Accounting rule change to inflate earnings
By Noelle Knox, USA TODAY
Many companies will see a significant boost in reported earnings in 2002 because of a new accounting rule. Expected boost to some industries' earnings:
Industry Increase
Telecommunications 23%
Aerospace 17%
Services 15%
Utilities 6%
Transportation 4%
Source: UBS Warburg
NEW YORK — As if investors haven't already suffered enough from two straight years of losses, this year they face the additional headache of dealing with a new accounting rule that will artificially inflate corporate earnings.
Many widely held companies, including General Mills, Lockheed Martin and J.C. Penney, will show a big increase in earnings this year.
The confusion for investors is that the gains will not come from a pickup in business, but from a new way the companies will be required to account for the price of previous mergers and acquisitions.
Patricia McConnell, an accounting analyst for brokerage Bear Stearns, went so far as to say that she knew of no other recent accounting change that has "the potential far-reaching implications for financial markets" as this one.
In total, the 500 largest U.S. companies that make up the Standard & Poor's index will see 7% added to their earnings in 2002 thanks to the change alone, estimates brokerage UBS Warburg.
The accounting change, dictated by the Financial Accounting Standards Board, ends the use of "pooling accounting" for mergers and acquisitions.
Under pooling accounting, the two companies simply combined their balance sheets.
Any premium paid over the value of the target company's assets was then amortized, or written off against their earnings, over a period of 40 years.
Under the new rules, the acquiring company must value that premium — which is known as "goodwill" in accounting parlance — as an asset on their books and valued once a year.
On one hand, many companies will report higher-than-expected quarterly profits in 2002 because they won't have quarterly write-offs of goodwill.
"There will be a benefit, that's unequivocal," says Chuck Hill of Thomson Financial/First Call, which tracks corporate earnings.
The accounting change doesn't affect the company's cash flow, so in theory, it shouldn't affect the stock price.
However, some investors might bid the stock up anyway because of its higher reported earnings.
But, Hill says, "My rough rule of thumb is you end up halfway between."
A 10% boost to earnings would result in a 5% increase in the stock price, Hill says.
On the other hand, after the initial bump this year, earnings will look paler by comparison in the following years.
"It reduces everybody's growth rate," says Ross Margolies of Salomon Bros. |
