S. David Young
Professor of Accounting and Control
Back in the 1980s, Tandem Computers’ robust earning reports made it a darling of Wall Street. Its CEO and cofounder James Treybig had pioneered a super hot technology, a way to make “fault tolerant” computers for companies like banks and telecommunications business running data-processing operations around the clock. But in 1983, it came to light that Tandem had counted a chicken or two before they’d hatched. Some of the revenue reported in its most recent financial statements had not actually materialized, and earnings had to be restated.The Street’s retribution was swift: Tandem’s share price immediately dropped 30%. In time, the company recovered (it was ultimately acquired by Compaq), but the event left a lasting impression. When a Wall Street Journal reporter asked Treybig to recall his most exciting day at Tandem, he couldn’t. But when asked to pick his worst day, he answered without pause: “The day we restated”.The nightmare of risky accounting is on the increase. In the current economic climate, there is tremendous pressure – and personal financial incentive for managers – to report sales growth and meet investors’ revenue expectations. According to the SEC, misleading financial reports, especially involving game playing around earnings, are being issued at an alarming rate. Needless to say, it’s a nightmare that affects more than CEOs’ sleep. The shareholders suffer most – and today’s stock price volatility makes Tandem’s 30% hit look mild. Little wonder that lawsuits related to financial reporting are on the rise. Back in 1991, 55 security class-action suits alleging accounting fraud were filed in the United States. By 1998, the number had nearly tripled.To avoid such a calamity, shareholders and their representatives on corporate boards should keep their eyes peeled for common abuses in six areas: revenue measurement and recognition, provisions for uncertain future costs, asset valuation, derivatives, related-party transactions, and information used for benchmarking performance. If disaster strikes, it will most likely occur in one of these accounting minefields.