Bradley Cipriano  by Bradley Cipriano, CPA
  Equity Analyst, Gradient Analytics LLC (a Sabrient Systems company)

As interest rates remain at historic lows, mergers and acquisitions (M&A) have soared in recent years. With the rise in M&A activity comes a rise in accounting complexity, introducing a plethora of ways that management can cosmetically improve their as-presented results – and mislead investors. Gradient Analytics specializes in forensic accounting analysis that helps to uncover these types of financial shenanigans, including overstated assets and revenues, understated liabilities and expenses, and weakening earnings quality. This type of analysis is useful for both vetting long positions and generating short ideas.

In this article, I describe four acquisitions that we believe were used to obscure underlying financial weakness at the parent company by temporarily shoring up growth and earnings. Key takeaways are how management can utilize acquisitions, purchase price accounting, and non-GAAP adjustments to optically improve their as-presented results. In each case, the theme will remain consistent: the acquiring company was under fundamental business stress.

The subject transactions include:

  • SodaStream (SODA) acquisition of its distributors in 2012 and 2013
  • SNC-Lavalin (SNC) acquisition of WS Atkins in 2017
  • Belden Inc. (BDC) acquisitions in 2017 and 2018
  • The Walt Disney Corporation (DIS) acquisition of 21st Century Fox in 2019

Read on....

Rachel Bradley  by Rachel Bradley
  Equity Analyst, Gradient Analytics LLC (a Sabrient Systems company)

“Every man hears only what he understands.” – Goethe

Often, details in the financial statements hold the key to understanding a company. Here at Gradient Analytics, we specialize in forensic accounting research and consulting, and our analysts stay up-to-date on changes in the regulatory landscape, including crucial updates to disclosure requirements. Normally, we focus research on areas that might tempt companies to “manage” or overstate earnings, either by pulling forward future revenues or pushing out current expenses. Layer on more complexity from changing reporting requirements and it becomes clearer how a vital piece to the puzzle might slip through the cracks.

Below, I cover three broad topics. First, effective January 1, 2020, the governing accounting boards updated the very definition of a business. This new definition has multiple implications for reporting, but my focus in this article is the impact on M&A transactions. Moreover, this year both the Financial Accounting Standards board (FASB) and the International Accounting Standards Board (IASB) changed required disclosures for U.S. and international companies. Among other things, there is a new method for determining appropriate loan loss reserves, and there will soon be a requirement for companies to stop using Inter-Bank Offered Rates (IBOR) as reference rates, instead switching to Alternative Reference Rates (ARR). I describe these updates with four real-life examples of how they shape financial statements, with the potential to mislead investors. Read on….

Bradley Cipriano by Bradley Cipriano, CPA
Equity Analyst, Gradient Analytics LLC (a Sabrient Systems company)

At Gradient Analytics, our forensic accounting analysis includes assessing the quality of a company’s reported earnings and the strength of its balance sheet. A key element of this process is understanding whether recently reported growth is sustainable and whether forward expectations are reasonable. New GAAP (Generally Accepted Accounting Principles) standards – such as Contracts with Customers (ASC 606), which went into effect at the beginning of this year – have distorted year-over-year growth figures, such that it has become routinely necessary for an investor/analyst to adjust income statement and balance sheet accounts to get a clearer like-for-like comparison. For example, ARRIS International plc (ARRS) has grown 2018 YTD GAAP EPS by $0.17, which includes an $0.18 benefit from ASC 606. So, while ARRS is showing earnings growth on the surface, its comparable YOY earnings have actually declined. Understanding how new accounting standards can be manipulated to positively impact earnings can help investors better assess reported results.

While such new standards are often viewed as “a wash” since there is no change to the underlying economics of a business, the changes under the new leasing standard Leases (ASC 842), which is coming into effect in 2019, may prove quite material for certain corporate filers. The new leasing standard follows a convergence in accounting principles between International Financial Reporting Standards (IFRS) and U.S. GAAP to improve comparability among different filers. Currently, operating leases (which are similar to debt) are disclosed off-balance sheet in the footnotes with limited qualitative or quantitative disclosures. But following the adoption of the leasing standard, this debt must be brought back onto the financial statements along with increased disclosure requirements. It is important to question why a company has relied on off-balance sheet debt in the past to better understand the risks that may surface once this debt is brought back onto the statements.

In this article, I explain ASC 842, summarize the major changes it introduces and its expected impact on corporate financial statements, and discuss how this new leasing standard allows for management subjectivity that might be used to distort earnings growth and disguise a firm’s sustainable operating performance. Read on….

gradient / Tag: asc 842, forensic accounting, earnings quality, lease, GAAP, IFRS, leasing standard / 0 Comments