Making(Up)Numbers 165As with Mercury Finance, a telltale re dflag flew high: AOL’s
balance sheet showe dan unusual asset calle dDeferre dSubscriber
Acquisition Costs. Mushrooming to $385 million between August
1995 an dOctober 1996, it became the largest asset on AOL’s balance
sheet. Angry shareholder agitation forced AOL to abandon the prac-
tice in the fall of 1996 an drestate its earnings, wiping out about 80%
of owners’ equity.
Fabri-Centers
Judgment plays a critical role in corporate accounting decisions, en-
abling managers to persuade auditors and directors to accept their
position when choosing to expense or capitalize a transaction or
make other accounting decisions. Even when the managerial deci-
sion is accepted, full disclosure about the judgment should be in-
cluded in the company’s financial statements but isn’t always.
If you have any doubt about the need for disclosing these diffi-
cult judgment calls, consider the enlightening story behind the set-
tlement of SEC charges against Fabri-Centers, an operator of over
900 retail stores, including the JoAnn Fabrics chain. Fabri-Centers
knew the daily sales figures at its stores but could not determine the
cost of goods sold or the profit margin until it conducted an annual
inventory, an dso it estimate dthem, using the so-calle dgross profit
metho dof applying the prior year’s actual profit margin to calculate
quarterly profits for the succeeding year.
During several quarters, however, heavy price competition sub-
stantially eroded the margin. Before the erosion was reported or pub-
licly disclosed, the company effected a public debt offering. The SEC
charged Fabri-Centers with inadequate disclosure about price com-
petition an dits estimation practice in that offering.
Under Fabri-Centers’ inventory system (it has since been mod-
ernized), a judgment about quarterly profit margins was necessary.
But those involve din the debt offering—aware that the quarterly
financial statements were unau dite dan dprepare din anticipation of
the offering—shoul dhave pai dgreater attention to the role that ac-
counting estimates played.
Sunbeam
Sunbeam committe da distinct but all too common type of accounting
fraud. Its widely publicized accounting machinations boiled down to