a majority of them don't seem to be setting aside enough money for maintaining their assets when it comes to calculating how much cash is available for unitholders. It didn't take some trust managers long to figure out that by underestimating maintenance needs, they could overstate distributable cash and get a higher selling price for their units. Recognizing that this is a problem, the CSA stated that it "might" require companies to improve disclosure on the issue in their prospectuses. The bigger problem, aside from the word "might," is how they are going to know who does and does not comply with this guidance. The truth will only be known years later when the selling shareholders have vanished and remaining investors have no recourse."
|Watchdog sniffs accounting firms
|"As a result of the inspections of 23 accounting firms, four firms have had restrictions placed on their business until they improve their auditing practices. Three firms (none of which are named in the report) have been barred from accepting new auditing work from publicly traded companies, while certain partners in a fourth firm will no longer be permitted to perform audits on publicly traded companies."
|A volatile brew
|"No more will investors be led astray by earnings that don't reflect the value of options to workers. Um, not so fast. Turns out the FASB didn't quite mandate the method managements use to figure out option costs, giving them wiggle room. Hence many companies have rewired the black box of accounting, the options pricing model, to ease the earnings hit--chiefly by tinkering with projected volatility assumptions of the underlying stock."
|Many trusts will turn out to be scams
|"Outspoken forensic accountant Al Rosen has a bit of a reputation in the industry. And it's no wonder. Rosen claims cooking the books is practically a national sport in Canada, laws make it impossible for investors to seek redress and because there are no big lawsuits, the issues are largely ignored by the media. Right now, Rosen has his sights set on income trusts. He says the market is running the same scam Nortel executives used in the late 1990s, only this time around the accounting tricks are being used by companies who are targeting retired people."
|Sarbanes seeks rent control
|"Dozens of companies have had to restate, adjust or delay earnings reports in recent months because of problems they've had in accounting for leases. Now some experts are warning that the restatements could be a sign of deeper problems."
|Earnings reports - PR tool?
|"While publicly held companies strive to put their best foot forward, too often they're disguising information that investors need to have"
|All together now
|"From 2005, more than 90 countries will either permit or require their quoted companies to present their accounts according to international financial reporting standards. This is a bigger step than many firms, or their shareholders, seem to realise"
|Firms must expense options
|"Companies must start expensing employee stock options in earnings statements next year, U.S. accounting rule makers declared on Thursday, a move that could signal the end of a long-standing bookkeeping practice that many argued allowed the masking of a key compensation cost."
|"Yet even as NGOs are becoming more cynical about what firms are producing, some investors now think it is (or could be) a valuable source of information, such as about business risks in a swathe of areas not included on standard financial balance sheets. "We are not social activists; we're independent risk assessors," says George Dallas of S&P. The information in non-financial reports "contributes to building up a company's risk profile." And although it has still not been convincingly demonstrated that good environmental and social practices create value for shareholders, it is clear, says Mr Dallas, that bad ones can destroy it. Exxon's cavalier attitude to the oil spillage from the Exxon Valdez drove customers away from its pumps."
|The fall of Andersen
|"Trading his customary dark suit for a pair of jeans, Mike Gagel trudged over pallet after pallet of multicolored bricks in the central Ohio storage yard. The summer heat was stifling as he counted once, then twice. Something was wrong."
|Reality vs. politics in accounting
|"Across the ocean, the House of Representatives voted 312-111 in favor of a bill that Warren Buffett has called "lunacy" but that the sponsors called the "Stock Option Accounting Reform Act." The bill would overrule the Financial Accounting Standards Board and let companies go on ignoring the value of options they give out."
|"The use of pro-forma earnings by a large number of companies is misleading not only for the specific companies involved, but for the market as a whole. Over a long period of time the average price-earnings ratio (P/E) for the S&P 500 has been about 15.5 times with a range, until 1998, of 22 on the high side to 7 on the low side. Keep in mind that this history is based on trailing reported earnings."
|Pensions: Still a problem
|"With the stock market's big recovery this year, worries about faltering corporate pension plans have all but faded away. But the pension mess is still very much with us."
|Tell it like it is
|"The time has come to change the way we design corporate pension plans, and here are seven concrete suggestions to help employers reduce their risk If you don't have a pension plan, don't start one"
|The horse is dead
|"I have spent most of my professional life trying to make defined benefit pension plans work -- for members as well as for shareholders. But as time passes and the pension system matures, the risks become harder to manage and the complexities harder to endure. And I wonder: Is there not a better way?"
|Still counting the cost
|"The lack of competition poses vexing problems. Chief among these, perhaps, is that the Big Four may all be too big to be allowed to fail. The point is not merely theoretical. In Britain, where auditors' liability is uncapped, a colossal lawsuit hangs over Ernst & Young, in relation to Equitable Life, a mutual insurer. In America Adelphia, a bust cable company whose former bosses are due to stand trial in January, is suing Deloitte & Touche."
|Unfunded pensions a problem
|"What's the single biggest cost in the making of a Chevrolet? Is it steel, technology, electronics, design or what? I bet that most of us don't know that the biggest cost component is medical care for retired workers."
|Issues with pensions
|"The pension issue for defined benefit pension plans is a problem in only some industries (such as manufacturing) but generally is being overemphasized as an issue in credit ratings"
|More pension troubles seen
|"While pension results continue to decline, the UBS study highlights that not all companies will share this pain in equal measure. A handful of companies, it notes, account for the lion's share of the funding shortfall. Just eight companies in its sample account for 70 per cent of the total pension shortfall -- $11.6-billion out of the $16.6-billion. The pension deficit at these eight companies also is greater than 10 per cent of their market capitalization as of July 7 of this year."
|Accounts must be brought to book
|"Bad accounting is an evil. But it's not unique to companies. The decline in standards has affected government accounts as well. There are examples both sides of the Atlantic. WorldCom has been lambasted for reclassifying current expenditure as capital. The same thing has been done in the national accounts of the US."
|The Enron story is nothing new
|"Long before Enron and off-balance-sheet accounting became part of the financial lexicon of average American investors, creative accounting was an accepted way of doing business in Silicon Valley. A small, perfectly legal and completely finished piece of financial engineering executed between 1998 and 2000 by Intuit illustrates that technology companies have long been willing to use accounting tactics to tell the stories they want told."
|Wall Street's den of thieves
|"The first thing you learn on Wall Street: Earnings don't mean anything. Everyone assumes that earnings are financially engineered ( sometimes downward! ) to meet a variety of stakeholder expectations. The key expectation -- the one that stakeholders want companies to meet -- is steady growth. Earnings that spike and swoon set off alarm bells at places like Fidelity. Steady growth makes fund managers feel calm and content."
|Optimism has no place in accounting
|"The fiasco at Enron had two causes: (1) perverted "financial engineering" that portrayed failure as progress and (2) generally accepted accounting principles that practically invited delusion and fraud."
|Stock options and common sense
|"The members of Congress decided to adjudicate the fight -- who, after all, could be better equipped to evaluate accounting standards? -- and then watched as corporate CEOs and their auditors stormed the Capitol. These forces simply blew away the opposition. By an 88-9 vote, U.S. senators made a number of their largest campaign contributors ecstatic by declaring option grants to be expense-free. Darwin could have foreseen this result: It was survival of the fattest."
|Prescription for disaster
|"In this post-Enron world, investors understandably want to know if Elan is an isolated case, or if the pharmaceutical industry is potentially as riddled with accounting problems as, say, the energy-trading business."
|How not to invest in the next Enron
|"While Wall Street analysts and Big Five auditors were looking the other way on Enron and financial journalists had their heads in the sand, signs of dubious accounting in Houston were there for anyone willing to wade through the company's mind-numbing corporate filings."
|Ex-Microsoft CFO steers new biz to negative revenues
|Hey, don't worry, they'll make it up on volume...
|Beware the buyback bonanza
|Share buybacks are only good news if the stock trades at a deep discount to fair value. Regrettably many high flyers use buybacks for more manipulative reasons...