In a Bull Market, Scrupulous Accounting Barely Matters

Investors consistently display a disregard for the merits of sound bookkeeping. In his speech to a CPA luncheon, the writer offers some specifics.
Author:
Publish date:

Editor's note: Adam Lashinsky never expected to become anything close to an authority on accounting issues. He still isn't. But first as the high-tech stocks columnist for the San Jose Mercury News and now as the Silicon Valley columnist for TheStreet.com, he's found himself writing repeatedly about the green-eyeshade crowd, its policies and its controversies. For the most part, that has endeared him to the accounting profession, which doesn't necessarily want to be agreed with as much as it is delighted to be paid attention to at all. And that is how Lashinsky ended up as the California CPA Education Foundation's luncheon speaker at its annual high-tech industries conference last week in Los Angeles and San Jose. In the spirit of TSC founder James J. Cramer, a heavily edited, polished and factually enhanced text of that speech follows.

Let me first tell you that I am far more amused to be addressing a roomful of accountants than you possibly could be listening to a journalist. I studied history and political science at the

University of Illinois at Urbana-Champaign

(I graduated before

Marc Andreessen

even showed up), where my only connection to the now-famous computer science department was that I had a roommate who was a computer-room monitor. This meant we had access to the laser printer late at night, so I could print my term papers without having to wait in line.

I did, however, take an accounting class at Illinois, a one-semester condensed version of the two semesters accounting majors endured. Taking our cue from the coursebook's abbreviations, nonaccounting majors called this short-form course "Accy. (pronounced ACK-ee) for Idiots." Idiotic it was not, of course. And that one semester of accounting has served me well as a business journalist. Thanks, Dad, for forcing me to take it.

In any event, I am here to deliver hopeful news to you: The rest of the world -- especially Wall Street and employees in Silicon Valley -- care deeply about accounting. In short, accounting matters. And I'm going to recount just a few of the accounting brouhahas into which I have injected myself over the last two years. But there is a downside to my hopeful message: Accounting counts, but in a great bull market it may not be relevant. Put differently, in case after case, simply pointing out questionable accounting practices has had much less impact than one might assume. And that calls into question whether or not the outside world should continue to care about accounting or if it's best left to the likes of you and, sometimes, me.

First, however, consider an anecdote to illustrate just how arcane the world of Silicon Valley accounting can seem to outsiders. Early in my earnest education phase of covering the Valley, I came across a curious comment in a quarterly filing by

Oracle

(ORCL) - Get Report

, describing its acquisition from

Netscape Communications

of an R&D-stage company called

Navio

. Oracle paid about $77 million in stock and proceeded to take a charge to earnings of $75.6 million. Why? Because "in the opinion of management and the appraiser, the acquired in-process research and development

associated with Navio had not yet reached technological feasibility and had no alternative future uses."

Now, in plain English this sounded an awful lot like Oracle had just exchanged $77 million in stock for something worth roughly $1 million. Confused, I phoned the father of a friend in Chicago who was a longtime partner with a major accounting firm. "What's this in-process R&D charge business all about?" I asked. The short answer: "I don't know. Call my partner in San Jose. He'll know."

Lesson learned: Don't feel bad if you don't understand the goofy things you read in securities filings. Trained professionals don't always get it either.

Now consider some of the other accounting topics I've struggled to make interesting for the average reader.

  • In early 1998, I chastised Web advertising firm Doubleclick (DCLK) for reporting as "revenue" a figure most of the rest of the world would better recognize as "billings" or "gross merchandise revenue." Why did this matter? Because unprofitable Internet companies typically are valued on a price-to-sales basis. Bigger revenue mean bigger valuations. Doubleclick, by the way, subsequently refined the way it reports revenue. But did it ever matter? Arguably not. The young company's stock has soared throughout.
  • For a while, the accounting industry was in a dither over a new directive called SOP 97-2, a fundamental rewriting of accounting policies for technology companies, especially software concerns. I devoted considerable time and ink to explaining what it meant while imploring readers to pay attention. Shortly after that, the accounting profession decided its SOP 97-2 directive wasn't quite ready for prime time, and nobody talks about it anymore. Important, yes. But relevant?
  • The former Excite search directory company created a stir about a year ago when it announced its first "profitable" quarter. A lower-down paragraph beneath the hoopla in its news release, however, was telling. "On a GAAP basis," it began, referring to the Generally Accepted Accounting Principles that all U.S.-listed companies must use to report their performance. Think about that. "On a GAAP basis," Excite wasn't profitable after all. But never mind such silliness. Excite ultimately was acquired for billions of dollars by another unprofitable company, now known as Excite@Home (ATHM) - Get Report, which itself had changed its accounting presentation once after a chat with the Securities and Exchange Commission. Whatever.
  • PeopleSoft (PSFT) , the software company, creatively followed the lead of the pharmaceutical industry by deploying what's properly called off-income-statement financing of its R&D. By creating, capitalizing and spinning off Momentum Business Applications (MMTM) - Get Report, PeopleSoft shifted some of its research expense to a shell company with no employees. The goal: lower PeopleSoft's expenses in the near term while retaining rights to buy back the fruits of the technology in the future. But did pointing out that this was a sham matter? Nah, PeopleSoft's stock cratered when its business dried up, not because people were outraged over its accounting practices.
  • Be (BEOS) and NetObjects (NETO) both carried "going concern" warnings in their initial public offering prospectuses this year. Accountants know this technically means, "We need the cash or we could go bankrupt," or in other words, cease to be a going concern. But Silicon Valley pros tut-tut such talk. Everyone knows that doing an IPO is simply the cheapest way to raise money but not the only one. So why would you get all hot and bothered over a little "going concern" warning? Both companies successfully raised tens of millions of dollars.
  • William Larson, CEO of Network Associates (NETA) , had the chutzpah to tell analysts in a conference call that Network Associates would keep making its projections because of "honey-pot" reserves it was stashing. I'd like to think this was the genesis of SEC Chairman Arthur Levitt's crackdown on the use of "cookie-jar" reserves. And indeed, this is perhaps the weak link in my thesis, because aggressive merger accounting and discernible channel stuffing may well have masked an eventual business slowdown at Network Associates, whose stock plunged when Larson's honey pot ran dry.
  • Finally, just last week, Goldman Sachs analyst Rick Sherlund assured investors that some new business-to-business e-commerce companies were confident of their ability to smooth out future quarterly performance by saving current sales to be recorded in the future. Sherlund acknowledged that the SEC might not look kindly on such a practice. But after all, it's common knowledge that that sort of behavior goes on. Accounting matters? Only to a point.

It's worth noting that my colleague

Herb Greenberg

has built a career out of scrutinizing balance sheets, particularly the "receivables" line item, as a way of ferreting out companies whose rising inventories are hiding fading sales.

But on balance, accounting matters less than does the great bull market, the forgiver of almost all transgressions. Accounting will matter again, to be sure. But perhaps not until investors' irrational exuberance becomes rational scrutiny.

Adam Lashinsky's column appears Mondays, Wednesdays and Fridays. In keeping with TSC's editorial policy, he doesn't own or short individual stocks, although he owns stock in TheStreet.com. He also doesn't invest in hedge funds or other private investment partnerships. Lashinsky writes a column for Fortune called the Wired Investor, and is a frequent commentator on public radio's Marketplace program. He welcomes your feedback at

alashinsky@thestreet.com.