Dressing up earnings has never been more fashionable.

It's well established that earnings have been dismal on Wall Street this year. The two firms that track those numbers,

Thomson Financial/First Call

and

Standard & Poor's

, both showed a steep drop in first-quarter operating profits at the big companies that make up the

S&P 500

. Second-quarter numbers, by all indications, will follow a similar pattern.

But what's striking in the First Call-S&P comparison is how much better earnings look when Wall Street analysts calculate them. The gap between Wall Street's numbers and bottom-line reality is widening, observers say, as companies increasingly lump all manner of costs into one-time charges that don't count against operating earnings. Driving this trend are companies anxious to gussy up their falling profits and sell-side analysts who are all too willing to help out. The result is that quarterly reports, as poor as they are, often give investors an unduly rosy view of how companies are faring.

Yawning Gap

First Call, which tracks the earnings followed by Wall Street analysts -- that is, operating earnings, excluding one-time charges -- showed first-quarter profits dropping 9.5% from a year ago. But S&P, which tracks a more narrowly defined operating profit number, showed earnings plunging 23%.

Grieve La Difference
Growing gap between operating earnings as tracked by First Call, Standard & Poor's

Source: Standard & Poor's, Thomson Financial/First Call

"This is the widest discrepancy ever," says Merrill Lynch chief economist Bruce Steinberg. "With all the bad news, companies decided to put a better gloss on things." Steinberg says he became aware of the problem when his rough estimate of first-quarter S&P 500 earnings, based on reported operating earnings, diverged wildly from Standard & Poor's figure.

In adding up the earnings numbers, Standard & Poor's routinely backs out truly extraordinary items -- unusual and infrequent events that affect results. If you are a homebuilder and a tornado rips through your project in New Hampshire, an area not known for tornadoes, then pulling that loss out of your operating earnings is acceptable. If you are a rancher and lightning strikes some of your cattle, however, taking that loss as an extraordinary charge is not appropriate because such strikes occur fairly frequently.

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In the first quarter, many companies, particularly in the hard-hit tech sector, took charges for their fallen cattle -- items such as payroll taxes on options, investment losses and severance costs. In assessing operating earnings, Standard & Poor's put those charges back on the income statement, reducing the bottom line.

"Excluding having to do the roof on my house and paying my kid's tuition," jokes Howard Silverblatt of Standard & Poor's quantitative research group, "I would have had a great year last year."

Sheep

As much as the gap between the First Call and Standard & Poor's earnings numbers shows the lengths to which companies have gone to paint over poor results, it also illustrates Wall Street's willingness to follow along. The First Call numbers are those that the analyst community has agreed to use despite having at some point, one assumes, taken an accounting class or two.

Merrill's Steinberg reckons that analysts eventually will mend their ways. "It's hard to speculate about the future," he says, "but at some point analysts are going to call companies on this."

That point probably won't come in the second quarter, however. In its second-quarter earnings, announced Monday,

Citigroup

(C) - Get Citigroup Inc. Report

excluded items "related principally to severance and costs associated with the reduction of staff in most businesses."

One analyst, Raymond James' Richard Bove, says that isn't appropriate. He contends that "layoff charges are not a nonrecurring item. They are considered a normal cost of doing business." Citigroup didn't immediately return calls seeking comment on its handling of the layoff costs.

Of course, Citigroup is far from the only company to treat firing expenses as a one-time item. And because most analysts abide by Citigroup's way of doing things, First Call does, too -- and asks that all analysts adhere to the majority's view.

"Unless I'm willing to conform to their EPS number, they will refuse to show my estimate," say Bove. First Call confirms that this is its general practice. So until more analysts cry foul, Wall Street's numbers will continue to reflect the reality that companies would like investors to believe.

And voices like Bove's will be lost in the wilderness.

Staff reporter

Eileen Kinsella contributed to this article.