Accounting Onion

Do Survey Results Mean that External Audits Don’t Protect Against Earnings Manipulation? (What a Surprise!)

Tom Selling — Tue, 14 May 2013 06:23:32 +0000

The results of a recent E&Y survey investigating financial manipulation must stun even the most cynical observers of accounting practice,:

Of the board members and senior management surveyed from companies in Europe, Middle East, India and Africa (EMEIA), 42% stated that their company’s sales and/or costs had been manipulated in the past fiscal year. The above percentage varies somewhat between companies in “developed” versus “rapid-growth” markets, but this does not blunt the overall impression of rampant financial statement manipulation. “In the financial services sector — where regulatory action has been intense [and should be a deterrent] — 9% of respondents had seen revenues recorded before they should have been; 7% were aware of underreporting of costs [it's not clear if this should total to 16%, or if there is some overlap]; and 9% knew of customers being sold unnecessary products to meet short-term sales targets.”

WOW. The actual numbers are probably even worse than what has been reported; because it stands to reason that at least some survey respondents would be cautious about admitting their company did a bad thing, even in the context of a confidential survey.

The leader of the study was David Stulb of EY’s Fraud Investigation & Dispute Services practice. He was interviewed [Read More...]

Could a Simple Spreadsheet Error Turn into Wall Street’s Watergate?

Tom Selling — Sun, 05 May 2013 00:39:57 +0000

A couple of posts ago, I waded in on the infamous Reinhard & Rogoff spreadsheet error, in an attempt to extract lessons of a cautionary nature for accountants of public companies.

Since then, two interesting developments have occurred. First, I stumbled upon a research report published by the Financial Executives Research Foundation (FERF), which indicated that spreadsheet solutions — as opposed to automated processes — are still prevalent among the public and private companies studied. It’s nice to have some indication that my concerns regarding widespread control issues amount to something more than mere academic musings.

The second development to occur serves as the motivation for this spreadsheet encore: Ken Baker, whose research I referred to in that earlier post, emailed me the ZeroHedge analysis of a pretty consequential JPMorgan spreadsheet error; which although it did not seem to affect the financial statements, did affect important MD&A disclosures. I found similar coverage of the JPMorgan error in other online news outlets, but my admittedly cursory reading found no discussion of the question of how regulators might/should react to the error — and ensuing disclosures.

Background: The SEC’s Market Risk Disclosures and The Nature of the Spreadsheet Error

Public companies are generally required [Read More...]

Grilled Accounting Onions

Tom Selling — Wed, 01 May 2013 00:41:10 +0000

Rob Nance of iShade, the online accounting network, recently interviewed me for his own blog. With Rob’s permission, I’m repeating (with some minor edits to my responses) his post, below.

* * * * *

Ever read The Accounting Onion? It’s a great addition to our profession’s giant accounting sandwich. Find out more about its creator, Tom Selling PhD, CPA, in this delightful, informative interview. You’ll never think about an onion the same way.

Q: What would you most like the accounting profession to know about what’s going on in Washington D.C.?

Ever since the FASB and IASB have embarked on convergence, it seems that the SEC has disengaged itself from the accounting standard setting process. The result, I believe, is that FASB projects take forever; because there is no longer a credible threat that the SEC could preempt a stalled or misdirected process by issuing its own guidance. For example, it seems that pretty much everyone thinks that bankers, and not the SEC, are effectively the clients for the proposed loan impairment standards. The bottom line is that I don’t think the SEC is doing its part to ensure that low-quality accounting standards will not [Read More...]

Why We Love Spreadsheets Too Much

Tom Selling — Thu, 25 Apr 2013 07:10:16 +0000

I have been a habitual spreadsheet user for 30 years, and a Keynesian for, like, forever. That particular pairing of predilections is probably why I experienced a brief and thrilling shiver of Schadenfreude as I read one of the many tellings in the press of the replication of a study frequently cited by deficit hawks, “Growth in a Time of Debt.” The results of the replication have called into question the accuracy of the original findings, and much of the brouhaha centered around the unearthing of a bug in an Excel spreadsheet. As reported in the LA Times:

“A new study by three researchers at the University of Massachusetts finds that Rogoff and Reinhart made several mistakes that invalidate their thesis. … Most important, they made a spreadsheet error that resulted in their leaving five countries out of an all-important average of countries with higher than 90% debt-to-GDP ratios. By restoring the full average, the UMass authors say, the growth rate for countries in that range becomes 2.2%, not the -0.1% cited by Rogoff and Reinhart.” [emphasis and link added]

But why, you may ask, is this an appropriate topic for this particular blog, which putatively concerns [Read More...]

Loan Accounting? The Public Can’t Handle the Truth!

Tom Selling — Fri, 19 Apr 2013 06:24:31 +0000

Even if the average citizen might have shrugged with resignation over the Senate’s abandonment of gun control legislation, surely she must be in awe of the power of the NRA to bend democratically-elected senators to its will. On a less-visible front, the FASB and IASB are doing their best imitation of U.S. Senators to appease even more powerful patrons than the NRA — very rich bankers.

The tune the accountants are singing about loan accounting is from the same songbook as the politicians, but played in a different key: inaction must be disguised as well-considered action. Actually, though, one FASB member has been doing something. Tom Linsmeier collaborated on a recently-published study* with three professors from Stanford, Michigan and Michigan State:

“Many have argued [principally, the ABA] that financial statements created under an accounting model that measures financial instruments at fair value would not fairly represent a bank’s business model….

We find that leverage measured using the fair values of financial instruments explains significantly more variation in bond yield spreads and bank failure than the other less fair-value-based leverage ratios [under U.S. GAAP or under regulatory rules for "Tier One" capital] in both univariate and multivariate analyses. We also find [Read More...]

Financial Accounting’s Relevance Lost

Tom Selling — Mon, 01 Apr 2013 04:12:58 +0000

My best insights (but who am I to judge?) come from reading something for which accounting is the furthest thing from the author’s mind:

“My own view is that people tend to underestimate the pace of technological change but they tend to overestimate the pace of human change. That is, if you go back to past visions of the future as they were displayed in world fairs, for example, they generally fail to anticipate how quickly we will invent things like wireless communication, but they always imagine that social structures will change faster than they actually do. They imagine people living without nuclear families, without dysfunctional political squabbles. They imagine that technology will streamline and rationalize social institutions. That never happens.” [emphasis added]

David Brooks, a moderate conservative, and his liberal colleague, Gail Collins, are widely read NYT columnists in their own rights. A couple of years ago, they decided to collaborate on “The Conversation,” a series of columns that is adequately described by the series title. That these two can have a humorous and constructive give-and-take in this polarized political climate is worth noting all by itself.

But, more to the point, the above statement from Brooks struck the nerve [Read More...]

How Deferred Tax Accounting Blunts Government Incentives to Invest in Renewable Energy

Tom Selling — Mon, 18 Mar 2013 07:46:52 +0000

One of the items in my inventory of pet peeves when I first started blogging (six years ago!) was interperiod tax allocation, familiarly known as “deferred tax accounting.” I’ve always objected to it on theoretical grounds, and know that it owes its existence to political conspiracy.

The theoretical issues are pretty much covered in college textbooks, so let’s review them extremely cursorily:
Are the potential future tax consequence of book/tax basis differences appropriately recognized as liabilities or assets? Not in my world. For one thing, if a company incurs losses, it won’t have future taxable income, and hence, won’t have to pay any income taxes at all. Assuming that a deferred tax liability/asset is appropriate to record, is it appropriately measured without taking into account the time value of money? Of course not, silly!
The political conspiracy angle is, somewhat understandably, given shorter shrift in the textbooks, and it derives from the theoretical questions. An empirical fact that I myself tested a number of years ago is that the ratio of reported “current tax expense” to reported net income before taxes is significantly lower than the statutory corporate tax rate. This is often due to timing differences like accelerated depreciation for the corporate tax return, [Read More...]

Has Convergence Been a Mixed Bag or a Bag of Fertilizer?

Tom Selling — Thu, 07 Mar 2013 23:40:54 +0000

Continuing with my theme of the U.S. GAAP/IFRS convergence misinformation campaign being waged by the Journal of Accountancy, the latest and greatest example is an article from the February edition, “What have IASB and FASB Convergence Efforts Achieved?” that appeared in the February issue.

That’s a big question to get one’s arms around in a slim magazine that can devote at most six or seven pages to one article. So, it’s informative to see how author Paul Pacter handled this weighty question.

The centerpiece of the article, and to my way of thinking its most useful part, is a four-column table listing all 37 convergence project. The other three columns describe the actions taken, the convergence outcome— and whether, in Mr. Pacter’s (a recently-retired IASB member) opinion, the project resulted in an improvement to IFRS.

After the table, there’s not much to the article. JofA is formatted like a conventional magazine with 3 columns per page. Within the non-table pages, the text adds up to about four columns—and, I’m not exaggerating, only three paragraphs directly address the topic promised by the article’s title. Honestly, I don’t know if I have ever seen an article posted any journal with a table longer than the text. [Read More...]

Don’t Rely on “Journal of Accountancy” for Balanced Reporting of IFRS

Tom Selling — Tue, 19 Feb 2013 23:02:44 +0000

In the main, the only reason my wife and I subscribe to magazines and newspapers in hardcopy is because she prefers them. I much prefer to get as much as possible from the web; the lone anomaly being the Journal of Accountancy, which I have received continuously since becoming a member of the AICPA in the late ’70s. According to the AICPA’s own FAQ page, there are nearly 370,000 members. Since nobody has ever asked me whether I actually want to receive my very own hardcopy, I presume that every member gets one.

In case you are interested, one obvious difference between JofA and my humble blog is circulation: compared to JofA, I am but a grain of sand. But there is another big difference: whereas I am opinionated, JofA is biased. Consequently, I can find hardly anything (except for some nerdy tips on using Excel) that is worthwhile reading; and once per month, I rue the number of trees that have died on my account.

JofA in the Good Old Days

My strong recollection is that JofA wasn’t always as biased and narrow as it has become in the last twenty years or so. For confirmation, I conducted a very modest experiment. I [Read More...]

Caterpillar: Another Sad Example of Bad Goodwill Accounting

Tom Selling — Mon, 04 Feb 2013 08:49:27 +0000

After having just written a post on HP’s massive write-off of goodwill, I am reluctant to keep on banging the drum of how bad goodwill accounting can be. But, I can’t resist following up on Bloomberg columnist Jonathan Weil’s coverage of yet another recent acquisition by a big-time company that went sour practically out of the box.

Mr. Weil’s main motivation was to express annoyance at companies that are wont to characterize asset impairment charges as being “non-cash” in nature — as if it could mute the impact of the largest single accounting entry by the company in recent memory. ‘If mistakes were made, they’re history. So just fuggedaboutit.’

But, in Caterpillar’s case, I think it goes deeper than merely choosing the words for best (or least bad) effect: it’s misleading.

The sad story began last June, when Caterpillar Inc. acquired ERA Mining Machinery Limited (ERA), including its wholly owned Chinese subsidiary Zhengzhou Siwei Mechanical & Electrical Manufacturing Co., Ltd., commonly known as “Siwei.” According to Caterpillar’s 10-Q for its second quarter, tangible assets acquired and recorded at fair value totaled $671 million, customer relationships and trade names were valued at $105 million, liabilities assumed were $592 million and goodwill in the amount of $461 million was recognized.

“Goodwill … represents [Read More...]