Warning Sign: Companies Narrowly Meeting Expectations

The Securities and Exchange Commission (SEC) is experimenting with a list of warning signs that may signal a need for additional investigation. These red flags include a pattern of narrowly meeting or exceeding the earnings estimates of securities analysts.

Charles Niemeier, chief accountant of SEC's enforcement division, reportedly told the Wall Street Journal a company that consistently met earnings expectations would be of special interest to the SEC, if it also showed revenue increases while cash flow was falling. ("Meeting Expectations Used to Draw Favor, Now It Invites Scrutiny," August 5, 2002.)

A study by the Journal based on earnings data provided by Multex.com shows that 43 of the companies, or 9%, in the Standard & Poor's 500-stock index consistently have met or beat estimates by a penny or two for the nine quarters through the first quarter 2002, and several have patterns of rising revenues and falling cash flow from operations.

Of course, experts caution there can be good and valid reasons why a company consistently makes its numbers, such as good management and the fact that some industries are relatively predictable. Then, too, some companies attribute their track records of matching or just beating estimates partly to good communication channels with analysts. But skeptics may see this as evidence of overly cozy relationships between analysts and the companies they follow.

Some experts argue that most companies manage their earnings to some extent. For example, a company could legitimately sell an asset, such as a plant, at the end of a period and report a gain on that sale. However, the practice may go too far, giving the phrase "earnings management" a negative connotation. Former SEC Chief Accountant Walter Schuetze has said, earnings management is "like dirt, it is everywhere. . . I saw companies regularly making their earnings estimates by all kinds by earnings management," he says, pointing to recognition of premature or fictitious revenue as a common abuse.

-Rosemary Schlank

You may like these other stories...

A proposal issued by the Governmental Accounting Standards Board (GASB) last week explains how fair value measurement should be defined for state and local government financial reporting.The exposure draft, Fair Value...
By Jason Bramwell The board of trustees of the Financial Accounting Foundation (FAF) finalized a new policy on November 19 that provides the Governmental Accounting Standards Board (GASB) with direction on what...
By Jason Bramwell The Governmental Accounting Standards Board (GASB) is now offering a free online toolkit designed to assist preparers and auditors of state and local government pension plans with implementing new...

Already a member? log in here.

Upcoming CPE Webinars

Sep 18
In this course, Amber Setter will shine the light on different types of leadership behavior- an integral part of everyone's career.
Sep 24
In this jam-packed presentation Excel expert David Ringstrom, CPA will give you a crash-course in creating spreadsheet-based dashboards. A dashboard condenses large amounts of data into a compact space, yet enables the end user to easily drill down into details when warranted.
Sep 30
This webcast will include discussions of important issues in SSARS No. 19 and the current status of proposed changes by the Accounting and Review Services Committee in these statements.
Oct 23
Amber Setter will show the value of leadership assessments as tools for individual and organizational leadership development initiatives.