US Business Accounting – Built of Fraudulent Bricks & Mythological Assumptions

 

US Business Accounting – Built of Fraudulent Bricks & Mythological Assumptions

It’s Not Just Legal, It’s Mandated!

Corporate accounting is predicated on an owner/management desire to overstate positive news and understate negative news, and the government’s desire to take advantage of that perpetual trend. For publicly traded companies, the primary metrics of success and failure are balance sheets, earnings/income and cash flow statements. The time metrics are the “quarter” and the “year.” And the mega-tool of financial manipulation is the required “accrual basis” accounting required of all but the smallest corporations.

When it is first explained in any accounting class, “accrual basis” accounting is an effort to align the cost of manufacturing a product against the income generated from the sale of that product. Economists love to call those items “widgets,” a term with an expanded definition in the Internet era. Since manufacturing usually takes place before a sale, and since the government does not want a company to postpone paying taxes (mild conflict of interest), accrual accounting will bring the expected income from the future sale of that item into the year of manufacture. It was usually a reasonably accurate guestimate, subject to ultimate adjustment based on actuals in the future.

Sounds just fine… sort of… until you factor in the rise in the complexity of modern manufacturing, the requirement of multiple vendor/sub-manufacturers, joint ventures, off-balance-sheet financing, globalization, off-shore partners and planning, outsourcing, the value and allocation of underlying intellectual property (patents, trademarks, copyrights, etc.), the use of subsidiaries and third party aggregators, venue shopping for tax advantages… and the required evolution of rules for capitalizing some costs, expensing others, amortization/depreciation (including special rules available to targeted industries like oil and gas), deferring or accelerating expected income, interest deductions, etc., etc., etc. Loopholes to some. Sensible incentivizing to others. All distortions of actual money flow… subject to the impact of mega-moments of unexpected crises.

For corporate planners of public companies, they generally target a slow, steady annualized growth percentage (20%+ in good times and 10%+ otherwise), measured quarter-by-quarter. Expecting too much now and not so much later, shift income forward. Subject to rules aimed at over-forecasting upside, accrue “future” money into relevant current quarters to show Wall Street how valuable your shares should be – pay the damned income tax to the government that is effectively your co-conspirator in this financial hyperbole – and worry about possible future issues… oh, in the future.

For some industries, average performance metrics from similarly situated competitors may force managers to adopt policies that may ultimately appear totally foolhardy in a year or two. Cut costs no matter the longer-term consequences. Don’t keep on-site inventory; use “just in time” supply-chain systems. Pay shareholders a dividend regardless of the capital needs of the company. For recent acquisitions of other corporations, lay-off, cost-cut and load that acquisition with tons of debt, debt used to pay the acquiring parent a pile of cash, with the debt still sitting in the acquired entity… and spin that acquired entity off… woo hoo! The avarice and short-term mindset of Wall Street does not seem to care about long-term strategies and values. The professional investment groups, hedge funds, private equity, merchant banks and infamous billionaire predators will be long gone by the time those feeble chickens come home to roost.

Why this blog now? Because the fact that over 85% of the December “bomb cyclone” related flight cancelations came from one airline – Southwest – which is the poster-company for what’s wrong with corporate accounting. Simply put, while other airlines worked it out, Southwest’s years of cost-cutting left it with operational systems and software that were incapable of facing any level of significant stress. It’s not as if Southwest is unique; there’s a bigger pattern here. As Michael Hiltzik tells us in his December 29th editorial for the Los Angeles Times, it was simply Southwest’s turn at failure:

“For decades, Big Business has been squandering its resources on handouts to shareholders instead of spending on workers and infrastructure. There’s not enough give in the system, so when crisis comes, it doesn’t bend, but breaks… What drives this tendency is economics. Business managements have become hostages to cost-cutting, squeezing expenses out of their systems in every way possible, trusting to luck that what works under normal conditions will continue to work when the outside world goes haywire. They’re betting their companies on a bad strategy.

“There are numerous manifestations of this cheeseparing habit. One is just-in-time production, which spread like wildfire from Toyota, where it originated in the 1980s, to the rest of the automobile industry and eventually to the manufacturing sector generally… The idea was to slash waste by coordinating inventories of parts, the supply of workers and the time for production so that everything was in place when needed and not a minute before or after… The pace of work sped up, workers were squeezed on wages and hours, parts suppliers operated on ever-narrower margins. It all worked fine, until it didn’t.

“The dream of a production line ‘inherently flexible, inventoryless, even computerless, replenished by infinitely responsive suppliers’ was too simple, Uday Karmarkar, an expert in manufacturing strategy and technology at UCLA’s Anderson School of Management, observed as long ago as 1989. ‘Just-in-time manufacturing is producing revolutionaries who don’t know when to stop.’… Beginning in the summer of 2021, logjams in the global supply chain, compounded by a surge in post-pandemic goods orders from consumers returning to shops, left manufacturers without needed parts and retailers without merchandise… Only since that crisis erupted have manufacturers recognized that they need to move away from just-in-time to just-in-case — that is, keeping more parts inventory on site and more workers, with better training, on call.

“Another manifestation is outsourcing. Boeing could have learned the lesson that outsourcing can increase costs and place a heavy burden on management from its experience with its 787 Dreamliner… The next-generation aircraft came in billions of dollars over budget and years behind schedule when it finally began to fly commercially in 2011, in part because Boeing farmed out more of the work to foreign contractors…. Some of the pieces manufactured by far-flung suppliers didn’t fit together. Some subcontractors couldn’t meet their output quotas, creating huge production logjams when crucial parts weren’t available in the necessary sequence.

“‘We gave work to people that had never really done this kind of technology before, and then we didn’t provide the oversight that was necessary,’ Jim Albaugh, then the company’s commercial aviation chief, acknowledged. ‘The pendulum swung too far.’… Yet Boeing pursued an outsourcing strategy for crucial systems in its 737 Max. After the plane suffered two fatal crashes in 2018 and 2019 because of malfunctioning software, leading to a years-long grounding by aeronautics regulators around the world, Bloomberg reported that Boeing had outsourced its software development to overseas firms employing engineers for as little as $9 an hour.” Hope and luck are no substitute for solid business planning based on reality.

I’m Peter Dekom, and American businesses are not engines that operate on a quarterly basis; they’re just measured that way… with rules that compound complexity and distort genuine business planning.