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Nike is a great real-world example of how a company manages earnings. They use different forms of revenue recognition, some coming from GAAP but some that do not fall under the GAAP principles. A couple of examples of non-GAAP conforming principles used by Nike are wholesale equivalent revenues and currency-neutral revenues reporting method. The wholesale equivalent revenues consist of 2 things: sales to external wholesale customers, and internal sales from their wholesale operations to their Direct to Consumer operations, which are charged at similar price points to those charged to external wholesale customers. Next, the currency-neutral revenues used by Nike are calculated by using the actual exchange rates during the comparative prior year period which enhances the visibility of the underlying business trends.

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During our groups’ search for a real-world example that shows how a company manages earnings we came across the WorldCom scandal. WorldCom was a telecommunications company and the second largest long-distance phone company in the United States. WorldCom’s downward spiral began in the late 90’s when their CEO, Bernard Ebbers, resigned likely because he took almost 400 million dollars in personal loans from the company. In 2002, Arthur Anderson audited WorldCom’s 2001 financial statements and their books for the beginning of 2002. This is when it was discovered that WorldCom transferred over 3 billion dollars of expenses into their capital expenditures account! Not only is the transfer of these expenses and the misrepresentation a violation of GAAP, it also leads to EBITDA appearing higher than it should. This of course would make them appear more profitable, thus leading to an increase in their stock prices.

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Satyam Computer Services, Ltd. was an Indian based global IT company which was involved in a major scandal for overstating its earnings and cash using fraudulent invoices and bank statements by $1.4 billion and is infamously known as the ‘Enron of India’. The fraud was revealed when the chairman of the company Ramalinga Raju admitted to falsifying the financial statements in a letter to the shareholders which sent shockwaves across the world and among Indian investors as the Bombay Stock Exchange (BSE) plunged by 7% as the Satyam stock price spiraled down by 78%. Satyam’s auditors PwC India have come under scrutiny for not detecting manipulative accounting procedures and have been heavily fined by the SEC and recently banned for two years by SEBI. This case also saw sweeping new regulations in the Indian marketplace to protect investors to increase oversight to prevent fraud.

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Team Netflix: HealthSouth Earnings Scandal

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Team Netflix: HealthSouth Earnings Scandal

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HealthSouth was a company that at one point was the largest publicly traded healthcare company in the United States. In 2002, the CEO sold of 75 million dollars in shares right before the stock price plummeted, which aroused suspicion and an investigation by the SEC was launched. It turned out HealthSouth had been understating their accounts receivable reserves and overstating their revenues for years. The company managed their earnings to misstate revenue while simulateneously taking advantage of the fact that bad debt is expense is an estimate- as a healthcare company, almost all of its earnings would be on account initially, and they grossly underestimated how much bad debt would be expensed, inflating their earnings by as much as 250 million at a single time.

http://ww2.cfo.com/fraud/2017/03/two-cfos-tell-tale-fraud-healthsouth/

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Our group decided to use a situation with the Under Armour company. Their revenue statistics increased 3% over 2016, yet 2017 sales decreased 5% compared to the previous year in North America. Under Armour is also having issues because its shares have not done well in the S&P Index. In order to manage their earnings, UA is focusing on the relationships they maintain with their partners, such as Dick's Sporting Goods, Foot Locker, and Kohls. UA is also using its earnings to explore the international market. Under Armour's accounting process is very conservative, and they tend to over estimate deductions like returns, rebates, and discounts. This means that UA's likelihood of overstating inventory is less than some other companies. They use FIFO to account, which is a conservative method. They are using their earnings to reinvest in their own company, with an increase in Property, Plant, and Equipment on their balance sheet. One final concern is that the cash conversion cycle has gone up 14%, which could be reason for further investigation into the company by accountants.
https://seekingalpha.com/article/4133815-analysis-armour?page=2

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Team Tencent - Cardinal Health Scandal

Cardinal Health, Inc. a pharmaceutical distribution company based in Dublin, Ohio settled in 2007 was filed by SEC to pay a $35 million dollar penalty as a result of their long lasting fraudulent revenue and earnings management scheme. The company intended to use fraudulent earning information to manipulate investors and analysts. Cardinal Health misclassifying more than 5 billion dollars of bulk sales as operating revenue by holding their bulk products in the warehouse for more than 24 hours . In addition, the company failed to timely disclose the impact of change in the method of applying LIFO accounting principle. Lastly, Cardinal Health was also charged with prematurely recognizing millions of dollars of revenue from their acquisition of Pyxis, their subsidiary. This case presents the fact that sound accounting practices and consistent earning management is in place to keep consistency of numbers and present better information to investors.

https://www.sec.gov/news/press/2007/2007-147.htm

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The former long distance telecommunications company WorldCom committed one of the biggest accounting scandals in United States history in 2002. During an internal audit, it was discovered that they were listing non capital items as capital expenses rather than operating expenses. Since capital expenses do not immediately go against revenues, they were falsely inflating their assets. They were found as having $3.8 billion in fraud and as much as $11 billion in inflated assets, seriously fooling investors. The backlash from this was strong, as the CFO was fired and the company filed for bankruptcy. The CEO and co-founder Bernie Ebbers was sentenced to 25 years in prison, and after emerging from bankruptcy in 2003 WorldCom became MCI.

http://www.foxnews.com/story/2002/06/26/worldcom-discloses-38-billion-accounting-scandal-global-markets-reel.html

http://www.foxnews.com/story/2005/03/15/mci-worldcom-timeline-183-present.html

http://www.accounting-degree.org/scandals/

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Freddie Mac, one of the largest mortgage financier, was charged of understating it’s earnings by $5 billion dollars over the course of 3 or more years. The company’s reasoning was to smooth out its earnings to reduce volatility over financial periods, trying to fake a steady growth. The company also overstated some periods by withholding earnings from previous ones and stating them later. This fraud greatly misled investors resulting in numerous penalties and fines, including one to the Office of Federal Housing Enterprise Oversight for $125 million. Stricter regulations were placed on large financial institutions. The risk from these scandals put the entire United States economy at risk and greatly contributed to the housing market collapse.

http://www.nytimes.com/2003/12/11/business/market-place-freddie-mac-gets-penalty-and-rebuke-over-scandal.html

http://www.nbcnews.com/id/21027918/ns/business-us_business/t/freddie-mac-settles-accounting-fraud-charges/#.WrJ7H8gh1rN

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Health South, which is now known as Encompass Health, is one of the largest healthcare providers in the United States. Fraudulent accounting practices began occurring within the company after they went public in 1986, most significantly between 1999 and 2002 when they misstated their earnings by more than 1.4 billion dollars, the goal being to align the company’s earnings with Wall Street predictions. Under the direction of their CEO, managers would compare unreported earnings to Wall Street estimates, then they would increase earnings to match estimates by reducing a contra revenue account called contractual adjustment. The contra revenue account essentially being an estimate of the portion of customer billings to be paid by insurance companies. The changes to the contractual adjustment account were matched with increases to fixed asset accounts. This case highlights the influence wall street has on the actions of companies, in this case the CEO of Health South held stock and was being compensated based on stock performance, so it was in his interest to match Wall Street expectations to manipulate the Stock Price for his own benefit.
https://www.sec.gov/litigation/complaints/comphealths.htm

https://www.sec.gov/litigation/litreleases/lr18044.htm

https://en.wikipedia.org/wiki/Encompass_Health

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In 2015, it was uncovered that Toshiba had engaged in fraudulent misrepresentation of their earnings. The problem arose in the start of the financial crisis, and continued well beyond then, resulting in overstating their earnings by 151 billion yen since 2008. Pressure to report positive earnings led managers to manipulate the numbers to mislead investors to believe the company had recovered from the market crash. Managers used a variety of techniques to improperly increase earnings including underreporting the cost of raw materials and components, reporting uncertain future income, some of which never materialized, and delaying write-offs related to cancelled contracts and other business setbacks. Top managers from several departments of the corporation were aware of this fraudulent behavior but did nothing to intervene. Eventually, auditors caught on to Toshiba’s incorrect earnings reports. Today, Toshiba continues to reform their accounting policies to reestablish their reputation and build back trust from investors.

Soble, J. (2015, July 20). Toshiba Inflated Earnings by $1.2 Billion, a Panel of Experts Says. Retrieved March 20, 2018, from

https://www.nytimes.com/2015/07/21/business/international/internal-panel-says-toshiba-inflated-earnings-by-1-2-billion.html

Carpenter, J. W. (2015, August 13). Toshiba's Accounting Scandal: How It Happened (OTCBB:TOSBF). Retrieved March 20, 2018, from

https://www.investopedia.com/articles/investing/081315/toshibas-accounting-scandal-how-it-happened.asp

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The example that our group was able to find that showed how a company mismanaged their earnings was in 2006 with a huge company in Enron. Enron was adding 1 single cent to its earnings per share so that they could overstate what they were actually earning. They were doing this for various reasons and they didn’t care who or what it would hurt in the long run, they were driven by the money. One key feature to this whole thing had to be the high up execs making money according to how much the company was making, which overstatement of numbers would do. Enron also was said to have tipped off top analyst when their earnings were higher that the estimates, which of course is now illegal per SEC. Enron was facing immense pressure since their numbers indicated so much success that they even began to manipulate revenue numbers in recognizing long term contracts before they even happened. Example- A 25 year contract with Blockbuster had been recognized years before the contract was up. All in all, Enron manipulated its fair share of earnings and revenues in turn causing more and more problems for them.

https://www.chron.com/business/enron/article/Enron-case-may-show-earnings-manipulation-1862093.php

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One example that really caught our attention was the case of Centennial Technologies Inc., who specialized in person computer equipment. Headquartered in Billerica, Massachusetts, only about 80 miles from us, this company committed extreme fraud on multiple different occasions. The craziest incident was that they claimed to have sold over $2 million of “PC memory cards” when in reality they never actually shipped them out at all. In fact, the company actually shipped out baskets of fruit out to the customers. Besides that, this company overstated their revenues by approximately $40 million. Instead of recording losses of around $28 million, they claimed they profited over $12 million. These overstatements of earnings manipulated their stock price and caused it to rise 451% after their earnings were made public. Eventually, members of Centennial were found guilty of securities fraud, which caused the stock to become delisted from the NYSE.
http://www.nytimes.com/1997/02/12/business/chief-is-dismissed-at-centennial-technologies.html

http://articles.latimes.com/1997-02-28/business/fi-33326_1_stock-exchange

https://www.investopedia.com/articles/00/100900.asp

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Team Gucci - Waste Management Fraud Scandal

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Team Gucci - Waste Management Fraud Scandal

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Since the 1970’s, Waste Management Inc. has been major player for environmental services. However, the company was charged for fraudulent accounting activities that occurred between 1992-97. One crime that the company committed was the purposeful misstating of depreciation expenses. The company increased the salvage value and extended the useful life of their trucks. Thus, accumulated depreciation for the trucks was much lower than what it was meant to be. They also frequently avoided recording major events or expenses that decreased the value of their landfills. Overall, the company eliminated approximately $490 million in operating expenses and reported $1.7 billion in fake earnings, making it the largest restatement in history at the time. The firm hired to audit Waste Management was bribed to overlook any errors in the accounting books. When the fraud was discovered, the company had to settle for $457 million and SEC fined auditors $7 million.

https://ensscpa.com/waste-management-inc-1998-fraud-scandal/
http://www.accounting-degree.org/scandals/
https://www.sec.gov/litigation/litreleases/lr17435.htm

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In August of 2004, the SEC filed civil fraud charges against two former head officers of Bristol-Meyers Squibb Company of the US. They involved Bristol-Meyers in a huge fraud earnings management scandal from 2000-2001 that deceived investors of the actual performance, profitability, and growth trends of the company and its division of U.S. medicine business. The company was inputting its own distribution channels with millions of dollars of excess inventory being sold to its wholesalers, which they were able to achieve by using financial incentives with these wholesalers. This artificially inflated financial results by overstating revenue by $1.5 billion. The company still fell short of the consensus estimate and tapped into fraud reserves, and reversed portions of these reserves into income, thus only further inflating their earnings. The SEC charged them with violations of the antifraud, reporting, books and records, and internal controls provisions of the federal securities laws. In 2004, Bristol-Meyers settled the case by agreeing to pay $150 million and appointing an independent adviser to monitor and review its accounting practices, financial reporting, and internal controls.

https://www.sec.gov/news/press/2005-118.htm

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Waste Management Earnings Management Scandal - Cydney Brooks, Kaleigh Gavrilles, Samantha Pender, Nick Colangelo, and Dan Sharaf

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Waste Management Earnings Management Scandal - Cydney Brooks, Kaleigh Gavrilles, Samantha Pender, Nick Colangelo, and Dan Sharaf

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From 1992-1997, Waste Management cooked its books. The company reported around $1.7 billion in false earnings through many expense management techniques. They avoided depreciation expense on trucks by increasing trucks’ salvage value and extending trucks’ useful lives. Both techniques caused depreciation expenses to appear lower than they were. The company also understated expenses by assigning salvage values to assets that did not have or need them causing the company to report less depreciation expense. Waste Management also refused to recognize decreases in values of landfills when full, failing to establish sufficient reserves to pay income taxes, and netting to eliminate $490 million. Netting allowed Waste Management to eliminate operating expenses by offsetting them with costs of a one-time gain. The company created a “one-off” problem so the scheme was ongoing - earnings created in one period had to be inflated in following periods. The scandal awarded executives millions in bonuses.

http://www.accounting-degree.org/scandals/

http://www.nytimes.com/2002/03/27/business/waste-management-executives-are-named-in-sec-accusation.html

https://www.sec.gov/news/headlines/wastemgmt6.htm

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Toshiba Earnings Management Overstatement (Team Target)

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Toshiba Earnings Management Overstatement (Team Target)

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Reports of Toshiba overstating its earnings over the course of seven years came out in 2015. Top executives at Toshiba, a multinational conglomerate headquartered in Tokyo, Japan, pushed the heads of divisions to meet unachievable financial targets that its stakeholders would like to see. Over the course of seven years, Toshiba’s top management overstated its earnings by more than $1.2 billion. Beginning in 2008, the year of the financial crisis, problems arose for Toshiba and meeting their financial targets.  Toshiba managed earnings in such a way that would not only overstate profits, but also understate or push back the recording of losses. Toshiba also delayed write-offs that related to cancelled contracts and business setbacks. The president, chief executive, and vice chairman of Toshiba were all aware of the overstatement of profits and the delay in reporting losses.

https://www.reuters.com/article/us-toshiba-accounting/toshiba-inflated-profits-by-1-2-billion-with-top-execs-knowledge-investigation-idUSKCN0PU0E920150720

https://www.nytimes.com/2015/07/21/business/international/internal-panel-says-toshiba-inflated-earnings-by-1-2-billion.html

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Diamond Foods Earnings Management (Team Tesla)

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Diamond Foods Earnings Management (Team Tesla)

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In 2014, Diamond Foods, a large producer of walnuts from California, was charged for falsely reporting expenses regarding their production of walnuts. They had done this by choosing to report current period inventory purchases as prepayments for the next period. This has caused their earnings to be overstated by $20 million in 2011. They also overstated predicted ending inventory from the previous periods allowing Diamond to get a lower price on purchases of future inventory. These actions caused a significant increase in the company’s earnings per share allowing executives to receive large bonuses. The inflated stock price was also used as deceptive payment while they were trying to acquire Pringles potato chip from Procter and Gamble. The event led to the firing of both the CEO and CFO. The company also had to pay a $5 million settlement to the SEC.
https://danielsethics.mgt.unm.edu/pdf/diamonds.pdf

www.huffingtonpost.com/2012/03/19/diamond-foods-accounting-scandal_n_1361234.html

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Toshiba - Earnings Management (Team Google)

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Toshiba - Earnings Management (Team Google)

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In 2015, it was found that the company Toshiba had been mismanaging and overstating their earnings for the prior seven years. In order to meet unrealistic goals set by top level executives, department heads throughout the company used multiple unacceptable accounting methods to overstate earnings. These methods included underreporting costs of raw materials, giving inconsistent and incomplete information to auditors, reporting large amounts of uncertain income as profits and cash in the bank, and continuously delaying write offs related to things like cancelled contracts. By using these techniques, managers were able to overstate earnings by a total of $1.2 billion over the seven years, almost triple what their original estimates showed. Such outrageous mismanagement and overstatement of earnings by a multinational conglomerate of this size is a serious offense that has extreme effects on external users of the company’s financial statements, such as shareholders and investors.

https://www.nytimes.com/2015/07/21/business/international/internal-panel-says-toshiba-inflated-earnings-by-1-2-billion.html

https://www.bloomberg.com/news/articles/2015-08-31/toshiba-delays-earnings-report-on-additional-accounting-probe

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A real-world example that our group found about earnings management was this article about Sunbeam Corporation, a maker of various home goods. They largely mismanaged their earnings in the late 1990’s when the SEC began cracking down on fraudulent earnings management practices. Sunbeam executives were managing their earnings in a way to make their numbers look good to their shareholders. The profits reported in its financial statements increased greatly in 1997, although Sunbeam had taken a large write-off in 1996 due to laying off thousands of employees and closing manufacturing facilities. It ended up that $62 million of Sunbeam’s reported income was not consistent with GAAP, as they were recognizing expenses in the wrong years. They created bogus profits in 1997, although the company had negative operating cash flow. Arthur Anderson wrongly signed off on 16% of profits that had been challenged, allowing Sunbeam to successfully mismanage their earnings for a profit.

http://www.nytimes.com/2001/05/16/business/sec-accuses-former-sunbeam-official-of-fraud.html