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Companies' Use of Accounting Maneuvers to Report Higher Earnings Comes Under Scrutiny

S.J. Steinhardt
Published Date:
Jun 2, 2023

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Many companies are managing their earnings—using the flexibility in accounting rules to improve reported earnings per share—in the face of slowing business, The Wall Street Journal reported.

The practice, which has been around for years and is acceptable under accounting rules, has always come in for criticism. Warren Buffett called it “one of the shames of capitalism” in a letter to investors earlier this year, the Journal reported.

Companies are also engaging in "pro forma measures"—providing numbers that don’t adhere to accounting standards— to make their results look better.

A report published Thursday by research firm Calcbench found that adjusted numbers for 200 randomly selected companies in the S&P 500 were higher by $1.1 billion, on average, last year than a similar sample from the year before—an increase of more than 130 percent. The Beneish M-score, another indicator of earnings flattery, as it is also called, found the aggregate score of a sample of nearly 2,000 companies was at its highest level in more than 40 years. Historically, the aggregate score peaks ahead of a downturn, according to the Journal.

First-quarter earnings exceeded expectations by an unusually large amount, the Journal reported. Seventy-seven percent of the 485 companies on the S&P 500’s roster that had reported first-quarter earnings as of May 26 surpassed analysts’ expectations, according to data provider Refinitiv. Since 1994, 66 percent of companies beat expectations in an average quarter.

In addition, companies in aggregate are reporting earnings 6.9 percent above expectations, compared to a long-term average of 4.1 percent, according to Refinitiv—and some of that overperformance was due to changes in the way the numbers were calculated.

The heightened use of the practice has attracted the attention of regulators. In December, the Securities and Exchange Commission (SEC) warned companies that pro forma measures that replace traditional accounting methods with individually tailored disclosure could violate its rules. The SEC also told companies to reconcile how they get to the pro forma figures from the reported ones and expanded the guidance with more details on what constitutes a possible violation.

One accounting professor questioned two material changes in accounting by Google's parent company, Alphabet, that altered its bottom line: The company revised its estimates on the useful life of its server infrastructure, saying it would last up to six years instead of four, and shifted its stock-compensation awards for employees from January to March, so that it recognized less expense in the first quarter relative to the rest of the year.

“It’s highly suspect,” Melissa Lewis-Western of Brigham Young University told the Journal. “Actual performance hasn’t changed, you’re just changing the allocation of the cost.”

Online used-car seller Carvana’s shares lost 97 percent of the value in 2022, and analysts expected the company to post a loss of $2.03 a share for this year’s first quarter. Ten days before the quarter ended, Carvana executives said they expected adjusted gross profit per car sold to come in between $4,100 and $4,400 for the quarter, but it reported an adjusted gross profit per car sold of nearly $4,800. The company lost only $1.51 a share, causing its stock to rise by more than 80 percent.

One reason Carvana’s earnings jumped was because it unwound $51 million in charges it made in the previous quarter. The company had taken the charges because it had expected to sell its cars for less than it originally expected.  But the company was able to sell them for more as used car prices appreciated. Unwinding the $51 million boosted earnings by 48 cents a share.

The allowance’s potential impact was widely communicated to the market before the earnings release, according to a company spokesman.

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