Accounting & Tax

Ledger Domain: Explaining Away Bad Numbers

Another earnings season means one thing: creative reporting by some CFOs.
Stephen TaubOctober 2, 2001

The earnings reporting period that gets under way in a week or so should prove mighty interesting.

Clearly, a lot of companies are going to miss their consensus forecasts. But beyond that, this next batch of earnings reports will underscore the true creativity of finance executives.

First, a number of businesses will no doubt explain away their woes with the words ”September 11” or ”terrorist attacks.” Some excuses will be legitimate; many won’t.

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Further, expect to see some fascinating numbers coming out of Silicon Valley — pro forma numbers, to be precise. If only they were.

The fact is, technology companies have been the biggest embracers of pro forma results, which are really only hypothetical numbers. Or, more aptly, they are the numbers that the companies want you to think about — even though those numbers rarely reflect the true health of a company’s ongoing operations.

Obviously, pro forma numbers are generally much different than the ones companies must submit to the Securities and Exchange Commission. Those results, which must be calculated under Generally Accepted Accounting Principles, are frequently buried in corporate press releases.

If you don’t think there’s a disparity between pro forma results and GAAP results, chew on this: The Associated Press did an in-depth analysis of earnings reports by the 100 largest technology companies in northern California. The wire service calculated that, under GAAP standards, the 100 companies have reported combined losses of around $71 billion. Using pro forma figures, however, these same companies reported a tidy profit of $10 billion.

What accounts for the difference? Accounting. The AP survey noted that under GAAP, the 100 companies reported about $82.8 billion in bad investments, layoffs, and other special charges this year, up from $5.6 billion last year. The wire service found that JDS Uniphase alone accounted for $50.6 billion in losses.

Granted, pro forma figures have their place on a financial statement, particularly when used to exclude extraordinary events that don’t impact a company’s true performance. That includes things like noncash writeoffs for intangible assets associated with an acquisition.

But managers at some companies like to exclude items like inventory writeoffs when reporting pro forma results. Amazon.com, for example, has occasionally excluded stock-based compensation costs, goodwill amortization, and impairment-related and restructuring charges when reporting pro forma results.

Accountants at FASB seem to think the use of pro forma results is an important issue. According to the Associated Press, the independent accounting rules-making organization has set October 5 as a deadline for submitting comments on the issue. Stay tuned.