Wednesday, September 23, 2009

Mind the… GAAP?

Several years ago I read a research paper that added a new twist to human memory. The basic contention of the researchers was that memories are really not historical but rather a series of new memories as a result of accessing the incident, retrieving the memory, processing the memory and ‘re-filing the memory. Therefore we don’t remember the initial event, but rather the repetitious memory of the previous memory. It is for that reason, according to the study, that memories get distorted through the passage of time.

Recently I received a letter from a south Texas law firm that precipitated the Pandora’s Box of business memories. Almost eleven months ago I was retained by a South Texas multi-media organization to build risk based revenue models. This company had been in business for almost twenty-five years. Through which time, they have always operated on very simple business models, but as the economy softened they needed a means to ‘out-run’ their competition. As it turned out my end of engagement meeting coincided with a meeting of their external auditors. As the CEO, Mike, and I added closure to my engagement he expressed to me the auditor’s opinion of their financial statements. Mike was extremely agitated that the auditor’s opinion questioned the viability of the company and made such a reference in their disclosure. As this would not be a good thing, Mike pushed the audit partner to have the issue of ‘going concern’ dropped. After much wrangling, Mike got what he wanted – financials with a clean bill of health. Now eleven months later, the company was forced into dissolution!

Almost six weeks ago, I was in discussion with a heavy machinery manufacturer regarding our engagement. During one of our meetings an issue of a contingent liability came to light. The essence of which basically was that the company could stand to be liable for $364,000 in damages should a particular event occur. To the company, this would be a material event and would definitely send up red flags on their financials and eventually part of their SEC filing. Although this issue wasn’t part of my engagement how the firm was going to treat this event intrigued me. During lunch with the divisional CFO (Annette), I probed how she planned to address this issue. After considerable avoidance, I came out point blank and said ‘Annette, according to GAAP if there is a reasonable expectation that this event will materialize – it must be disclosed’. As it turned out, the situation was beyond ‘reasonable’; the event was materializing as we were speaking! However, the response I got from Annette was ‘we cannot make a full disclosure as it will trigger a bank audit, the investors will need answers and we already have a very soft year’. So now, this material issue remains known by a handful of people.

Just this morning, I was speaking with the revenue manager of a New York based law firm who openly disclosed that his firm ‘fixed’ the revenue numbers for 2008 to show a profit instead of a loss. Robert’s contention ‘it isn’t right, the partners demanded it and I have to put food on the table’. With these events a plethora of memories overtook me. In the last twenty years I have met organizations who have ‘made allowances’ to paint the right picture for the right reader. Whether it is using fictitious clients to overstate revenue or related companies burying profits to avoid tax liabilities; all of this behavior does have an impact on someone. To the perpetrator, I am appeasing some external body. However, the information does matriculate into the larger folds of the economic community.

All of this is synonymous with a ‘little white lie’, what harm could it be? The harm is tremendous; one only has to look at our current economic climate to realize that the unqualified issuance of credit has caused a global economic meltdown of the banking community. To this day I still cannot fathom how those who ignited and fueled this disaster didn’t realize that no matter how much you dice, slice and sell bad loans – they are still bad. However, the feeding frenzy of wealth and bonuses fueled this behavior. This was exactly the argument presented by one writer on the Enron demise. His contention was, the investors demanded gains that simply weren’t possible without ‘fixing’. Therefore the investors’ greed is to blame! The question is: did anyone suffer from these ‘fixings’? I am not sure; one should ask those whose retirement have been irrevocably altered or any of the 14.5 million unemployed people that are a casualty of our economic misfortune.

To those in the finance community the guard rails of their actions have to be Generally Accepted Accounting Principles (GAAP), the codified explanations how financial transactions must be recorded, otherwise financial statements become every company’s unique fairy tale. But what is at stake, for some it could be reprimand or even the loss of an income. Now that is something to put on one’s resume ‘I was fired because I didn’t bend the rules; I didn’t compromise my integrity’.

One doesn’t have to look back far in history to find the billions of dollars vanished and the countless lives impacted because of some type of falsification of information. Those companies, who strong-armed their auditors for the ‘right’ outcome, strong-armed their staff for the ‘right’ profit is contributing to an economy with a fragile economic infrastructure. The current meltdown and the elusiveness of repair could be the result of years of ‘adjusting’ the outcome.

Sadly this behavior is so pervasive in our economy. You would be too na├»ve to believe that ‘we are the only company that made a small fix’. Just to give you a recent example. I recently picked up a package of my regular detergent, luckily before my current supply end. As I looked at the two packages in the cupboard, I thought it odd that the sizes were just a bit different. As it turns out, the price remained at $4.39, but the package size went from 24 oz to 22 oz, in the matter of four months. I feel if the company wanted me to know they would have put in bold letters, Look our smaller size, we needed to help our profits! But they didn’t, I guess they didn’t want me to know. They needed to aid their bottom line, but knew full well that the price elasticity of the soap would not lend itself to a price increase; so I got a size decrease and they got a profit increase!

Throughout my career, I am thankful that I have always chosen the road of integrity regardless of the circumstances. It has not been easy, as clients simply take their money and go for ‘what they want’ rather than what is right. I only recall one incident where the client, after much dialogue realized that the method of foreign currency reporting she wanted was non-GAAP and would have been misleading. However, I rest assured that I have not and will not contribute to a fragile economic infrastructure. However, it causes me to ponder GAAP, has it evolved from being the guardrail of financial treatment to a list of ‘suggestions’, should be renamed to GAP (Good Accounting Presentations) to be more reflective of our behavior.

The next time you are out making a purchase, whether it is a plasma television or a steak dinner, think of how your purchase may have been compromised for the sake of the company’s rosier financial presentation – for the GAP!