154 ShowMetheMoney
counting issues that are hallmarks of earnings management. These
techniques are as ol das accounting itself an dhave been use dto full
advantage (sometimes appropriately, often not) by managers over the
centuries. Yet the contemporary problems are heightened, according
to Levitt, by a managerial obsession with meeting consensus earn-
ings estimates formulate dby the increasingly influential profession
of investment analysis.
This dizzying obsession with “making numbers” is documented
by the accounting professors Davi dBurgstahler of the University of
Washington an dIlia Dichev of the University of Michigan.^1 They
show that about one in ten managers facing small declines in earn-
ings manage to show earnings increases, an dthat about four in ten
facing negative earnings manage to report positive earnings! The ob-
session with “making numbers” leads managers to make them up.
Levitt single dout five issues of particular concern, giving each
a catchy phrase intended, one supposes, for both poetic and mne-
monic value.
- Big bath. Big bath accounting is a particularly aggressive version
of earnings management that is sort of a financial face-lift. It
lumps major events adversely affecting income in current periods
to facilitate improved financial appearances in succeeding periods.
It is particularly common in, but by no means limite dto, costs
occasione dby acquisitions, divestitures, reorganizations, an dother
extraordinary organic business changes. These transactions call for
numerous accounting judgments in regard to both timing and clas-
sification. Managers often expense as much of the potential cost
of a transaction at the time it is consummate das possible. It’s also
tempting to give current earnings a “big bath” in one year to create
a brighter-looking future when the year is so dismal anyway that
investors have written it off (this happens all the time, even at
otherwise reputable companies). - Merger magic. This describes a subset of creative accounting in
acquisitions. If a business buys another business for a price higher
than the seller’s book value, the buyer in most cases must record
an asset called accounting goodwill (discussed in the last chapter)
and amortize that account as an expense over future decades. That
reduces earnings over that period. To minimize the reduction, a
buyer’s manager can allocate some or a lot of that excess to other
things, most notoriously to in-progress research-and-development