Abracadabra! That piddly-sounding “change in accounting principle”
pumped up 1999 net income by $240 million after taxes—a fifth of all
the money Qwest earned that year.
Like a little chunk of ice crowning a submerged iceberg, aggressive
revenue recognition is often a sign of dangers that run deep and loom
large—and so it was at Qwest. By early 2003, after reviewing its previ-
ous financial statements, the company announced that it had prema-
turely recognized profits on equipment sales, improperly recorded the
costs of services provided by outsiders, inappropriately booked costs
as if they were capital assets rather than expenses, and unjustifiably
treated the exchange of assets as if they were outright sales. All told,
Qwest’s revenues for 2000 and 2001 had been overstated by $2.2
billion—including $80 million from the earlier “change in accounting
principle,” which was now reversed.^3CAPITAL OFFENSES
In the late 1990s, Global Crossing Ltd. had unlimited ambitions. The
Bermuda-based company was building what it called the “first inte-
grated global fiber optic network” over more than 100,000 miles of324 Commentary on Chapter 12(^3) In 2002, Qwest was one of 330 publicly-traded companies to restate past
financial statements, an all-time record, according to Huron Consulting
Group. All information on Qwest is taken from its financial filings with the
U.S. Securities and Exchange Commission (annual report, Form 8K, and
Form 10-K) found in the EDGAR database at http://www.sec.gov. No hindsight
was required to detect the “change in accounting principle,” which Qwest
fully disclosed at the time. How did Qwest’s shares do over this period? At
year-end 2000, the stock had been at $41 per share, a total market value of
$67.9 billion. By early 2003, Qwest was around $4, valuing the entire com-
pany at less than $7 billion—a 90% loss. The drop in share price is not the
only cost associated with bogus earnings; a recent study found that a sam-
ple of 27 firms accused of accounting fraud by the SEC had overpaid $320
million in Federal income tax. Although much of that money will eventually be
refunded by the IRS, most shareholders are unlikely to stick around to bene-
fit from the refunds. (See Merle Erickson, Michelle Hanlon, and Edward May-
dew, “How Much Will Firms Pay for Earnings that Do Not Exist?” at http://
papers.ssrn.com.)