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End the Numbers Game

What did the company earn? That's the most basic question an investor can ever ask. The equity culture that has generated so much growth over the years depends on a clear answer, but getting one has become impossible. Enron Corp. just announced that its earnings for the past three years were overstated by half a billion dollars. How did one of the biggest companies on the New York Stock Exchange manage to inflate its earnings by 20% without auditors, analysts, ratings agencies, and the business press (BusinessWeek included) discovering it? In part, blame the breakdown of standardized accounting rules and the anarchy that runs rampant in the financial statements of Corporate America. The U.S. needs a new set of accounting rules that gives a clear picture of financial performance. Without integrity in financial reporting, the U.S. cannot hope to remain the preeminent place to invest in the global marketplace.

The dot-com bubble was the first indication that there was something seriously wrong with accounting standards. Companies without much of a business model customized their quarterly statements to exclude a grab bag of expenses in order to put a positive financial spin on their operations. Wall Street conspired in this and encouraged big companies to join in. Soon, the method of calculating earnings began to vary from company to company and even from quarter to quarter within a company. It is now chaos.

A stricter adherence to accounting rules won't solve the entire problem. GAAP, the generally accepted accounting principles, allow all kinds of one-time expenses and noncash charges. This obscures the performance of ongoing operations. No one can fathom what are true operating earnings because there are no guidelines as to what constitutes an extraordinary expense. The result is total confusion. Take earnings per share for the Standard & Poor's 500-stock index for the second quarter. Under Thomson Financial/First Call standards, it is $11.82. But it's $9.02 according to S&P and $4.83 under GAAP. How can investors make intelligent decisions?

The Financial Accounting Standards Board clearly is failing to do its job. It has promised to write a set of rules that calculates operating earnings and relates them to net earnings, but it hasn't delivered. The rating agency Standard & Poor's (owned by The McGraw-Hill Companies, as is BusinessWeek) is doing a better job. It recently drew up a definition of "operating earnings" that includes restructuring costs (including severance), writedowns from ongoing operations, and the cost of stock options. It excludes merger and acquisition expenses, litigation settlements, impairment of goodwill, and gains or losses on asset sales. This is a beginning that FASB should build on. The accounting anarchy has to end.

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