Working With and Around the Rules
Although U.S. accounting rules and standards fill 12,000 pages, companies still have considerable latitude in compiling their balance sheets and income statements. Here are some of the more controversial ways companies have used the rules to burnish their financial reports.
* Changing assumptions: IBM Corp. boosted its earnings in 2000 when it increased the expected rate of return on its pension from 9.5% to 10%. The change generated $195 million in pretax income for the computer giant.
IBM changed its assumption at the start of a market slump, a year in which the Standard & Poor’s 500 index declined 10.1%. It fell an additional 13% last year and is down 5.1% this year.
IBM spokeswoman Carol Makovich defended the change, saying, “The expected return on plan assets is long-term view, not just current year. IBM has exceeded assumed return on plan assets, substantially, every year since 1995, save one.”
* Omitting crucial data: It was a big issue in the Enron failure, yet the energy trader was hardly a rogue company in this regard.
Last month, PNC Financial Services Group reduced its 2001 profit by $155 million because the Pittsburgh-based bank omitted the operations of three companies it had set up with American International Group Inc., a large insurance company.
PNC said its treatment of the subsidiaries followed the advice of its auditor, Ernst & Young. But the Federal Reserve Board, which oversees financial institutions, said PNC’s interpretation of generally accepted accounting principles was wrong.
* Hiding or obscuring debt: Companies attempt to obscure debt so they look more creditworthy. This allows businesses to obtain higher credit ratings, pay lower interest rates and avoid restrictive covenants in loan agreements.
The Standard & Poor’s credit rating company put Williams Cos. on a negative credit watch this month after learning the energy company might have to cover a potential liability from a former subsidiary with a loan.
Williams is on the hook for a $1.4-billion Williams Communications Group Inc. bond issue. Williams had said it could cover any potential default by the former subsidiary by issuing Williams stock. But declines in the stock price has made that solution untenable, putting Williams at risk of having to suddenly accept a huge debt, according to S&P.;
* Using mark to market accounting: This is one of the more controversial methods often used by companies, such as Enron, that trade energy, telecom services and other nontraditional commodities.
One use of this accounting practice is to estimate the value of a contract to deliver a product, service or good at a future time. It works where there are established futures markets, but becomes difficult for assets that can’t easily be sold or in areas where there are no uniform markets, such as in natural gas or electricity futures.
“What happens in electricity is a secret market,” said Robert McCullough, a Portland, Ore.-based financial analyst and economist. “Enron booked revenue and earnings on deals that go out 20 years. That is pricing by rumor. Without the transparency that we have in established markets, that fails pretty quickly.”
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Jerry Hirsch
