The trailing 12-month revenues are more than twice the
revenuesreportedinthelatest10-K,andthefirm’soperating
loss and net loss haveboth increased more than fivefold.
Googleinthemiddleof 2005 wasaverydifferentfirmfrom
Google in early 2005.
Correcting Earnings Misclassification
Inaconventionalaccountingstatement,theexpensesincurred
by a firmcanbe categorized into three groups—operating
expenses (like labor and material), which are expected to
generatebenefitsonlyinthecurrentperiod;capitalexpenses
(likeland,building,andequipment),whichareexpectedto
generate benefits over multiple periods; and financial
expenses (such as interest expenses), which areassociated
withtheuseofnonequityfinancing.Theoperatingincomefor
afirm,measuredcorrectly,shouldbe equaltoits revenues
less its operating expenses. Neither financial nor capital
expensesshouldbeincludedintheoperatingexpensesinthe
year that they occur, though capital expenses may be
depreciatedoramortizedovertheperiodthatthefirmobtains
benefitsfromtheexpenses.Thenetincomeofafirmshould
beitsrevenueslessbothitsoperatingandfinancialexpenses.
No capital expenses should be deducted to arrive at net
income.
The accounting measures of earnings can be misleading
because operating, capital, and financial expenses are
sometimes misclassified. We will consider the two most
commonmisclassificationsinthissectionandhowtocorrect
forthem.Thefirstistheinclusionofcapitalexpensessuchas
R&Dintheoperatingexpenses,whichskewstheestimation
ofbothoperatingandnetincome.Thesecondadjustmentis