Beware of Inflated Earnings (08/17/00) Vol. 5, No. 17 p.56; McCaffery, Richard

Accounting practices have become a controversial issue these days, with some saying new companies are avoiding traditional accounting practices to inflate their earnings reports, and others saying the traditional practices just do not work for many companies today. Companies have been criticized for making earnings reports intentionally complicated for tough reading for investors. However, accountants have had trouble figuring out a way to resolve the difference between public companies' market and book values. Companies whose values are derived from intellectual property, such as patents, rather than net assets, can vary their accounting treatment because products developed in-house are treated one way, while patents bought from other companies are valued another way. Some observers, including Baruch Lev of New York University and columnist Geoffrey Colvin of Fortune magazine, have come out in favor of capitalizing certain expenses, such as advertising. However, this practice brought America Online trouble with the Securities and Exchange Commission and could make financial statements misleading. One venerable concept in accounting is conservatism--if the same transaction can be reported in ways both negative and positive for the company, the negative one should be chosen.

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