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Minyan Mailbag: The Secrets of Company Earnings


...companies are "managing" earnings as much as they ever did.


Prof Succo,

One thing that has always puzzled me has been how common it is (or appears to be) that companies are able to meet their eps estimates or exceed them by a penny quarter after quarter. I own a small business with about 5 employees and each year I do planning trying to estimate costs and expected revenue and earnings. However, I never get it exact, especially quarter after quarter after quarter (perhaps this is an issue with me).

Public companies have tons of moving parts from having hundreds to thousands of employees to insure and provide retirement and pension expenses, raw material costs, sales, supply issues, equipment, technology costs, etc. It would seem statistically impossible for lots of companies to always meet their expected earnings or beat by a penny.

I wonder how many Minyans could accurately guess/estimate how much money they will have in their savings account in the next 3, 6, 9 and 12 months. The more I think about it, the more of a sick feeling I get that so many people are being fed a load for the enrichment of a few. Am I way off base? Thanks for sharing the truth and helping to answer the "why" questions.

Minyan Bryan


We were having this discussion last night at dinner.

You have put it succinctly and there is not much more for me to say other than in my opinion, companies are "managing" earnings as much as they ever did.

As you say, large companies have many moving parts and have several "tools" at their disposal.

The following is a list of the many shenanigans companies play to accomplish "smooth" or bogus earnings:

  • Recording revenue too soon or of questionable Quality
  • Recording revenue when future services remain to be provided
  • Recording revenue before shipment or customer's unconditional acceptance
  • Recording revenue although customer is not obligated to pay
  • Selling to an affiliated party
  • Giving customer something of value as a quid pro quo
  • Grossing-up revenue
  • Recording bogus revenue
  • Recording sales lacking economic substance - side agreements
  • Recording cash received from lender as revenue
  • Recording investment income as revenue
  • Recording as revenue supplier rebates tied to future required purchases
  • Release revenue improperly "held back" before a merger
  • Boosting Income With One-Time Gains
  • Recording gains selling assets recorded at deflated book value
  • Including investment income or gains as revenue
  • Including investment income as reduction in operating expenses
  • Creating income by reclassification of investment gains
  • Shifting current period expenses to a later or earlier period
  • Capitalizing normal operating costs, particularly if recently changed from expensing
  • Changing accounting policies and shift current expenses to an earlier period
  • Amortizing costs too slowly
  • Failing to write-down or write-off impaired assets
  • Releasing asset reserves into income
  • Failing to record (or Improperly Decreasing) liabilities
  • Failing to record expenses (and related liabilities) when future obligations remain
  • Reducing liabilities by changing accounting assumptions
  • Releasing questionable liability reserves into income
  • Creating sham rebates
  • Recording revenue when cash is received, yet future obligations remain
  • Shifting current revenue to a later period
  • Creating reserves and releasing them into income in a later period
  • Improperly holding back revenue just before an acquisition closes
  • Shifting future expenses to the current period (as a One-Time Charge)
  • Improperly inflating amount included in special charge
  • Improperly write off in-process R&D costs from acquisition
  • Accelerating discretionary expenses into the current period

A couple of adds on cash flow:

  • Securitizing receivables
  • Creative financing of accounts receivables
  • Outstanding checks overdrafts included in CFFO
  • LT Accounts or Notes Receivables recorded in investing section
  • Tax benefits from exercised stock options
  • Cash expended to offset dilutive effect
  • Characterizing transactions as non-cash to boost FCF
  • Keeping capital expenditures off the Cash Flow Statement

The most egregious of these offenses is the "recording of investment income as revenue" category. This is more commonly known as stealing money from the pension plan and becomes exposed when companies go bankrupt like the airlines. The average assumption company pension plans are making and their rate of return on assets is around 8%. If companies lowered this assumption as they should to reflect more reasonable expectations you would see massive write-offs from earnings.

In fact, new FASB rules being considered would require companies to pull the funded status of their pensions and OPEB (post retirement employee plans) out of the footnotes and put them on the balance sheet, possibly by the end of next year. A large research firm estimates that would cause the total shareholders' equity for S&P 500 companies to drop by 7% and for 25 of the largest capitalization companies to drop by over 25%, thus affecting debt to equity ratios and possibly debt covenants.

And par for the course, Wall Street is not worrying about this now.

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