盈利質(zhì)量和盈余管理

EarningsManagementandEarningsQuality

WhatisEarningsManagement(BryanHall’sWebpage)

Earningsmanagementisdefinedbyaccountingliteratureas“distortingtheapplicationofgenerallyacceptedaccountingprinciples.”ArthurLevitt,theoldSECChairman,definedearningsmanagementas“practicesbywhichearningsreportsreflectthedesiresofmanagementratherthantheunderlyingfinancialperformanceofthecompany.”

Earningsmanagementisoftendefinedastheplannedtimingofrevenues,expenses,gainsandlossestosmoothoutbumpsinearnings.Inmostcases,earningsmanagementisusedtoincreaseincomeinthecurrentyearattheexpenseofincomeinfutureyears.Forexample,companiesprematurelyrecognizesalesbeforetheyarecompleteinordertoboostearnings.Earningsmanagementcanalsobeusedtodecreasecurrentearningsinordertoincreaseincomeinthefuture.Theclassiccaseistheuseof"cookiejar"reserves,whichareestablished,byusingunrealisticassumptionstoestimateliabilitiesforsuchitemsassalesreturns,loanlosses,andwarrantyreturns.

Managersengageinincomesmoothingactivitiesbecausetheyknowthatvolatileearningsstreamstypicallyleadtolowermarketvaluations.Manysuccessfulmanagementteamsbelievethatthestrategictimingofinvestments,sales,expenditures,andfinancingdecisionsisanimportantandnecessarystrategyformanagerscommittedtomaximizingshareholdervalue.

Investorsaredissatisfiedwiththemanagementofearnings;however,investorsbecomeenragedwhenquarterlyorannualearningsforecastarenotmetbyfirms.Therefore,investorsandthepublicviewminorearningsmanagementasacceptableandaneverydaybusinesspractice.Inresponsetopubliccomplaintsandconcernforearningsmanagement,theSEChasissuedbulletinstohelppreventearningsmanagement.

2. ThePublicPerceptionofEarningsManagement

Earningsmanagementhasanegativeeffectonthequalityofearningsifitdistortstheinformationinawaythatitlessusefulforpredictingfuturecashflows.WithintheConceptualFramework,usefulinformationisbothrelevantandreliable.However,earningsmanagementreducesthereliabilityofincome,becausetheincomemeasureisbiased(upordown)and/orthereportedincomethatisnotrepresentationallyfaithfultothatwhichitissupposedtoreport.,volatileearningsaremadetolookmoresmooth).

Thetermqualityofearningsreferstothecredibilityoftheearningsnumberreported.Companiesthatuseliberalaccountingpoliciesreporthigherincomenumbersintheshort-run.Insuchcases,wesaythatthequalityofearningsislow.Similarlyifanonrecurringgainincreasesincome,butthegainisobviouslynotsustainable,thenthequalityofearningsisconsideredlow.

Forthemarketstoworkefficiently,itisvitalthatinvestorsbeabletotrusttheearningsnumbersofthecompaniesinwhichtheyhavechosentoinvesttheircapital.Recentstudieshaveshownthattheinvestingpublicbelievesthattheoccurrenceofearningsmanagementisbothwidespreadandpervasiveinthefinancialstatementsofcorporationsworldwide.However,itisinterestingtonotethattheinvestingpublicdoesnotnecessarilyviewminorearningsmanagementasunethical,butinfactasacommonandnecessarypracticeintheeverydaybusinessworld.Itisonlywhentheimpactofearningsmanagementisgreatenoughtoaffecttheinvestors’portfoliothattheyfeelfraudhasbeencommitted.

3. TheImpactofEarningsManagement

Publicperceptionaboutthewidespreadoccurrenceofearningsmanagementisaffectingthepublic’sconfidenceinexternalfinancialreporting.Thepracticeofearningsmanagementdamagestheperceivedqualityofreportedearningsovertheentiremarket,resultinginthebeliefthatreportedearningsdonotreflecteconomicreality.Investorsrelyonfinancialinformationprovidedbythecompanytomaketheirinvestmentdecisions,andwheninvestorsbelievetheyarebeinggivenmeaninglessinformationtheybecomewaryoftrustingthecompaniestheyhaveinvestedin.Investors’apprehensionwilleventuallyleadtounnecessarystockpricefluctuation.Asinvestorslosefaithinreportedearnings,theyareforcedintoaguessinggameconcerningtheactualfinancialpositionofacompany.Thisuncertaintyultimatelyhasthepotentialtounderminetheefficientflowofcapitaltherebydamagingthemarketsasawhole.

IncentivestoManageEarning

EXTERNALFORCES

AnalystForecasts-Companiesareunderextremepressuretomeetanalysts’earningsestimatesinordertopreventlargedropsintheirstockprice.

Debtmarketsandcontractualobligations-Companiesdependonachievingcertainearningsfigurestoobtainaccesstodebtmarkets,oreventomeettheircurrentdebtcovenantsandothercontractualobligations.

Competition-Thereispressureinhighlycompetitiveindustriestostayatthetopoftheindustryintermsofrevenueormarketshare.Companiesmaywanttomanagethesefigurestostayabovecompetitors.

B. INTERNALFACTORS

Potentialmergers-Ifthecompanyishopingtoenteramerge,astrongfinancialpositionwillmakeitlookmuchmoreattractivetoothercompanies.

ManagementCompensation-Stockoptionandbonusprogramsthataretiedtoearningsperformancewillprovideincentiveformanagerstomanipulateearningsnumberstoboosttheirowncompensation.

Planningandbudgets-Sometimescompanieswillestablishunrealisticplansandbudgetstopushmanagerstooverachieve.Thiscanprovidepressureformanagementtoboostearningstomeetthecompany’sownexpectations.

Unlawfultransactions-Somecompaniesevenuseearningsmanagementtocoveruptheirownunlawfultransactionssuchasembezzlement,fraud,misappropriation,andbribery.

C. PERSONALFACTORS

Personalbonuses-Somecompensationpoliciesareheavilyweightedtowardsincentives,andindividualshopetoreceiveabonusbasedontheirgoodperformance.

Promotionsandjobretention-Fudgingnumberstomakeperformancelookbettermayleadtopersonalpromotions,orevenhelptoretainanemployee’scurrentjob.

5. SECResponsetoEarningsManagement

Recently,severalstaffaccountingbulletinsconcerningearningsmanagementwerereleasedbytheSECandmanymoresuchregulationshavebeenpromisedinthefuture.ThesebulletinsandpromisesofmoretocomearepartlytheresultofformerSECchairmanArthurLevitt’scrusadetoeradicatetheproblemofearningsmanagementinUnitedStatescompanies.Recentpublicityofhighprofileearningsmanagementfromsomeofthenation’smostelitecompanies,combinedwithasaggingeconomyhaveheightenedinvestor’sfearsabouttheoccurrenceofearningsmanagement.Throughoutthelastfewyearsofthechairman’stermMr.Levittwidelypublicizedhisbeliefsaboutthepervasivenessofearningsmanagementandhisintentiontoaddresstheseissues.

ThiscrusaderesultedinatorrentofstaffaccountingbulletinsbeginningwiththeissuanceofSAB99regardingMaterialityinAugustof1999.Thisbulletinattemptstoclarifyanauditor’sappropriatescopeofmaterialitywhileconductinganaudit.Sinceafavoritepracticeofcorruptmanagementistojustifyearningsmanagementbyclaimingitisimmaterial,thisstatementisparticularlyhelpfultocurrentandfutureauditors.SAB100wasreleasedinNovemberof1999inanattempttoeradicatethecommonearningsmanagementpracticeoftakinga“bigbath”throughtheuseofrestructuringandimpairmentcharges.AnotherfavoritecomponentofearningsmanagementwasaddressedinMarchof2000whenSAB101AconcerningRevenueRecognitionwasreleased.Themostcommonformofearningsmanagementistheintentionalmanipulationofrevenuerecognition,thereforethisstatementanditslatercounterpartSAB101Barealsoveryhelpfultoanauditorattemptingtosnuffoutearningsmanagement.Finally,Julyof2001sawtheissuanceofSAB102concerningLoanLossAllowances,anotherpreferredtoolofearningsmanagement.

Thesebulletinswillnotcompletelypreventearningsmanagement,andthereforetheywillnotbethelastoftheirkind.Earningsmanagementwillremainanimportantproblemfacingthemarketsaslongasthereispressureoncompaniesandindividualmanagerstoperform.However,carefulauditingproceduresandcontinuingattentivenessbytheSECandotherregulatorybodieswillhelpreducetheoccurrenceofearningsmanagementintothefuture.

6. TypesofEarningsManagementandManipulation(byScottMcGregor)

a."Cookie-jar"Reserves

Theaccrualofexpensesistoreflecttheperiodinwhichtheexpensewasincurred.Forexample,ifafirmhiresaconsultanttoperformaparticularactivity,itshouldreflecttheexpenserelatedtothatactivityintheperiodinwhichitisincurred,notwhenthebillispaidorinvoicereceived.Inmanycases,theaccrualofexpenses,orreservesinparticularindustriessuchasinsuranceandbanking,arebasedonestimates.Assuch,theestimateshavevaryingdegreesofaccuracy.Duringtimesofstrongearnings,thefirmestablishesadditionalexpenseaccrualsandsubsequentlyreducestheliabilitytogenerateearningswhenneededinthefuture-pullinga"cookiefromthejar".

b.Capitalizationpractices-Intangibleassets,softwarecapitalization,researchanddevelopment.

In1997,companieswereallowedtocapitalizethecostsofinternallydevelopedsoftwareandamortizeitovertheusefullife,generallythreetofiveyears.Capitalizationistorepresentthedevelopmentcosts.Thecapitalizationprocessofcompanieshasthepotentialformanipulationbecausetheseassetsareoftenintangibleandbasedonjudgment.Afirmmayallocatemoreexpensestoaprojectthatcanbecapitalizedtoreducecurrentoperatingexpenses.

c."Bigbath"one-timecharges

Unusualornon-recurringchargeshavebecomeone-techniqueusedbyfirmstoescapethemazeofoveraggressiveaccountingpractices.Manybelieveandanecdotalevidencehasshownthatanalystsoverlooknon-recurringchargesbecausetheyarenotpartofthefirmsongoingoperationsoroperatingincome.Typicalnon-recurringchargesincludewritingdownassets,discontinuanceofanoperatingdivisionorproductlineandestablishingrestructuringreserves.

Asdiscussedpreviously,firmspracticingearningsmanagementdepletetheeconomicearningsfromfutureperiods.Astheirabilitytosustainearningsgrowthdiminishes,theymayseekaneventthatcanbecharacterizedasone-timeeventand"overload"theexpensesattributabletothatevent.Theone-timechargemaybediscountedbyanalystsasnotbeingpartofoperatingearningswhilethestockpricedoesnotsuffertheconsequencesnormallyassociatedwithmissingearningstargets.Toprovideitselfwithmore"cookiejar"reservesormaskitspastsins,thefirmmaytakeotherwrite-offsorcreateotheraccrualsnotdirectlytiedtotheeventandattributethoseexpensestotheone-timeevent.

AstudybyElliotandHanna(1996)reportedthatreportsoflarge,one-timeitemsincreaseddramaticallybetween1975and1994.In1975,lessthan5%ofcompaniesreportedalargenegativewrite-offcomparedto21%in1994.Theauthorsalsoshowedthatcompaniesthathadpreviouslyreportedsimilarwrite-offsweremorelikelytodoso.

d.Operatingactivities

Managersoftenhavetheabilitytomodifythetimingofeventssuchthattheaccountingsystemwillrecordthoseactivitiesintheperiodthatismostadvantageoustomanagement.Theactivitydoesnotalterthelong-termeconomicvalueofthetransaction,justthetimingandthus,comparabilityoffinancialstatements.Forexample,acompanycouldaccelerateitssalesanddeliveryprocesssuchthatitrecordssalesinDecemberthatnormallywouldhavebeenreportedinJanuary.Thus,thecompanyreportshigherfourthquartersales,revenueandprofits.Inthelong-term,thecompanywouldultimatelyreportthesamesalesandprofits;however,ithasinflateditsgrowthinthenearterm,andreducedprofitsinthefutureperiod.

e.Mergerandacquisitionactivities

Onetypeofsignificanteventthatmaybeusedtomaskothercharge-offismergersandacquisitions.Inmostcases,thereissomeformofrestructuringinvolvedcreatingtheneedforalargeone-timechargealongwithothermerger-relatedexpenses.Theeventprovidestheacquirerwiththeopportunitytoestablishaccrualsforrestructuringthetransaction,possiblyattributemoreexpensethannecessaryforthetransaction.Thecompanymayalsoidentifycertainexpensesthatarerevaluedontheseller'sbalancesheet,increasinggoodwill.Iftheconservativevaluationsprovetobeexcessive,thecompanyisabletoreduceitsoperatingexpensesintheneartermbyreducingitsestimatefortheliability.Theadditionalgoodwillcreatedwouldbeamortizedoveralongperiodoftimeandnothaveasignificantimpactonneartermresults.

Therearetwomethodsofaccountingformergersandacquisitions.Poolingofinterests("pooling")accountingandpurchaseaccounting.Poolingrecognizesthetransactionasamergerofequals,thusthetransactionisrecordedascompanyApluscompanyB.Purchaseaccountingtreatsthetransactionasapurchase.Thefairvalueofthepurchasedcompanyisassessedandcomparedtothepurchaseprice.Anyexcessorpremiumpaidabovethefairvalueoftheassetsisrecognizedasgoodwill.Goodwillisamortizedoveraperiodoftimenottoexceedfortyyears.

1.Poolingoninterests

AbrahamBrilloff,professoremeritusatBaruchCollege,inanarticleintheOctober23,2000issueofBarron'sentitled"PoolingandFooling"broughtattentiontotheuseofpoolingaccountingbyCiscoSystemstoinflateitsoperatingearnings.Ciscohasbeenanactiveacquirerpaying$16billionfortwelvecompaniesinfiscal2000alone,butthroughtheuseofpoolingaccounting,Ciscoonlyrecognizedonly$133millionincostinitscapitalaccountsforthesetransactions.Inaddition,fiveoftheacquisitionsweredeemed"tooimmaterial"torestatepriorperiodfinancialstatements.BrilloffcontendsthatCisco'searningsfor2000shouldhavebeenreducedby$billionreducingthe$billiongainintoa$.4billionloss.

Ifacompanypaysapremiumtoacquireanotherfirm,thepremium,orgoodwill,isamortizedandreducesearningsgoingforward.Thus,companiesseektransactionsthatwillallowthemtousepoolingofinterests.Ithasbeencontendedthatadditionalpremiumshavebeenpaidininstanceswherepoolingofinterestswillbeallowed.

CriticismofpoolingaccountinghasbeensignificantandtheFASBhasreactedbyannouncingtheeliminationofthemethod.However,theeffectivedatehasbeendelayedastheFASBhasreceivedstrongoppositionfromindustry.

2.Purchaseaccountingandgoodwill

Underthepurchasemethodofaccountingforacquisitionsifthepricepaidbytheacquiringfirmexceedsthefairvalueofthecompanyacquired,thedifferenceisrecordedasanintangibleasset,goodwill.Goodwillisamortizedoverfutureperiods,thus,thecreationofgoodwillcausesfutureexpenses,thereforereducingreportedearnings.Iftheacquirerconservativelyvaluesassets(suchasprivateplacementorilliquidsecuritiesandrealestate)orliabilities(reserves,accruedliabilities),thecompanymaybeabletorecognizeadditionalearningsinthenearfutureasitestimatesbecomelessconservative.

ProfessorBrilloffhasalsobeenacriticoftheaccountingpracticesofConseco,afinancialservicescompany.Mr.BrilloffcontendedthatConsecohadmanipulateditsearningsthroughitsacquisitionpractices.Insummary,hearguedthatConsecohadinflatedthelossorclaimreservesoftheinsuranceentitiesitacquiredandrecognizedacorrespondingassetofgoodwillatthetimeofacquisition.Itcouldthenreducethereservesovertheneartermtoinflateearningswhileamortizingthegoodwilloverasignificantlylongerperiodoftime.

f.RevenueRecognition

Thetimingoftherecognitionofrevenueisthemostlikelyareatotargetformanagementandmanipulation.Fromanoperationalstandpoint,firmscantakeaggressiveactionstoboostrevenuesandsalesinoneperiodthroughprovidingincentivestotheirsalesforce,utilizeovertimetopushshipmentsoutthedoor.Theymayalsotakeaggressiveaccountingactionssuchassellingsecuritiesclassifiedheldforsalesrecognizegainsinincomeversusstockholdersequity,aggressiveinthetimingoftherecognitionofsalesoraggressiveintheapplicationofbroadorunclearaccountingguidance.

g.Immaterialmisapplicationofaccountingprinciples

MaterialityisaconceptthathasbeenunderfirefromtheSECduetoitsmisuse.Aspreviouslydiscussed.Errors,misstatementsandmisapplicationofaccountingprincipleshavebeenoverlookediftheyfellbelowthematerialitythreshold.Acompanymayknowinglymisstateearningsbyamountsthatfallbelowthematerialitythresholdbynotcorrectingknownerrorsorothermisstatements.Ifthepracticecontinuesforanumberofperiods,thebalancesheet(retainedearnings)maybecomesignificantlymisstated.

h.Reserveone-timecharges

Theuseofone-timecharges,establishedintheformofareserve,canbeusedtomanageearnings.Thecompanyconservativelyrecognizesaone-timechargeintheformofacontingencyreserveforapossiblefuturelossorfutureexpense.Theyanticipatethatanalystswilldiscountthechargesinceitisnotdeemedtobepartofoperatingincome.Overtime,thecompanychangesitsestimate(reduces)torecognizeadditionalearnings.

7. Examplesofcasesofearningsmanipulation

a.Cendant

Cendant(AAER1272,06/14/00)Cendantwascreatedina1997"mergerofequals"betweenCUCInternationalandHFS.InApril1998,legacyHFSofficialslearnedthatpriortothemerger,CUCexecutiveshadengagedinaccountingirregularitiesthatinappropriatelyrecordedover$500millioninphonyprofits.TheaccountingirregularitiesatCUCwerewidespread,usedatleastfourearningsmanipulationtechniquesandinvolvedmorethan20employees.

SECdocumentsassertthattheaccountingmanipulationsatCUCweredrivenbyseniormanagement'sdeterminationtomeetWallStreetanalyst'sexpectationsand"fueledbydisregardforanyobligationthattheearningsreportedneededtobe`real'."AccordingtotheSECdocuments,CUCmanagementmaintainedanannualschedulesettingforth"opportunities"thatwereavailabletoinflateoperatingincome,creatinga"cheatsheet"listingtheopportunitiesthatwouldbeusedinthecomingyearandtheamountsthatwouldbeneededfromeachopportunity.

Attheendofeachfiscalquarter,financialreportingpersonnelatCUCheadquarterspreparedpreliminaryconsolidatedquarterlyfinancialresults.CUCmanagementthendirectedtopsideadjustmentsconsistingofsimplyaddingordeductingspecificlump-sumamountstoorfromreportedrevenuesandexpensesuntilreportedresultsmetorexceededpublishedearningsexpectations.Onceincomewasadjusted,CUCseniormanagementwouldmakeadditionalalterationsamongspecificlineitemstoensurethatreportedexpensecategoriesweresetatapproximatelythesamepercentageofrevenuesasinpreviousquarters.AccordingtotheSEC,thechangesdirectedbymanagementwere"adeliberate,top-downprocessof`reverseengineering,'virtuallydivorcedfromwhateverfiscalandbusinessrealitiesactuallyhadtranspiredinthatquarteratCUC"and,therefore,"thequarterlyreportsthatCUCfiledwiththeCommissionandreleasedtoinvestorswereequallydivorcedfromthoserealities.!"

SincetheCUCincomewasaddedinquarterlytop-sideadjustmentsduringtheconsolidationprocessanddidnotappearindivision'sbooks,CUCmanagementusedunsupportedpost-closingjournalentriescarryingeffectivedatesspreadretroactivelythroughouttheyeartoconcealtheirearningsmanipulationsschemesfromoutsideauditors.Tomaketheadjustmentslessnoticeable,theunsupportedentriesweredisaggregatedintosmallercomponentsandintentionallycreatedinoddamounts.

Intheearlieryearsofthemanipulationschemes,managementreliedprimarilyonmanipulatingtherecognitionofmembershipsalesrevenueandassociatedliabilitiesarisingfromallowancesforrejects,cancellationsandobligationstopaycommissions.Seniormanagementwouldreviewprojectedmembershipsalesfigures,calculateadditionalamountsneededtoinflateincometodesiredlevelsandgenerateoperatingresultsatpredeterminedamounts.CUCalsomanipulatedincomebypostingfictitiousentriestokeepmembershipsalesrejectsoffbooks,intentionallyunderstatingmembershipcancellationreserves,and,occasionally,simplyreversingthecancellationreserveorthecommissionspayableliabilitydirectlyintorevenueoroperatingexpenseaccounts.Forexample,infiscal1997,CUCmanagersdirectedpost-closingentriesmoving$millionfromcommissionspayabledirectlytorevenue.CUCmanagementusedschedulesandotherdevicestosupportunderstatingcommissionspayable.

SECdocumentsindicatethatbythemid-1990s,opportunitiesrelatedtoCUC'smembershipsalescouldnolongersustainthemanipulationschemes.Accordingly,inthemid-1990smanagementdecidedtokeeprevenue-relatedopportunitiesatconstantpercentagelevelsanduseopportunitiesrelatedtoacquisitionandpurchasereservestokeepincomeinlinewithever-increasinggoals.

In1996,CUCestablishedmergerreservesinconnectionwithseveralnewacquisitions.AccordingtoSECdocuments,CUC'saccountingforliabilitiesrelatedtoitsbusinesscombinationswentfarbeyondwhatGAAPpermitted.CUCmanagersarbitrarilydeterminedtheamountsthatCUCwouldreserveforliabilities,attimessimplydoublingtheamountscalculatedasCUC'struecosts.Inaddition,theSECstatedthat"acquisitionswereviewedinlargepartasopportunitiestoensuretheviabilityoffuture'earnings'atCUC,"andthatliabilitiesintheformofreserves"wereestablishedtostockpilefutureincome."Theacquisitionreserveswere"subsequentlyreversedtobringthosefutureearningstofruition."

Atfiscalyearend,CUCmanagersutilizedthe"cushion"reservesbyreversingthereservesdirectlyintorevenueoroperatingexpenseaccounts.AccordingtoSECdocuments,CUCmanagersdirectedsubordinatestoreversespecificaggregateamountstorevenueorexpenseaccounts,"leavingittothesubordinatestodecidearbitrarilywhichaccountsshouldbenefitandinwhatamounts."CUCmanagersalsotransferredpartoftheacquisitionreservestoincomeaccountsondivision'sbooks.Forthesetypesoftransactions,CUCmanagementtypicallyselectedsmallerdivisionsthattheyknewwouldnotbefullyaudited.

WhenoperatingshortfallsatanewCUCdivisiondepleteditsreserves,CUCwasdesperateforamajorbusinesscombinationandbegandiscussionswithHFS.InMay1997,themergerdiscussionsresultedintheCendantagreementandthepossibilityofreserveslargeenoughtocontinuetheearningsmanipulationschemes.

InadditiontousingtheCendantmergerreservestocontinueitsrevenuemanipulationschemes,CUCmanagementalsodirectedthatmillionsofdollarsofCUCassets,bothimpairedandunimpaired,bewrittenoffagainsttheCendantreserve.ThewriteoffofimpairedassetswasnecessarytocoverCUC'sfailuretowriteofftheassetsinthefiscalyearsprecedingtheDecember1997mergerwithHFS.ThewriteoffofunimpairedassetsallowedCUC/Cendanttoavoidmassiveasset-relatedchargestoincomefromcontinuingoperations.

InApril1998,CendantbecameawareofsomeoftheaccountingirregularitiesatCUC,restatedearnings,andagreedtochangeitsrevenueaccountingpractices.InJune2000,theSECbroughtcivilandadministrativefraudchargesagainstsevenformerofficialsofCUC,includingthechieffinancialofficer,thecontroller,thevicepresidentofaccountingandfinancialreportingandthedirectoroffinancialreporting.Thechargesagainsttheseindividualsincludedviolationsoftheantifraud,periodicreporting,corporaterecord-keeping,internalcontrolsandlyingtoauditorsprovisionsofthefederalsecuritieslaws.TheSECalsobroughtchargesagainstCendantforviolatingtheperiodicreporting,corporaterecord-keepingandinternalcontrolsprovisionsofthefederalsecuritieslaws.InDecember,Ernst&Young,CUC'sauditors,agreedtopayCendantshareholders$335million.

ThecurrentinvestigationofEnron'saccountingpracticesbytheSECandseveralCongressionalCommitteesmayleadtothesametypesofsanctionsagainstindividualsasthoseimposedonCendantexecutives.Recentreportssuggestthatseveralhigh-levelexecutivesatEnronengagedindeliberateattemptstoconcealthemagnitudeofEnron'sdebtfrominvestorsandcreditors,usingoffbalancesheetpartnershipstoconcealdebtobligations(Emshwilleretal,2001).Accordingtopublishedreports,EnronviolatedGAAPbysettinguppartnershipswhichitcontrolledandrecordingthetransferofEnronstocktothepartnershipsinexchangefornotesreceivable(EmshwillerandSmith,2002).PublishedreportsalsoindicatethatEnronusedthepartnershipsitcontrolledtoexchangeimpairedassetsfornotesreceivable.ThispracticeallowedEnrontoincreaseearningsbytheexcessofthenotesreceivableoverthebookvalueoftheassetsexchangedand,atthesametime,removeimpaire!dassetsfromitsbalancesheet(EmshwillerandSmith,2002).AlthoughtheaccountingpracticesinpublishedreportshavenotbeenconfirmedbySECinvestigation,Enron'spastaccountingpracticesledthemtorestateearningsby$586million(Emshwilleretal,2001).

b.ManhattanBagel

Fromitsinitialpublicofferingin1994toJune1996,thestockpriceofManhattanBagelrosefrom$5pershareto$29.ThecompanygrewtobethethirdlargestbagelfranchiseintheUnitedStateswithambitiousplansforsubstantialexpansion.Salesandearningsweregrowing.Thecompanybegantoexpandthroughacquisition.InJanuary1996,thecompanyacquiredaWestCoastbageloperation,however,thefirmfailedtoperformthenecessaryduediligenceandacquiredmillionsofdollarsofoverstatedrevenues.

InJune1996,thefirmannouncedaccountingproblemsinitsrecentlyacquiredWestCoastoperations,anditsstockpricewascutinhalfwithindays.Thefree-fallinitsstockpricecontinuedandwiththenegativepublicityandshareholderlawsuitsthatfollowed,thecompanywasunabletosellfranchisesatanywhereneartheirpreviouspace.Eventually,thecompanywasfo