I have a theory about the way earnings are managed. With little more than an Excel spreadsheet, you too can manage earnings so you exceed analysts expectations by $.01 each quarter. Here's how it's done.|
The liability section of the balance sheet includes an account called accrued liabilities. That general caption may include separate accounts for over dozens of different accrued liability accounts: accrued warranty expense, accrued vacation pay, accrued bonuses, accrued pension liabilities, accrued legal fees, accrued income taxes, accrued relocation expenses, etc. etc. You get the picture.
An accrual account, unlike an account payable balance, is an "estimate". Based on facts and circumstances, as well as preferences for meeting or beating street expectations, estimates for various accrued balances can be finagled up or down depending on the amount of earnings you wish to....go away.
So, if during the first cut through your preliminary financial statements, you notice, "Well, if we report these numbers, we're going to beat analysts expectations by $.15 per share. That's good because we look to our shareholders like we're doing our job. But that's bad for us because a year from now, we've set an awfully high bar for us to hurdle on a quarter to quarter comparison. So, you do what all good controllers and CFO's never acknowledge doing: you rejigger the amount of dollars you can pack into the accrued liability accounts so you beat estimates by a penny without causing your outside auditors to blush.
To be sure, IMO, the auditors are in on this too. Although I couldn't say for sure, the audit fees for CSCO are likely more than a little north of $1M per year. That's a substantial amount of fees that would be difficult to replace, so you play the game with your client, knowing you get to keep the audit engagement, and that in the long-term, you didn't hurt anybody because your accrual "estimates" will change, for better or for worse.
In the quarters where you are shy of analyst expectations, you simply pull some of those dollars out of the accrued liability accounts, effectively reducing expenses and increasing earnings per share so you can at least meet, if not beat analyst expectations.
It is a game, to be sure, that appears to be played if not successfully managed by many notable corporations of size. Of course this is all IMO and there may really be one or two companies out there that actually beat expectations by the $.01 per share without all of these machinations.
But personally, I doubt it.
Mark A. Peterson