Our entire corporate tax system is skewed in favor of skilled “accrual-based” economics that push taxable earnings forward so the government can feast on monies today that actually have not come in yet. The accrual system of accounting was designed to match manufacturing costs with the revenues that will come in when the goods so manufactured are sold, often in a subsequent year. In the simplest of terms, the expected revenues from future sales are brought back to the year of manufacturing to figure out what the profits will be… and then taxed before they are necessarily received.
Well and good in an earlier era where companies focused on a single line of business, did not have overseas operations, joint ventures, multiple lines of business, service income and lots of subsidiaries. That’s just not the real world today. And since accruing income generates great “earnings” reports, and since share prices are based in part on earnings, many companies don’t mind paying that extra current tax if they can jack up their share prices. In a strange way, the government is complicit in this fraudulent overstatement of value by insisting on the accrual system of accounting.
But to curb abuses and standardize financial statements in the U.S., the Financial Accounting Standards Board (FASB) sets out rules (Generally Accepted Accounting Principles or GAAP, which may differ in different countries) for certified public accountants presenting certified financials, at least allowing apples-to-apples financial comparisons and analyses. They tell you how quickly you can write off expenses, when you can write them off, when to accrue income (and the limits to such accruals), how to treat income from joint ventures and subsidiary operations, etc., etc. The IRS and state tax statutes and regulations put hard boundaries on financial reporting, at least for tax purposes, and in theory, the federal Securities & Exchange Commission (SEC) is supposed to regulate public corporate financial statements to protect the public from receiving misleading financial information. In theory.
The SEC requires GAAP accounting in public corporate statements and filings, but the Republican Congress, which has announced to the world that it opposes most forms of federal regulation (particularly in the financial and environmental sectors), has systematically cut the SEC’s budget in hopes that they can deregulate indirectly. The plan worked. So corporations are increasingly releasing financial reports that restate the company’s performance in more flattering terms… and intentionally avoid compliance with GAAP requirement… knowing that the odds of an SEC enforcement action are minimal. Simply, they have a proclivity to overstate earnings and understate costs. Last time companies played this flagrantly with numbers, the SEC reacted quickly and severely. Not happening today.
“Lynn E. Turner was the chief accountant of the S.E.C. during the late 1990s, a period when pro forma figures really started to bloom. New rules were put in place to combat the practice, he said in an interview, but the agency isn’t enforcing them.
“For example, Mr. Turner said, some companies appear to be violating the requirement that they present their non-GAAP numbers no more prominently in their filings than figures that follow accounting rules.
“‘They just need to go do an enforcement case,’ Mr. Turner said of the S.E.C. ‘They are almost creating a culture where it’s better to beg forgiveness than to ask for permission, and that’s always really bad.’
“As it happens, the commission is in the midst of reviewing its corporate disclosure requirements and considering ways to improve its rules ‘for the benefit of both companies and investors.’… This would seem to be a great opportunity to tackle the problem of fake figures. But such work does not appear to rank high on the S.E.C.’s agenda.
“Kara M. Stein, an S.E.C. commissioner, expressed concern about this in a public statement on April 13. Among the questions the S.E.C. was not asking, she said: ‘Should there be changes to our rules to address abuses in the presentation of supplemental non-GAAP disclosure, which may be misleading to investors?’
“With the presidential election looming, [Jack T. Ciesielski, publisher of The Analyst’s Accounting Observer] said it was unlikely that any meaningful rule changes on these types of disclosures would emerge anytime soon. That means investors will remain in the dark when companies don’t disclose the specifics on what they are deducting from their earnings or cash flow calculations.” Gretchen Morgenson writing for the New York Times, April 22nd.
But exactly how prevalent is this trend towards misreporting? “According to a recent study in The Analyst’s Accounting Observer, 90 percent of companies in the Standard & Poor’s 500-stock index reported non-GAAP results last year, up from 72 percent in 2009… Regulations still require corporations to report their financial results under accounting rules. But companies often steer investors instead to massaged calculations that produce a better outcome.
“I know, I know — eyes glaze over when the subject is accounting. But the gulf between reality and make-believe in these companies’ operations is so wide that it raises critical questions about whether investors truly understand the businesses they own.
“Among 380 companies that were in existence both last year and in 2009, the study showed, non-GAAP net income was up 6.6 percent in 2015 compared with the previous year… Under generally accepted accounting principles, net income at the same 380 companies in 2015 actually declined almost 11 percent from 2014.” NY Times. And exactly how are taxpayers and shareholders supposed to benefit, how is their government working for them by fostering honesty and transparency, from this complete failure to support the regulatory mandate of the SEC?
I’m Peter Dekom, and how comfortable do you feel living in a society where so many of the most relevant facts and statistics – numbers folks and the government use to create and implement policy and make decisions – are just plain fabricated?
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