EarningsCenter

America's CFOs Admit: Lots of Companies Are Fudging Their Numbers
If sometimes you have that nagging feeling that the investment playing field is not exactly tilted in the individual investor's favor, you just might be on to something.

Last week, a survey of 500 financial professionals revealed there is indeed real reason to hold onto one's wallet when dealing with those "helping" us invest our life savings: Almost one-third of respondents to the survey had firsthand knowledge of wrongdoing in the workplace. And one-third of these financial pros reported feeling pressured to violate the law or engage in unethical conduct at work.

The Shenanigans Continue

Now, another study just out further undermines our confidence in the investing world: Researchers at the business schools of Emory and Duke universities came to the conclusion that "in any given period, about 20% of firms manage earnings to misrepresent their economic performance."

The research team came to this finding after surveying 169 CFOs of publicly traded companies and interviewing 12 others on their opinions of "earnings quality."

A great majority of those CFOs said that the reason to manage earnings was to "influence stock price." Other reasons given were external and internal pressures to hit benchmarks. Wall Street, most of those interviewed said, hates surprises.

Earnings also can affect executive compensation. One CFO said, "Over the last five years, compensation consultants have shifted many companies toward using a GAAP-based earnings hurdle for their stock compensation. ... I think earnings management is still done, and in many cases it is for executive compensation."

Red Flags

The study uses the term "earnings management" as meaning "aggressive reporting choices within GAAP, i.e., we explicitly rule out fraudulent transactions in both our survey instrument and interviews."

OK, so if earnings management does not entail outright lying, how are the numbers fudged and how can one know when they are?

One of the first places to look for managed earnings, according to the CFOs surveyed, is at cash flow. "[E]arnings strength with deteriorating cash flows," and when "earnings and cash flows from operations move in different directions for 6-8 quarters," should raise eyebrows, they said.

Another red flag would be deviations from industry norms in "cash cycle, average profitability, revenue and investment growth, and asset impairments." The research team points out that these items would have shown up in the Enron and WorldCom earnings manipulations cases.

The study suggests one should also look at "unusual behavior in accruals, including large jumps in accruals." Accrual accounting puts a transaction on the books when it occurs, not when actual payment is made or received. However, accruals without the cash to eventually back them up make the bottom line look good, but won't show up where it really matters: the cash flow statement.

Other suspicious activities could include "earnings and earnings growth that are too smooth for fundamentals," and "frequent one-time items."

One aspect of earnings management that could do real and lasting harm to a company is when company executives pretty up the bottom line by cutting items such as R&D, maintenance expenses, and marketing expenditures. Whether those actions are justified or not is hard for those on the outside to know.

Buyer, Really Beware

So the disappointing bottom line is, in any given quarter, one-fifth of those earnings reports that investors and analysts doing their due diligence are poring over might just as well be copies of Great Expectations for all the useful financial information they will provide.

Then again, for the optimists out there, that leaves 80% or earnings reports that could be helpful.



Dan Radovsky is a contributing writer to The Motley Fool.

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chaspharrington

LIKE THIS IS SOMETHING THAT WE ALREADY DIDN'T KNOW, THERE IS NOT A COMPANY IN AMERICA THAT DOES NOT FUDGE ITS BOKS TO MAKE SURE THAT THEY ALL RECIEVE LARGER BONUS!!!
ANS AS IF THE GOVERNEMENT DOESN'T KNOW THIS, AND THE ONLY REASON THEY LOOK THE OTHER WAY, IS BECAUSE THEY DO THE SAME THING!!!

July 27 2012 at 12:34 PM Report abuse +2 rate up rate down Reply
Miguel Jose Himenez

POSITIVE News U say Marris about the Markets

Yes Tim.

They are positively run by Satan and La Cosa Nostra.




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July 27 2012 at 12:13 PM Report abuse -1 rate up rate down Reply
GymmyKramir

Oh FBI,

La Cosa Nostra NYC PIGGS asks that u use assault weapons on them 4 being the world number 1 terrorists.

Pop

Pop Pop

Pop pOp Pop

Satans NYC Casino = ZERO ODDS = SEC + Brokerages + Hedge Funds = NYC PIGG = RED Plague Cultist Party = La Cosa Nostra

GROUND ZERO 4 NYC

but much farther below.

July 27 2012 at 11:40 AM Report abuse -2 rate up rate down Reply
Alec Wilkins

The average investor does not belong on Wall St. It is tantamount to a Vegas casino. The deck is stacked against you.

July 27 2012 at 11:18 AM Report abuse -1 rate up rate down Reply
GymmyKramir

FEAR

There is no fear when U have NYC PIGGS and SEC PIGGS and E-Trade PIGGS and Fidelity PIGGS that PACK white dust UP THEIR NOSES and PACK ANELL MUSTARD in their MOUTHS and AZZ.

FEAR NOT PIGGS

Satans REWARDS 4 U

July 27 2012 at 11:04 AM Report abuse +1 rate up rate down Reply
keithrico47

CFO= CHIEF FUDGING OFFICER.

July 27 2012 at 10:52 AM Report abuse +2 rate up rate down Reply
GymmyKramir

THis IS why Gymmy is at the North Pole.

BUNKERS and FOOD available here NYC and

SAFE
T

July 27 2012 at 10:43 AM Report abuse -1 rate up rate down Reply
GymmyKramir

E-Trade Tampa - UNDER SIEGE

FIDELITY - UNDER SIEGE

WELLS FARGO - UNDER SIEGE

AMERIPRISE - UNDER SIEGE

NYC - UNDER THE GROUND

July 27 2012 at 10:42 AM Report abuse -1 rate up rate down Reply
GymmyKramir

Alabama Resident, Elisha Romney
Hi,
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• I means killing animals with weapons on land in the air and under the sea which supports Satan.
• I means drilling 4 oil in our Oceans where we have been IN DENIAL of what exists IN OUR OCEANS supporting Satan.
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U CANNOT.
U can ONLY UNDEVELOP it 4 Satan WHO WANTS IT and KEEPS TAKING IT with his followers.
• Fracking 4 oil using DIESEL FUEL 2 POISON THE WATER SUPPLY - AZZZZZZZZZZZZHOLES
• I means stealing from mom and pop with the RED NYC dirty white boyz La Cosa Nostra Collection Agency.
AND ITS ALL
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• And America DOES NOT HATE. BUT WE R LOUD, WE R LOUD, WE R LOUD and WEEEEEEEEEEE, sez the TV commercial PIGG, WILL BE HEARD.
And I gotz a song 2. Y’all know it. An old song
Blue, blue, my world is BLUE
Blue is my world
And RED without U
Blue, Blue, My world is BLUE
Blue is my world and RED without U.
My papa told me as a child.
Weez R here 2 LOVE each other and take care of the Earth and animals.
Y’all have a Good Day now, ya hear sez Andy and Gomer.

July 27 2012 at 10:40 AM Report abuse -1 rate up rate down Reply
GymmyKramir

The NEXT POP U hear America and World-

will NOT b your stock or investments.

Charts and knowledge DO NOT work when EVIL Man PIGGS in the NYC Financial World focus on laundering your INVESTMENTS and the SEC HELPS them ALL.

THE NEXT POP WILL B

NYC

Blue, Blue, my world is Blue
Blue is my world and RED
WITHOUT U

Blue, Blue, my world is Blue
Blue is my world and RED
WITHOUT U

July 27 2012 at 10:39 AM Report abuse -1 rate up rate down Reply