Accounting & Tax

Expenses as Earnings Management?

Latest FASB guidance means corporates can use out-of-pocket expenses to boost earnings.
Alix StuartFebruary 6, 2002

The Financial Accounting Standards Board’s (FASB) recent effort to clarify accounting for out-of-pocket expenses has left many CFOs scratching their heads. Such expenses, which are reimbursed by clients, typically are a wash for companies. But remarkably, FASB’s Emerging Issues Task Force concluded in November that out-of-pocket expenses should be included as revenues. The FASB guidance, which is not a rule, took effect this quarter.

“There is nothing gained and potentially something lost by this ruling,” says Edward Goldfinger, CFO at IT consulting firm Sapient Corp. “It allows for artificially-inflated revenues at a time when many companies are being valued on revenue multiples.”

A number of consulting-industry CFOs wonder if FASB is actually trying to aid earnings management. At the very least, the ruling — which does not require a company to specify which portion of revenues is coming from reimbursables — could lead to some chicanery. Says Inforte Corp. CFO Nick Padgett: “I think it’s going to lead to a lot of gaming.”

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Padgett, for one, sent an eight-point letter to FASB director Timothy Lucas criticizing the decision. The letter also included Padgett’s personal survey of eight analysts — none of whom favor the announcement. Says Padgett flatly: “I have yet to talk to a single person who thinks this is a good idea.”

FASB must. While officials at the standards setter briefly reconsidered the expense issue in January, the board made no changes to the guidance. The basis for its decision, FASB said in a statement announcing the guidance, was a board ruling two years ago that requires companies to include bill shipping and handling charges in revenues.

The upshot of the new guidance? Companies must now factor client reimbursements into revenues, and report any costs charged to clients as expenses. Businesses must also restate past revenues to conform to the new guidance.

Some observers believe FASB is merely trying to shed a little light on the financial statements of consulting firms. Wachovia Securities analyst Clint Fendley points out that consultancies take on some credit risk by covering things like hotel bills and airfare. Indeed, a Wachovia survey found that reimbursables make up around 15 percent of billed revenue for technology consulting firms. That figure goes even higher for firms with consultants who travel a lot, the survey found.

Nevertheless, Fendley disagrees with the FASB decision. “We believe that the net presentation is more conservative and are disappointed by the task force’s move,” he wrote with Wachovia analyst Edward Caso in a recent report. Although the reporting changes won’t affect bottom-line results, he says gross margins may be trimmed by up to 400 basis points.