Contents

PART I

Reading between the Lines                                                              1

CHAPTER 1

The Adversarial Nature of Financial Reporting                                3

The Purpose of Financial Reporting 4

The Flaws in the Reasoning 8

Small Profits and Big Baths 11

Maximizing Growth Expectations         12

Downplaying Contingencies 18

The Importance of Being Skeptical       20

Conclusion 24

PART II

The Basic Financial Statements                                                       27

CHAPTER 2

The Balance Sheet                                                                           29

The Value Problem 30

Issues of Comparability 31 “Instantaneous” Wipeout of Value 33

How Good Is Goodwill? 34

New Roman">Losing Value the Old-Fashioned Way 37

True Equity Is Elusive 39

Pros and Cons of a Market-Based Equity Figure 42

Undisclosed Hazards 45

The Common Form Balance Sheet 46

Conclusion 48

CHAPTER 3

The Income Statement

Making the Numbers Talk 49

How Real Are the Numbers? 55 Conclusion 90

CHAPTER 4

The Statement of Cash Flows

49

91

The Cash Flow Statement and the LBO 93 Analytical Applications 98

Cash Flow and the Company Life Cycle 99

The Concept of Financial Flexibility 107

In Defense of Slack 110

Conclusions 112

PART III

A Closer Look at Profits

CHAPTER 5 What is Profit?

Bona Fide Profits versus Accounting Profits 117

What Is Revenue? 118

Which Costs Count? 120

How Far Can the Concept Be Stretched? 122 Conclusion 123

CHAPTER 6

Revenue Recognition

Informix’s Troubles Begin 125

Calling the Signals             130

Astray on Layaway             136

Recognizing Membership Fees 137

A Potpourri of Liberal Revenue Recognition Techniques 140 Conclusion 152

115

117

125

CHAPTER 7

Expense Recognition                                                                     153

AOL’s Search for Wiggle Room 153

IBM’s Innovative Expense Reduction 156

Simple Analysis Foils Elaborate Deception 157

Oxford’s Plans Go Astray 159 Conclusion 162

CHAPTER 8

The Applications and Limitations of EBITDA                                163

EBIT, EBITDA, and Total Enterprise Value 164

The Role of EBITDA in Credit Analysis 168

Abusing EBITDA 172

A More Comprehensive Cash Flow Measure 174

Working Capital Adds Punch to Cash Flow Analysis 177 Conclusion 179

CHAPTER 9

The Reliability of Disclosures and Audits                                      181

An Artful Deal 182

Death Duties      185

Chainsaw Al       186

Stumbling Down the Audit Trail 190

Conclusion 191

CHAPTER 10

Mergers-and-Acquisitions Accounting                                          193

The Twilight of Pooling-of-Interests Accounting        194

Maximizing Postacquisition Reported Earnings          197

Managing Acquisition Dates and Avoiding Restatements 198 Conclusion 200

CHAPTER 11

Profits in Pensions                                                                        201

An Admonition from the SEC

Conclusion 207

PART IV