Making(Up)Numbers 163buyers who pai dtheir accounts early. Following bookkeeping rules,
receipt of those early cash payments calle dfor a cre dit to Accounts
Receivable equal to 100% of the list price. Since the buyer received
a 10% discount on the price, the debits should have been made to
Cash for 90% of the list price, with the other 10% going to an expense
account. Adding it up, those 10% discount expenses would have re-
duced reported earnings.
Instea dof following these stan dar dbookkeeping rules, Pearson
apparently recorded receipts of early payments as a debit to Cash
for 90% of the list price an da cre dit to Accounts Receivables for
90% of the list price, an dso the 10% discount never showe dup as
an expense. It simply remaine dpart of the asset account—Accounts
Receivable—an dartificially inflate dreporte dearnings.
While Penguin’s 10% individual discounts given on a per cus-
tomer basis may at first seem like small change, they aggregate dover
six years to $163 million. Pearson’s management eventually discov-
ere dthe burie d discounts when integrating Penguin an dPearson’s
newly acquire dPutnam Berkley publishing house. Dirty bookkeep-
ing then turne dinto housecleaning.
Mercury Finance
In January 1997 Mercury Finance announce dthat it ha doverstate d
earnings for the first three quarters of 1996 an dfor the whole of
1995 by a total of more than 100%. All corporate hell broke loose at
Mercury Finance, a company in the business of lending to consum-
ers with weak credit ratings. Its CEO and controller both left, a
turnaround specialist was recruited, and pending deals with the
Bank of Boston an dSalomon Brothers were terminate d. It lacke d
cash to meet its maturing commercial paper obligations an dteetere d
on the edge of bankruptcy.
The company and the consumer finance industry made headlines
every other day. Some commentators correctly noted that many com-
panies in high-risk businesses like Mercury Finance’s use “aggressive
accounting techniques”; other so-calle dexperts incorrectly state d
that accounting in finance companies is “extraordinary complex.” It
is not all that complex.
To lenders, loans are assets even though some loans are unlikely
to be repaid. Bad loans are an expense—a cost of doing business.
Expenses reduce net income. Estimating the amount of bad loans
may involve complex judgments, but the accounting is simple. The