Why Pencils Have Erasers : Mistakes at Patlex, MiniScribe Show Even Accountants, Auditors Can’t Always Add Right

Patlex Corp., a Chatsworth company that earns money from laser patents, last month issued a typical press release announcing its first-quarter financial results. The numbers showed a near tripling of Patlex’s profit, to $797,000 from $287,000 a year earlier.

But a week later, on May 25, Patlex issued another press release--this one far from typical. Patlex said its profit for the quarter that ended March 31 actually was $70,000 higher than had been originally reported.

Patlex Treasurer Richard Laitinen said its outside accounting firm, Wiss & Co. of Livingston, N.J., simply goofed. It was “an honest-to-goodness mistake,” Laitinen said.

Edward O’Connell, a Wiss partner, said the error was as simple as “not dividing something by four.” As a result, Patlex’s tax liability in the quarter initially was miscalculated.

But he laid part of the blame on Patlex, saying the company rushed the numbers out to the public--before Wiss’ management could thoroughly review their accuracy--so that Patlex’s sparkling results could be available in time for Patlex to announce them at its annual meeting May 17. “There was a lot of pressure from management to get the thing done in time for the stockholders’ meeting,” O’Connell said.

The mistake at Patlex provides a glimpse into the arcane world of corporate accounting and underscores how even experienced corporate number crunchers occasionally have trouble counting, particularly when they grapple with the Byzantine federal tax laws and the accounting profession’s own guidelines, which often are open to wide interpretation. For investors, of course, publicly released financial results have a major bearing on whether they buy or sell a company’s stock.

In Patlex’s case, it corrected the numbers quickly. But in other cases, accounting mistakes might not be uncovered for years.

Consider the math problems at MiniScribe, the Longmont, Colo.-based maker of computer disk drives. Last month, MiniScribe announced that its financial results for the last three years “should not be relied upon,” partly because the figures overstated the size of its assets. Overstating assets could mean that MiniScribe overstated its profit and net worth for three years.

During those years, MiniScribe’s chairman was Q. T. Wiles, a Sherman Oaks businessman who is considered a corporate turnaround specialist. But Wiles quit in February amid mounting financial woes at MiniScribe.

On the day that MiniScribe admitted its accounting mistake, its stock sank 40% to less than $2 a share. Not surprisingly, the company has been hit by nine shareholders’ lawsuits alleging that the company broke various securities laws.

MiniScribe said it earned $26 million on sales of $603 million and had assets of $492 million in 1988. Those figures no longer seem chiseled in stone.

A MiniScribe spokeswoman said the company’s outside auditor has been Coopers & Lybrand, one of accounting’s “Big Eight” firms, but that MiniScribe is not blaming the firm. Instead, she said, MiniScribe suspects that its own internal accounting guidelines “were circumvented.” In other words, MiniScribe’s own financial people apparently provided Coopers & Lybrand with incorrect or unreliable figures.

As the Patlex and MiniScribe cases show, it’s not just small auditors such as Wiss that sometimes don’t spot problems in time. Even the Big Eight firms say they can only audit the figures that they receive from a company. If the company gives them wrong numbers, the incorrect results might very well go unchanged.

In rare cases, the investing public can be duped by out-and-out fraud. In recent years the most extreme example of this was ZZZZ Best, the Reseda carpet-cleaning company founded by teen-ager Barry Minkow.

ZZZZ Best submitted phony numbers to its accountants, and company officials went to great lengths to pretend that it was actually a growing, profitable firm when it was not. The accountants didn’t catch on, and $13 million worth of stock was sold to the public. The company later collapsed, Minkow was sentenced to prison, and the accounting firms that were duped by Minkow have all been sued by investors.

More typically, however, every effort is made by a company and its accountants to get the numbers right. A company’s own financial people calculate the numbers to produce quarterly and annual results. Then most companies hire an outside accounting firm for help, such as explaining tax questions or doing a complex calculation.

For a company’s full-year results, the accountants do a thorough audit. Then they must certify whether the numbers fairly represent the company’s performance and whether they are in compliance with the industry’s so-called “generally accepted accounting principles.”

To be sure, accounting is a complicated business, and companies are given wide latitude in how they depreciate assets, which in turn affects their profitability. Should a company change those depreciation schedules by several years, a company might be able to report profits where losses would otherwise have been reported, or vice versa.

Of all a company’s financial statements, its quarterly financial statements are the ones most likely to contain errors because they “would not be subject normally to an audit but to lesser scrutiny,” said Doyle Williams, an accounting professor at USC. Indeed, the press releases that companies issue announcing their quarterly sales and profits often note that the figures are unaudited.

But when a public company does make a math error in its quarterly earnings statements, “most people just bury these things,” accountant O’Connell said. In other words, he said, accountants will fudge the numbers in subsequent quarterly results to mask mistakes that already might have been made.

The error at Patlex involved overstating its tax burden from income earned on its patent rights. Patlex gets 64% of royalty income paid by users of laser technology patented by Gordon Gould, a laser pioneer. Patlex helped finance Gould’s bid to secure the patents.

Rushing the Numbers

The accounting mistake probably would have been caught had Wiss been given some time to go over the results, O’Connell said. But because Patlex rushed the numbers out the next day, they “never went through an internal review process” by Wiss, he said.

It’s unclear whether the confusion ruffled investors. On the day that Patlex announced the erroneous results, its stock jumped 62.5 cents a share, to $11.875, in over-the-counter trading. The stock then fell during the next week, but on the day that Patlex corrected the mistake--thereby giving it even higher earnings--the stock rose 37.5 cents to $10.75 a share.

The first-quarter results were ironically Wiss’ last piece of business with Patlex, O’Connell said. When it spun off its laser business earlier this year, Patlex decided to hire a Big Eight firm to replace the smaller Wiss, and it has since chosen KPMG Peat Marwick, Laitinen said.

Patlex figures that a Big Eight firm “adds some pizazz” to the company, he said.

Provided it can add, or catch those who can’t.