New Bookmarks
Year 2011 Quarter 3:  July 1 - September 30 Additions to Bob Jensen's Bookmarks
Bob Jensen at Trinity University

For earlier editions of New Bookmarks go to http://www.trinity.edu/rjensen/bookurl.htm 
Tidbits Directory --- http://www.trinity.edu/rjensen/TidbitsDirectory.htm 

Click here to search Bob Jensen's web site if you have key words to enter --- Search Site.
For example if you want to know what Jensen documents have the term "Enron" enter the phrase Jensen AND Enron. Another search engine that covers Trinity and other universities is at http://www.searchedu.com/.

Choose a Date Below for Additions to the Bookmarks File

2011
September 30, 2011

August 31, 2011

July 31, 2011

September 30, 2011

Bob Jensen's New Bookmarks September 1-30, 2011
Bob Jensen at Trinity University 

For earlier editions of Fraud Updates go to http://www.trinity.edu/rjensen/FraudUpdates.htm
For earlier editions of Tidbits go to http://www.trinity.edu/rjensen/TidbitsDirectory.htm
For earlier editions of New Bookmarks go to http://www.trinity.edu/rjensen/bookurl.htm 

Click here to search Bob Jensen's web site if you have key words to enter --- Search Box in Upper Right Corner.
For example if you want to know what Jensen documents have the term "Enron" enter the phrase Jensen AND Enron. Another search engine that covers Trinity and other universities is at http://www.searchedu.com/

Bob Jensen's Blogs --- http://www.trinity.edu/rjensen/JensenBlogs.htm
Current and past editions of my newsletter called New Bookmarks --- http://www.trinity.edu/rjensen/bookurl.htm
Current and past editions of my newsletter called Tidbits --- http://www.trinity.edu/rjensen/TidbitsDirectory.htm
Current and past editions of my newsletter called Fraud Updates --- http://www.trinity.edu/rjensen/FraudUpdates.htm

Bob Jensen's Pictures and Stories
http://www.trinity.edu/rjensen/Pictures.htm

All my online pictures --- http://www.cs.trinity.edu/~rjensen/PictureHistory/

Hasselback Accounting Faculty Directory --- http://www.hasselback.org/

Humor Between September 1 and September 30, 2011 --- http://www.trinity.edu/rjensen/book11q3.htm#Humor093011

Humor Between August 1 and August 31, 2011 --- http://www.trinity.edu/rjensen/book11q3.htm#Humor083111 

Humor Between July 1 and July 31, 2011 --- http://www.trinity.edu/rjensen/book11q3.htm#Humor073111

Humor Between May 1 and June 30, 2011 --- http://www.trinity.edu/rjensen/book11q2.htm#Humor063011   

Humor Between April 1 and April 30, 2011 --- http://www.trinity.edu/rjensen/book11q2.htm#Humor043011  

Humor Between February 1 and March 31, 2011 --- http://www.trinity.edu/rjensen/book11q1.htm#Humor033111 

Humor Between January 1 and January 31, 2011 --- http://www.trinity.edu/rjensen/book11q1.htm#Humor013111 

Some of Bob Jensen's Pictures and Stories
http://www.trinity.edu/rjensen/Pictures.htm

The videos of the lead Speakers at the American Accounting Association 2011 Annual Meetings in Denver are available at the AAA Commons ---
http://commons.aaahq.org/hives/629d926370/summary
I don't think these videos can be downloaded by non-AAA members
For members like me who were unable to attend the Denver meetings, these videos are a lot of value added on the AAA Commons Website

Gregory Waymire—Video

Justin Fox—Video

Kevin D. Stocks—Video

Robert H. Herz—Video

Ruth McCartney—Video

Stephen A. Zeff—Video

I've still not viewed all of them, but I'm working on it. Only the Greg Waymire received much action to date on the AECM with respect to the shortage of accounting PhD graduates in light of high demand over the past two decades. Interestingly, commentators who were present in the audience came away with differing evaluations of Greg's presentation. I have not yet viewed his video. It would be interesting to see more commentaries on the other videos on the AECM.

Hi Steve and Jagdish,

Buried in the 2011Denver presentation by Greg Waymire is a lament about two of my hot buttons. Greg mentions the lack of replication (shall we call them reproductions?) in findings (harvests)  published in academic accounting research journals. Secondly, he mentions the lack of commentary and debate concerning these these findings. It seems that there's not a whole lot of interest (debate) about those findings among practitioners or in our academy ---
http://commons.aaahq.org/hives/629d926370/summary 


At long last we are making progress in finally getting the attention of the American Accounting Association leaders regarding how to broaden research methods and topics of study (beyond financial reporting)  in academic accounting research. The AAA Executive Committee now has annual retreats devoted to this most serious hole that accountics researchers have dug (Steve calls it a "dig" in the message from Jagdish) us into over the past four decades.


Change in academic accounting research will come very slowly. Paul Williams blames the slowness of change on the accountics scientist-conspired monopoly. I'm less inclined to blame the problem of conspiracy. I think the biggest problem is that accountics research in capital markets studies is so much easier since the data is provided like manna from heaven from CRSP, Compustat, AuditAnalytics, etc. No added scientific effort to collect data is required by accountics scientists. At CERN, however, physics scientists had to collect new data to cast doubt on prevailing speed of light theory.


Two years ago, at a meeting, I encountered one of my former students who eventually entered a leading accounting PhD program and was completing his dissertation. When I asked him why he was doing a traditional accountics-science dissertation he admitted that this was much easier than having to collect his own data.


Now more to the point concerning the messaging of Jagdish and Steve is my message earlier this week about the physics of economics in general.

Purpose of Theory: Prediction Versus Explanation

"Milton Friedman's grand illusion," by Mark Buchanan, The Physics of Finance: A look at economics and finance through the lens of physics, September 16, 2011 ---
http://physicsoffinance.blogspot.com/2011/09/milton-friedmans-grand-illusion.html

Three years ago I wrote an Op-Ed for the New York Times on the need for radical change in the way economists model whole economies. Today's General Equilibrium models -- and their slightly more sophisticated cousins, Dynamic Stochastic General Equilibrium models -- make assumptions with no basis in reality. For example, there is no financial sector in these model economies. They generally assume that the diversity of behaviour of all an economy's many firms and consumers can be ignored and simply included as the average behaviour of a few "representative" agents.

I argued then that it was about time economists started using far more sophisticated modeling tools, including agent based models, in which the diversity of interactions among economic agents can be included along with a financial sector. The idea is to model the simpler behaviours of agents as well as you can and let the macro-scale complex behaviour of the economy emerge naturally out of them, without making any restrictive assumptions about what kinds of things can or cannot happen in the larger economy. This kind of work is going forward rapidly. For some detail, I recommend this talk earlier this month by Doyne Farmer.

After that Op-Ed I received quite a number of emails from economists defending the General Equilibrium approach. Several of them mentioned Milton Friedman in their defense, saying that he had shown long ago that one shouldn't worry about the realism of the assumptions in a theory, but only about the accuracy of its predictions. I eventually found the paper to which they were referring, a classic in economic history which has exerted a huge influence over economists over the past half century. I recently re-read the paper and wanted to make a few comments on Friedman's main argument. It rests entirely, I think, on a devious or slippery use of words which makes it possible to give a sensible sounding argument for what is actually a ridiculous proposition. 

The paper is entitled The Methodology of Positive Economics and was first published in 1953. It's an interesting paper and enjoyable to read. Essentially, it seems, Friedman's aim is to argue for scientific standards for economics akin to those used in physics. He begins by making a clear definition of what he means by "positive economics," which aims to be free from any particular ethical position or normative judgments. As he wrote, positive economics deals with...
 

"what is," not with "what ought to be." Its task is to provide a system of generalizations that can be used to make correct predictions about the consequences of any change in circumstances. Its performance is to be judged by the precision, scope, and conformity with experience of the predictions it yields.

Friedman then asks how one should judge the validity of a hypothesis, and asserts that...
 

...the only relevant test of the validity of a hypothesis is comparison of its predictions with experience. The hypothesis is rejected if its predictions are contradicted ("frequently" or more often than predictions from an alternative hypothesis); it is accepted if its predictions are not contradicted; great confidence is attached to it if it has survived many opportunities for contradiction. Factual evidence can never "prove" a hypothesis; it can only fail to disprove it, which is what we generally mean when we say, somewhat inexactly, that the hypothesis has been "confirmed" by experience."

So far so good. I think most scientists would see the above as conforming fairly closely to their own conception of how science should work (and of course this view is closely linked to views made famous by Karl Popper).

Next step: Friedman goes on to ask how one chooses between several hypotheses if they are all equally consistent with the available evidence. Here too his initial observations seem quite sensible:
 

...there is general agreement that relevant considerations are suggested by the criteria "simplicity" and "fruitfulness," themselves notions that defy completely objective specification. A theory is "simpler" the less the initial knowledge needed to make a prediction within a given field of phenomena; it is more "fruitful" the more precise the resulting prediction, the wider the area within which the theory yields predictions, and the more additional lines for further research it suggests.

Again, right in tune I think with the practice and views of most scientists. I especially like the final point that part of the value of a hypothesis also comes from how well it stimulates creative thinking about further hypotheses and theories. This point is often overlooked.

Friedman's essay then shifts direction. He argues that the processes and practices involved in the initial formation of a hypothesis, and in the testing of that hypothesis, are not as distinct as people often think, Indeed, this is obviously so. Many scientists form a hypothesis and try to test it, then adjust the hypothesis slightly in view of the data. There's an ongoing evolution of the hypothesis in correspondence with the data and the kinds of experiments of observations which seem interesting.

To this point, Friedman's essay says nothing that wouldn't fit into any standard discussion of the generally accepted philosophy of science from the 1950s. But this is where it suddenly veers off wildly and attempts to support a view that is indeed quite radical. Friedman mentions the difficulty in the social sciences of getting
new evidence with which to test an hypothesis by looking at its implications. This difficulty, he suggests,
 

... makes it tempting to suppose that other, more readily available, evidence is equally relevant to the validity of the hypothesis-to suppose that hypotheses have not only "implications" but also "assumptions" and that the conformity of these "assumptions" to "reality" is a test of the validity of the hypothesis different from or additional to the test by implications. This widely held view is fundamentally wrong and productive of much mischief.

Having raised this idea that assumptions are not part of what should be tested, Friedman then goes on to attack very strongly the idea that a theory should strive at all to have realistic assumptions. Indeed, he suggests, a theory is actually superior insofar as its assumptions are unrealistic:
 

In so far as a theory can be said to have "assumptions" at all, and in so far as their "realism" can be judged independently of the validity of predictions, the relation between the significance of a theory and the "realism" of its "assumptions" is almost the opposite of that suggested by the view under criticism. Truly important and significant hypotheses will be found to have "assumptions" that are wildly inaccurate descriptive representations of reality, and, in general, the more significant the theory, the more unrealistic the assumptions... The reason is simple. A hypothesis is important if it "explains" much by little,...   To be important, therefore, a hypothesis must be descriptively false in its assumptions...

This is the statement that the economists who wrote to me used to defend unrealistic assumptions in General Equilibrium theories. Their point was that having unrealistic assumptions isn't just not a problem, but is a positive strength for a theory. The more unrealistic the better, as Friedman argued (and apparently proved, in the eyes of some economists).

Now, what is wrong with Friedman's argument, if anything?  I think the key issue is his use of the provocative terms such as "unrealistic" and "false" and "inaccurate" in places where he actually means "simplified," "approximate" or "incomplete."  He switches without warning between these two different meanings in order to make the conclusion seem unavoidable, and profound, when in fact it is simply not true, or something we already believe and hardly profound at all.

To see the problem, take a simple example in physics. Newtonian dynamics describes the motions of the planets quite accurately (in many cases) even if the planets are treated as point masses having no extension, no rotation, no oceans and tides, mountains, trees and so on. The great triumph of Newtonian dynamics (including his law of gravitational attraction) is it's simplicity -- it asserts that out of all the many details that could conceivably influence planetary motion, two (mass and distance) matter most by far. The atmosphere of the planet doesn't matter much, nor does the amount of sunlight it reflects. The theory of course goes further to describe how other details do matter if one considers planetary motion in more detail -- rotation does matter, for example, because it generates tides which dissipate energy, taking energy slowly away from orbital motion. 

But I don't think anyone would be tempted to say that Newtonian dynamics is a powerful theory because it is descriptively false in its assumptions. It's assumptions are actually descriptively simple -- that planets and The Sun have mass, and that a force acts between any two masses in proportion to the product of their masses and in inverse proportional to the distance between them. From these assumptions one can work out predictions for details of planetary motion, and those details turn out to be close to what we see. The assumptions are simple and plausible, and this is what makes the theory so powerful when it turns out to make powerful and accurate predictions.

Indeed, if those same predictions came out of a theory with obviously false assumptions -- all planets are perfect cubes, etc. -- it would be less powerful by far because it would be less believable. It's ability to make predictions would be as big a mystery as the original phenomenon of planetary motion itself -- how can a theory that is so obviously not in tune with reality still make such accurate predictions?

So whenever Friedman says "descriptively false" I think you can instead write "descriptively simple", and clarify the meaning by adding a phrase of the sort "which identify the key factors which matter most." Do that replacement in Friedman's most provocative phrase from above and you have something far more sensible:
 

A hypothesis is important if it "explains" much by little,...   To be important, therefore, a hypothesis must be descriptively simple in its assumptions. It must identify the key factors which matter most...

That's not quite so bold, however, and it doesn't create a license for theorists to make any assumptions they want without being criticized if those assumptions stray very far from reality.

Continued in article

Jensen Comment
Especially note the comments at the end of this article.

My favorite is the following:

Herbert Simon (1963) countered Friedman by stating the purpose of scientific theories is not to make predictions, but to explain things - predictions are then tests of whether the explanations are correct.

Both Friedman and Simon's views are better directed to a field other than economics. The data at some point will always expose the frailest of assumptions; while the lack of repeatable results supports futility in the explanation of heterogeneous agents.

September 16, 2011 3:27 PM

That's perceptive. Scientists should just steer clear of economics. Economics is so complex it is better suited to astrologists.

Also see the following comment"

David K. Waltz said...

There are certainly financial theories with patently false assumptions. For example, the Capital Asset Pricing Model:

> all investors are rational
> all investors have perfect information
> all investors can borrow and lend at the risk-free rate
> all investors can buy and short the market in unlimited quantities

We know none of these assumptions are true. How many of us can borrow at the risk-free rate? Yet they are some of the assumptions that underlie Nobel Prize winning theories.

As suggested in the blog, these false assumptions are made because they are ancillary to the main point of the theory, which speaks to asset pricing being a function of risk vs. return, and how these assets together comprise portfolios.

For these items the above does not matter.

However, if we were to go about modeling the stock or bond market for a month to assess our own portfolio, the false assumptions would matter greatly.

I wrote a brief blog post along similar track a couple months back if you are interested -
http://treasurycafe.blogspot.com/2011/07/capm-interlude-theory-of-theory.html 

September 16, 2011 9:39 PM

Bob Jensen's threads on accounting theory are at
http://www.trinity.edu/rjensen/Theory01.htm

Video on "Capitalism at Risk," by Dutch Leonard and Lynn Paine, Harvard Business Review Blog, September 2011 --- Click Here
http://blogs.hbr.org/video/2011/09/capitalism-at-risk.html?referral=00563&cm_mmc=email-_-newsletter-_-daily_alert-_-alert_date&utm_source=newsletter_daily_alert&utm_medium=email&utm_campaign=alert_date

Deloitte is the "Biggest Winner" following the 2008 economic meltdown

"Deloitte reports record 2011 revenue of $28.8 billion," by Dena Aubin, Reuters, September 22, 2011 ---
http://www.reuters.com/article/2011/09/22/us-deloitte-revenues-idUSTRE78L68Z20110922

Jensen Comment
Deloitte is the only Big Four firm that did not shed it's consulting division following the auditor independence scandals near the beginning of the 21st Century. This has proven to be a winner for Deloitte but increasingly raises questions about potential conflicts of interest since consulting appears to be more profitable than auditing and has much better growth potential. Of course the other Big Four firms keep increasing their new consulting divisions in a "rebranding" effort such that lack of independence is becoming of greater concern among all the large international auditing firms ---
http://www.trinity.edu/rjensen/Fraud001c.htm
 

This is a repeated link from June

"American Institute of Certified Public Accountants and Chartered Institute of Management Accountants agree to offer new CGMA designation," Chartered Institute of Management Accountants," May 23, 2011 ---
http://www.cimaglobal.com/en-gb/About-us/Press-office/Press-releases/2011/May-2011/cima-aicpa-joint-venture/

SSRN has updated its monthly rankings of 750 American and international law school faculties and 3,000 law professors by (among other things) the number of paper downloads from the SSRN database.  Here is the new list (through September 9, 2011) of the Top 25 U.S. Tax Professors in two of the SSRN categories: all-time downloads and recent downloads (within the past 12 months):
Thank you Paul Caron for the heads up.

Teaching Case
From The Wall Street Journal Accounting Weekly Review on September 23, 2011

UBS: Rogue Trader Hit Firm
by: Deborah Ball, Paul Sonne and Carrick Mollenkamp
Sep 16, 2011
Click here to view the full article on WSJ.com
 

TOPICS: Auditing, Banking, Derivatives, Hedging, Internal Controls

SUMMARY: UBS has announced that "...a rogue trader has run up losses of $2 billion." This amount is only slightly more that 10% of UBS's pre-tax profit of $1.9 billion in the second quarter of this year. However, as the author writes "...the mind boggles as to how it could have run up a loss equivalent to 28 times its second-quarter average daily value-at-risk via unauthorized trades [because]...even in the current volatile markets...sizeable trades must have gone undetected. At least no client money was lost, but the fact the bank could become so exposed is alarming." The related article focuses most directly on issues in assessing risk controls.

CLASSROOM APPLICATION: The article can be used to discuss auditing concepts of control weakness and materiality concepts. It also can be used in a graduate class combining both financial reporting and auditing issues in derivatives trading and hedging activities.

QUESTIONS: 
1. (Introductory) Summarize how the UBS trader Kweku Adoboli allegedly lost $2 billion at UBS.

2. (Advanced) What aspect of derivative securities makes it possible that the total value at risk is not evident when a trade is executed?

3. (Introductory) Based on your reading of the main and related articles, what systems do banks use to control value at risk via derivatives trading? What weakness is evident in these systems?

4. (Advanced) If the amount of the loss from unauthorized trades is only slightly more than 10% of UBS's quarterly pre-tax profit-so likely less than 2.5% of annual pre-tax profit-do you consider this loss material to the company's financial statements? Support your answer.

5. (Advanced) The related article focuses on "some of the questions risk specialists advise banks to ask themselves when looking for unauthorized traders." Do answers to these questions come from of audit procedures to test internal controls, to test propriety of substantive account balances, or both? Support your answer.

6. (Introductory) Again refer to the related article. What are the risks of bank personnel beginning careers as a staff member in the accounting offices of these firms then moving to trading desks?

7. (Introductory) Banks have considered preventing accounting office staff from moving to trading desks but have decided against banning such personnel moves. What are the benefits to banks of allowing these career moves? What control procedures are introduced to compensate for the risks identified above? What weaknesses exist in the control procedures?
 

Reviewed By: Judy Beckman, University of Rhode Island
 

RELATED ARTICLES: 
Questions Arise, Again, Over Risk Controls
by Alistair MacDonald and Deborah Ball
Sep 16, 2011
Page: C3

How Trader Racked Up Big Loss
by Carrick Mollenkamp
Sep 20, 2011
Online Exclusive

"UBS: Rogue Trader Hit Firm." by: Deborah Ball, Paul Sonne and Carrick Mollenkamp, The Wall Street Journal, September 23, 2011 ---
http://online.wsj.com/article/SB10001424053111904060604576571931690088522.html?KEYWORDS=UBS%3A+Rogue+Trader+Hit+Firm

UBS AG said a rogue trader racked up as much as $2 billion in losses using the firm's own money, a dramatic admission that raised new questions about the ability of one of the world's largest banks to manage risk and global regulators' ability to monitor it.

The losses stemmed from unauthorized derivatives-trading bets, according to a person familiar with the matter. The bank said no client positions were affected.

The Swiss bank made the discovery late Wednesday and notified London police at 1 a.m. Thursday, alleging that one of its traders had committed fraud. At 3:30 a.m., police arrested a 31-year-old man on "suspicion of fraud by abuse of position."

The man arrested is Kweku Adoboli, according to the person familiar with the matter, and is a trader in London who makes bets using UBS's money on financial instruments tied to exchange-traded funds, which allow clients to trade securities that track the performance of broad indexes. Police said the person arrested hasn't been charged, but remained in custody late Thursday. Mr. Adoboli couldn't be reached for comment.

According to the person familiar with the matter, John Hughes, a trader who worked with Mr. Adoboli, has resigned. Mr. Hughes didn't respond to an emailed request for comment.

The bank has suspended a number of other members of the desk, pending questioning as to whether any were involved.

The crisis slammed shares of UBS, which on Thursday fell nearly 11% in Swiss trading and 10% in New York Stock Exchange trading.

Moody's Investors Service said it was reviewing UBS's credit rating for a possible downgrade, citing concerns about UBS's reputation and its abilities to manage risk and rebuild its investment bank. Moody's said its review will focus on "ongoing weaknesses" in UBS's risk management "that have become evident again by the events leading" to the trading loss. Moody's said it believed a $2 billion loss would be financially "manageable" for UBS.

The losses raised questions among industry executives about supervision at the bank, as well as the ability of regulators to police such activity.

Various aspects of the scheme remain unclear, including which specific trades Mr. Adoboli allegedly executed, how such heavy losses could be generated without supervisors knowing and the way the bank uncovered the unauthorized trades.

UBS declined requests to provide details. [ubs_chart]

The Swiss financial regulator Finma, the Swiss Finance Ministry and the Swiss central bank all declined to comment on the potential loss or its likely causes, as did the U.K.'s Financial Services Authority.

Because of the way UBS's operations are structured in the U.K., it wasn't immediately clear which country's regulator was responsible for the London ETF operation.

The losses from alleged unauthorized trading rank among the largest in the history of finance. Over the past two decades, banks including Société Générale SA, Barings PLC and Kidder Peabody also have been victims of alleged rogue traders.

The news dealt a heavy blow to efforts by UBS Chief Executive Oswald Grübel to win back client confidence in a bank that was among the hardest hit by the financial crisis. It raised fresh questions about UBS's risk-management systems three years after its investment bank had to write down about $50 billion in securities trades.

For five years, Mr. Adoboli has worked on a desk that trades large baskets of securities or allows clients to bet on them through options or other instruments, according to a LinkedIn profile under the name Kweku Adoboli.

He traded derivative contracts, using the bank's money, based on securities included in ETFs, according to people familiar with the matter.

His desk specialized in so-called Delta One products that allow banks and investors to track underlying assets or indexes. The "delta" terms describe a level of risk—a delta of one implies limited risk of losses. There are about a half-dozen Delta One products that banks offer, including ETFs.

One avenue that is being examined is whether the trading loss is tied to the volatility in European stocks, a result of worries that Greece could default. One possibility is that Mr. Adoboli picked the wrong time to either bet that a European stock index would rise or fall and that an ETF was used in the trade.

ETFs, which typically track market indexes and trade like stocks, have become a big business for banks. Global ETF assets under management rose to $1.3 trillion last year from $410 billion in 2005, according to the Bank for International Settlements.

Some ETFs have become increasingly complex and opaque because banks have identified ways to replicate derivative exposure using ETFs.

Before trading, Mr. Adoboli worked for three years in a "back office" position as a trade-support analyst, according to the LinkedIn profile. Back-office employees input transactions and carry out accounting relating to trades, while so-called front-office workers execute trades and speak with clients.

Mr. Adoboli appeared to have initially worked with the technical side of these trades before becoming an employee executing these transactions. Some banks have restricted the shift of back-office, technical personnel to the client-facing trading desk because of the risk of their exploiting their knowledge to manipulate trades.

UBS didn't respond to a request for comment on whether it had such a restriction.

Continued in article

"UBS Systems Failed the "Too Big to Fail" Bank," by Michael Schrage, Harvard Business Review Blog, September 20, 2011 --- Click Here
http://blogs.hbr.org/schrage/2011/09/ubs-systems-failed-the-too-big.html?referral=00563&cm_mmc=email-_-newsletter-_-daily_alert-_-alert_date&utm_source=newsletter_daily_alert&utm_medium=email&utm_campaign=alert_date

Step aside, Nick Leeson. Get off the stage, Jerome Kerviel. If "Delta One" trader Kweku Adoboli really was responsible for blowing a $2.3 billion hole in UBS, then his chutzpah puts Europe's past rogue traders to shame. But their shame pales into invisibility compared to the humiliation inflicted on Switzerland's biggest bank. The acknowledged breakdown in systems oversight and risk controls is simply shocking. Every single Chief Risk Officer and every single non-executive director of every single "too big to fail" financial institution should be challenged by shareholders to prove they've got a surer grasp of risk than UBS.

UBS's failure merits particular disgrace because the bank's board commissioned public review after public review of its risk management systems in the wake of roughly $40 billion in 2007 losses and a Swiss government bailout. While these reviews have been inexplicably and lazily minimized in the media coverage of Adoboli's adventure, there's no doubt their findings should have been top-of-mind at every single UBS trading desk and back office.

The April 2008 "Shareholder Report on UBS's Write-Downs" was damning both in clarity and specificity. Senior UBS management was charged with a "failure to demand holistic risk assessment," a "failure to manage [its] agenda," and a "lack of succession planning." The report excoriated the firm's risk management controls and testing methodologies, asserting "complex and incomplete risk reporting," "lack of substantive assessment," "inadequate systems," "lack of strategic coordination," and "inability to accurately assess valuation risk on a timely basis." The board's own processes lacked accountability for evaluating the firm's risk exposures, assessments, and management.

If this weren't enough, the bank published a "Transparency Report" in September 2010 responding to Swiss government inquiries about its subprime performance. "The UBS Crisis in Historical Perspective" findings affirmed the organizational dysfunctions identified earlier: "The problem at UBS was not that the Bank's leadership simply ran rampant without any restraint. In fact, the contrary was the case: top management was too complacent, wrongly believing that everything was under control, given that the numerous risk reports, internal audits and external reviews almost always ended in a positive conclusion. The bank did not lack risk-consciousness; it lacked healthy mistrust, independent judgement and strength of leadership."

Remember that last sentence. Even as UBS was supposedly fixing its demonstrably flawed risk oversight and operational systems, the seeds of the "Delta One" debacle were apparently being sown. In other words, the bank's fundamental overhaul neither deterred nor detected a multibillion dollar fraud in the making. So what did the bank have to say for itself when its latest losses came crashing down?

"The true magnitude of the risk exposure was distorted because the positions had been offset in our systems with fictitious, forward-settling, cash exchange-traded funds positions, allegedly executed by the trader," UBS declared. "These fictitious trades concealed the fact that the index futures trades violated UBS's risk limits."

Fictitious trades? Really? You don't say. This explanation is laughable (if true). The whole purpose of a risk control system is to eliminate the possibility of "fictitious" positions and "fictitious trades." Indeed, the distinction between the two isn't subtle but represents, in practice, a dual systems failure. Competent risk management systems run by competent managers would have two opportunities to detect possible malfeasance: the first when the positions were taken; the second when the trades were executed. Of course, a myriad of ways exist to prevent the financially fictitious from becoming the fraudulently factual but, apparently, UBS failed to exploit them.

What makes these lapses particularly reprehensible is their apparent violation of one of the most important elements of risk management systems design: single point failures should simply not be possible. Enough overlaps, redundancies and checks should exist to prevent them. That a single individual — painfully reminiscent of Nick Leeson's 1995 destruction of Barings — could effectively manipulate a "new & improved" risk oversight system over time without detection beggars belief. We can decry the greed, selfishness and poor character of dishonest individuals all we want, but even minimally competent systems successfully dissuade or detect single bad actors.

Thwarting a sophisticated gang of internal thieves may be asking too much. But having single individuals wreak multibillion dollar destruction over the span of years — even as UBS publicly insists risk management its top managerial priority — reveals more about the bank's integrity than the dishonesty of a rogue trader. The cultural, organizational, technical and institutional inability to learn from its previous disaster and its extensive external reviews makes UBS a shining example of everything that can go wrong, from top to bottom, in a "too big to fail" financial institution.

A future post will discuss possible — and preferable — risk management innovations to better prevent rogue traders from taking root. But the most important lesson the "Delta One" debacle teaches is that UBS, its board and top management displayed the wrong kind of transparency. The self-flagellation and acknowledged oversight failures missed the fundamental point. What UBS should have done — what its investors and the Swiss government should have ruthlessly demanded— is ongoing disclosure as to quarter-by-quarter improvements in its risk management systems. UBS was very open about what it had done wrong; it was clearly not as usefully or usably transparent about the changes it was making to dissuade, deter or detect the Kweku Adobolis.

Continued in article

Jensen Comment
The first-course Accounting 101 students of Karen Pincus could've designed a better internal control system for UBS traders before her students even learned how to spell "Internal Control."

I mention Karen Pincus, because she was perhaps the first innovator who sent teams of her first-term students into real-world businesses to study accounting and internal controls before they knew a debit from a credit or the principles of division of authority and responsibility ---
http://waltoncollege.uark.edu/acct/directory.asp?id=kpincus
Karen has won many teaching and service awards and is now the 2011 President-Elect of the American Accounting Association
Her controversial first-year philosophy of teaching accounting is to first inspire students to want to learn accounting and think creatively before drilling down into principles of bookkeeping. This is controversial because her inspired students are purportedly not quite as ready, at least on average, for intermediate accounting as those that spent more time drilling on traditional prerequisites for intermediate accounting.

In fairness, Karen implemented this field study approach in the roaring 1990s when accounting was having a much more difficult time competing for top students when the job markets were burning hot for computer science, MIS, and finance graduates. The Big Four accounting firms were so discouraged by the numbers and quality of accounting graduates that these firms donated $4 million to the AAA to develop an Accounting Education Change Commission to inspire experimentation for change in accounting curricula and pedagogy. One of the principle complaints was that colleges were making accounting too boring to compete dynamically for student majors ---
http://aaahq.org/AECC/history/cover.htm

After the economic crash of the roaring 1990s, accounting survived as one of the best career alternatives vis-a-vis such disciplines as computer science, MIS, and finance. Accordingly, pressures for change in accounting curricula and pedagogy have eased. Read that as meaning we can go back to boring students to death and still get the top students to major in accounting even in the face of having to take a fifth year to sit for the CPA examination.

Also see UBS: Roguery at the Bank Provides a Teaching Moment ---
http://www.jamesrpeterson.com/home/2011/09/ubs-roguery-at-the-bank-provides-a-teaching-moment.html

Accountics is the mathematical science of values.
Charles Sprague [1887]

Accountics Research History --- http://www.trinity.edu/rjensen/395wpTAR/Web/TAR395wp.htm

"Individual Accounting Faculty Research Rankings by Topical Area and Methodology," by Jeffrey Pickerd, Nathaniel M. Stephens, Scott L. Summers, and David A. Wood, Issues in Accounting Education, American Accounting Association Vol. 26, No. 3, August 2011, pp. 471–505 ---
http://aaapubs.aip.org/getpdf/servlet/GetPDFServlet?filetype=pdf&id=IAEXXX000026000003000471000001&idtype=cvips
(Access limited to paid subscribers)

Rankings of Accountics Science Researchers
It's only slightly misleading to call the Pickerd (2011) et al. accountics science researcher rankings (see below). There are a small percentage of non-accountics research articles included in the thousands of articles in the 11 journals in this study's database, but these these were apparently insignificant since Table 2 of the study is limited to three accountics science research methods. In Table 2 only three research methods are recognized in the study --- Analytical, Archival, and Experimental.  Accounting Information Systems (AIS) does not fit neatly into the realm of accountics science. The authors mention that there are "Other" occasional non-accountics and non-AIS articles published in the 11 journals of the database, but these are totally ignored as "research methods" in Table 2 of the study.

The top-ranked academic accounting researchers listed in the tables of this study are all noted for their mathematics and statistical writings.

The articles in the rankings database were published over two recent decades in 11 leading academic accounting research journals.

The "Top Six" Journals
The Accounting Review (TAR),
Journal of Accounting Research (JAR),
Journal of Accounting and Economics (JAE),
Contemporary Accounting Research (CAR),
Review of Accounting Studies (RAST),
Accounting, Organizations and Society (AOS).

Other Journals in the Rankings Database
Auditing: A Journal of Practice & Theory (Auditing),
Journal of the American Taxation Association (JATA),
Journal of Management Accounting Research (JMAR),
Journal of Information Systems (JIS),
Behavioral Research in Accounting (BRIA).

Probably the most telling bias of the study is the bias against normative, case method, and field study accountancy research. In fact only three methods are recognized as "research methods" in Table 2 --- Analytical, Archival, and Experimental. For example, the best known and most widely published accounting case method researcher is arguably Robert Kaplan of Harvard University. Kaplan is not even listed among the hundreds of accountics scientists ranked in Table 1 (Topical Areas) of this this study although he was, before 1990, a very noted accountics researcher who shifted more into case and field research. Nor is the famous accounting case researcher Robin Cooper mentioned in the study. For years both Kaplan and Cooper have complained about how the top accountics science journals like TAR discourage non-accountics science submissions
"Accounting Scholarship that Advances Professional Knowledge and Practice," The Accounting Review, March 2011, Volume 86, Issue 2,
Also see http://www.trinity.edu/rjensen/TheoryTAR.htm

What is not clear is what the Pickerd (2011) et al. authors did with non-accountics articles in Table 1 (Topics) versus Table 2 (Methods). These articles were obviously not included in Table 2 (Methods) . But were their non-accountics study authors included in Table 1 (Topics)? My guess is that they were included in Table 1. Other than for AIS, I could be wrong on this with respect to Table 1. In any case, the number of non-accountics articles available for the database is extremely small relative to the thousands of accountics science articles in the database. Except in the area of AIS in Table 1, this is an accountics scientist set of rankings.

"Individual Accounting Faculty Research Rankings by Topical Area and Methodology," by Jeffrey Pickerd, Nathaniel M. Stephens, Scott L. Summers, and David A. Wood, Issues in Accounting Education, American Accounting Association Vol. 26, No. 3, August 2011, pp. 471–505 ---
http://aaapubs.aip.org/getpdf/servlet/GetPDFServlet?filetype=pdf&id=IAEXXX000026000003000471000001&idtype=cvips
(Access limited to paid subscribers)

ABSTRACT: This paper ranks individual accounting researchers based on their research productivity in the most recent six, 12, and 20 years. We extend 
prior individual faculty rankings by providing separate individual faculty research rankings for each topical area commonly published in accounting journals 
(accounting information systems [AIS], audit, financial, managerial, and tax). In addition, we provide individual faculty research rankings for each research  
methodology commonly used by accounting researchers (analytical, archival, and experimental). These findings will be of interest to potential doctoral  students
and current faculty, as well as accounting department, business school, and university administrators as they make decisions based on individual faculty members’ research productivity.

When reading the rankings the following coding is used in the cells:

Table 1 presents the top 100-ranked accounting researchers by topical area based on publication counts in the selected accounting journals. In the tables, the first number reported is the ranking that does not take into account coauthorship; the second reported number (after the *) is the ranking if authors receive only partial credit for coauthored work. The table shows the author rank based on article counts over the entire sample period of the study (20 years), as well as ranks based on the number of articles published in selected journals over the past 12-year and six-year windows. Even though specialization is common in accounting research, it is interesting to note that some professors publish widely in a variety of topical areas.

In other words, Jane Doe (3*32) means that Jane ranks 3 in terms of authorship of articles in a category but has a lower rank of 32 if the rankings are adjusted for joint authorship partial credit.

It should also be noted that authors are listed on the basis of the 20-year window.

One of the most noteworthy findings in this study, in my viewpoint, is the tendency for most (certainly not all) leading academic researchers to publish research more frequently in the earliest years of their careers (especially before earning tenure) relative to later years in their careers.

Here are the top two winners in each category:

---

Table 1, Panel A: AIS
Author                                                           6-Year (2004–2009)      12-Year (1998–2009)      20-Year (1990–2009)
Hunton, James E., Bentley University                         1 *1                                1 *1                                1 *1
Murthy, Uday S., University of South Florida           10 *35                              8 *4                                2 *3

Table 1, Panel B: Audit
Author                                                            6-Year (2004–2009)      12-Year (1998–2009)      20-Year (1990–2009)
Raghunandan, K., Florida International U.                   1 *4                               1 *2                                 1 *3
Wright, Arnold M., Northeastern University                7 *9                               5 *5                                 1 *2

Table 1, Panel C: Financial
Author                                                            6-Year (2004–2009)      12-Year (1998–2009)      20-Year (1990–2009)
Barth, Mary E., Stanford University                           60 *159                           2 *8                                 1 *2
Francis, Jennifer, Duke University                                6 *26                             3 *13                               2 *5

Table 1,Panel D: Managerial
Author                                                            6-Year (2004–2009)      12-Year (1998–2009)      20-Year (1990–2009)
Banker, Rajiv D., Temple University                           12 *30                             3 *13                              1 *3
Reichelstein, Stefan, Stanford University                        1 *2                               1 *1                                2 *1

Table 1,Panel E: Tax
Author                                                           6-Year (2004–2009)      12-Year (1998–2009)      20-Year (1990–2009)
Sansing, Richard C., Dartmouth College                        1 *1                               1 *1                                1 *1
Dhaliwal, Dan S., The University of Arizona                  1 *3                                2 *3                                2 *4

---

Table 2, Panel A: Analytical
Author                                                           6-Year (2004–2009)      12-Year (1998–2009)      20-Year (1990–2009)
Reichelstein, Stefan, Stanford University                        1 *1                                1 *1                                1 *2
Feltham, Gerald A., Retired                                          8 *26                              4 *9                                2 *7

Table 2, Panel B: Archival
Author                                                           6-Year (2004–2009)      12-Year (1998–2009)      20-Year (1990–2009)
Barth, Mary E., Stanford University                           107 *174                            8 *15                               1 *1
Francis, Jennifer, Duke University                              5 *23                                  3 *13                               2 *3

Table 2, Panel C: Experimental
Author                                                           6-Year (2004–2009)      12-Year (1998–2009)      20-Year (1990–2009)
Libby, Robert, Cornell University                               4 *9                                    2 *3                                 1 *3
Tan, Hun-Tong, Nanyang Technological U.                1 *1                                    1 *1                                 2 *1

Table 2, Panel D: Other
Author                                                           6-Year (2004–2009)      12-Year (1998–2009)      20-Year (1990–2009)
None listed

I call your attention to a similar BYU study in which accounting research programs in universities are ranked ---
http://www.byuaccounting.net/rankings/univrank/rankings.php

Click on the name of a university to learn more about the research done by that university.

University	Last 6 Years	Last 12 Years	Last 20 Years
Stanford University	1	1	1
The Ohio State University	2	7	8
University of Texas at Austin	3	3	2
University of Chicago	4	5	9
University of Illinois at Urbana-Champaign	5	9	14
Nanyang Technological University	6	12	26
Texas A&M University	6	4	6
University of Toronto	8	20	20
Michigan State University	9	2	5
Duke University	10	18	23
University of Arizona	10	18	16
Emory University	12	14	19
University of Pennsylvania	12	5	7

What is interesting is to note how poorly some of these universities do in the Pickerd (2011) rankings of their individual faculty members. Some like Stanford and Duke do quite well in the Pickerd rankings, but many other highly ranked accountics science programs in the above the list do much worse than I would've expected. This suggests that some programs are ranked high on the basis of numbers of accountics scientists more than the publishing frequency of any one resident scientist. For example, the individual faculty members at Chicago, the University of Illinois, Wharton (Pennsylvania), and Harvard don't tend to rank highly in the Pickerd rankings.

Ignoring the Accountics Science Controversies
Pickerd (2011) et al. make no mention of the limitations and heated controversies concerning accountics science and the fact that one of the journals (AOS) among the 11 in the database (as well as AOS's founder and long-time editor) is largely devoted to criticism of accountics science.
"Whither Accounting Research?" by Anthony G. Hopwood The Accounting Review 82(5), 2007, pp.1365-1374 

Organizations like the American Accounting Association also have a role to play, not least with respect to their presence in the field of scholarly publication. For the American Accounting Association, I would say that now is the time for it to adopt a leadership role in the publication of accounting research. Not only should every effort be made to encourage The Accounting Review to embrace the new, the innovative, what accounting research might be in the process of becoming, and new interdisciplinary perspectives, but this should also be done in a way that provides both a catalyst and a model for other journals of influence. For they need encouragement, too. While the Association has done much to embrace the need for a diversity of gender and race, so far it has done relatively little to invest in intellectual diversity, even though this is not only of value in its own terms, but also an important generator of innovation and intellectual progress. I, at least, would see this as appropriate for a learned society in the modern era. The American Accounting Association should set itself the objective of becoming an exemplar of intellectual openness and thereby innovation.

"The Absence of Dissent," by Joni J. Young, Accounting and the Public Interest 9 (1), 2009 --- Click Here

ABSTRACT:
The persistent malaise in accounting research continues to resist remedy. Hopwood (2007) argues that revitalizing academic accounting cannot be accomplished by simply working more diligently within current paradigms. Based on an analysis of articles published in Auditing: A Journal of Practice & Theory, I show that this paradigm block is not confined to financial accounting research but extends beyond the work appearing in the so-called premier U.S. journals. Based on this demonstration I argue that accounting academics must tolerate (and even encourage) dissent for accounting to enjoy a vital research academy. ©2009 American Accounting Association

Also see the following references critical of the accountics science monopoly on academic accounting research:

Shielding Against Validity Challenges in Plato's Cave ---
http://www.trinity.edu/rjensen/TheoryTAR.htm

What went wrong in accounting/accountics research?
http://www.trinity.edu/rjensen/theory01.htm#WhatWentWrong

Where Principles-Based Standards meet Bright Lines
The Boards also instructed the staff to develop a principle to determine the line between Bucket 1 and Bucket 2

From Ernst & Young's Week in Review on September 23, 2011

Financial instruments: impairment - The Boards instructed the staff to change direction and pursue an absolute credit-quality approach for the three-bucket impairment model, rather than the relative credit-risk approach they favored in July. Under the absolute credit-quality approach, all originated loans would be initially included in either Bucket 1 or Bucket 2, depending on the credit quality of the loan at origination, and loans would move between buckets based on changes in credit quality. The absolute credit-quality approach would align more closely with existing credit risk management practices and systems than the relative credit-risk approach, which would put all purchased and originated loans in Bucket 1, regardless of credit quality. The staff's outreach efforts indicated significant concerns about operational challenges related to the relative credit-risk approach.

The Boards also instructed the staff to consider the effect of an absolute credit-quality method on “geographies” that primarily originate loans of lower quality (e.g., subprime loans). Although the FASB expressed concern with developing a separate impairment model for these types of loans, the Board agreed to consider the staff's research.

The Boards directed the staff to consider the application of an absolute credit-quality approach to purchased impaired loans (e.g., loans purchased with significant discounts to their face amount). The Boards also instructed the staff to develop a principle to determine the line between Bucket 1 (where 12 or 24 months of expected losses would be recognized) and Bucket 2 (where full lifetime losses would be recognized) rather than take a ratings-based approach. The principle would be based on deterioration or improvement of credit quality (e.g., collectability of cash flows) to a particular level at each reporting period. The staff will provide additional information about applying the principle and examples of fact patterns.

Bob Jensen's threads on Principles-Based versus Bright-Line Standards ---
http://www.trinity.edu/rjensen/Theory01.htm#BrightLines

September 11, 2011 message from John Ensminger

 Bob—I noticed you’ve been blogging about the WikiLeaks documents. I recently did a number of searches for “canine,” “police dog,” and “dog” on a beta search site and found about 70 documents. I summarized 51 of them in a blog.
http://doglawreporter.blogspot.com/2011/09/wikidogs-canines-in-leaked-us.html 

Most of them involve embassies notifying Washington headquarters about the successes of bomb and drug detection dogs used by other countries but funded, one way or another, by the State Department’s Bureau of International Narcotics and Law Enforcement Affairs (“INL” in the cables). I’ll keep digging and update the blog as I find more. Thanks for keeping me on your email list. You find real gems. –
John

Jensen Comment
Books by John Ensminger --- http://www.amazon.com/John-J.-Ensminger/e/B0033FKZMW

Teaching Case on Forecasting
From The Wall Street Journal Accounting Weekly Review on September 23, 2011

Economy Clips Factories
by: James R. Hagerty and Bob Tita
Sep 15, 2011
Click here to view the full article on WSJ.com
 

TOPICS: Financial Analysis, Financial Reporting, Financial Statement Analysis

SUMMARY: The article discusses the implications of earnings forecasts for U.S. manufacturers on the overall U.S. economy. Analysts covering "big industrial companies" have begun "chopping forecasts" even though corporate managers haven't yet made adjustments to their own guidance to the markets. "The average Wall Street forecast for 2012 earnings growth by 35 industrial companies included in the Standard & Poor's 500-stock index stood at about 16% Wednesday, [September 14, 2011,] down from 19% as of June 30, according to FactSet Research Systems."

CLASSROOM APPLICATION: The article is useful for any class discussing analyst forecasting, management guidance, and the relationship between financial reporting and financial markets. The article also mentions using corporate estimated tax payments to assess what companies are expecting for overall annual profits.

QUESTIONS: 
1. (Introductory) Who are the analysts whose work is described in this article? For whom do they work?

2. (Introductory) What data points are analyzed in this article? From where is this information obtained?

3. (Advanced) What is management's role in informing market participants about its expectations for overall profits?

4. (Introductory) What are the implications of these data for the overall U.S. economy?

5. (Advanced) How do corporations pay corporate income tax throughout the year? How is information about tax receipts by the U.S. government used to further assess the issues raised by analysts' forecasts?
 

Reviewed By: Judy Beckman, University of Rhode Island

"Economy Clips Factories," by: James R. Hagerty and Bob Tita, The Wall Street Journal, September 15, 2011 ---
http://online.wsj.com/article/SB10001424053111904491704576570900742148500.html?KEYWORDS=Economy+Clips+Factories

The earnings outlook for American manufacturers, whose rebound propelled the U.S. recovery last year, is deteriorating as the global economy sputters.

Big industrial companies generally haven't begun chopping their own forecasts, but analysts are starting to do it for them. The average Wall Street forecast for 2012 earnings growth by 35 industrial companies included in the Standard & Poor's 500-stock index stood at about 16% Wednesday, down from 19% as of June 30, according to FactSet Research Systems.

Even as they stand by their forecasts, companies are sounding more cautious. Cummins Inc., which makes engines for trucks and machinery, reaffirmed Tuesday a forecast for record sales and profit this year and projected strong growth through 2015. Even so, Tom Linebarger, its chief operating officer, due to become chief executive Jan. 1, said in an interview Wednesday that Cummins can't forecast with as much confidence as it had three months ago.

The U.S. economy "is clearly not recovering anymore," Mr. Linebarger said. "We're just not sure how deep or long [the slowdown] is going to be." Cummins already has seen a decline in orders for standby power-generation units used at such facilities as factories, office buildings and hospitals, he said.

While the U.S. struggles with a stubbornly weak housing market, Europe's financial troubles are threatening to choke off growth there. At the same time, China and India have slowed their economies deliberately to fight inflation. Opinion

Herman Cain: My Plan to Revive Economic Growth

Over the past two years, U.S. companies have done "an amazing job" of increasing profit margins and finding new markets around the world, said Ed Yardeni, chief economist at Yardeni Research Inc., Brookville, N.Y., "but it's going to be tougher now."

One sign of weaker profit growth, he said, is an abrupt slowdown in the rise of U.S. corporate-tax receipts. They were up about 12% in the 12 months through August, much less than their 61% rise in the 12 months through January.

Companies are still hoping for a muddle-through scenario of continuing modest economic growth in the U.S.—but bracing for the possibility of another recession.

Diversified manufacturer Ingersoll-Rand PLC, which is based in Ireland but has the bulk of its operations in North America, has redoubled its contact with customers to keep from being caught off guard by a sudden drop in demand for its products, which include Trane heating and air-conditioning systems, Thermo-King refrigeration units for truck trailers and industrial air compressors. "It's a very good time for us to have our ear right on the tracks," Chief Executive Michael Lamach said in an interview.

Danaher Corp., whose products include water-treatment systems and dental equipment, last week said it was cutting costs in a "quiet restructuring." Danaher also is eliminating about 1,000 jobs at a newly acquired maker of medical-test equipment. "We're mindful that the environment is likely to get more challenging as we go forward," CEO Lawrence Culp, told analysts.

Analysts are busy rethinking forecasts. For the third quarter, the average forecast for earnings growth at the 35 selected industrial companies in the S&P 500 has fallen to about 14% from 16% as of June 30, according to FactSet. Those companies are mostly in the aerospace, defense, electrical-equipment, machinery and building-products businesses.

"We haven't had companies come out and wave the red flag and cut numbers yet," said Shannon O'Callaghan, an analyst at Nomura Securities International in New York. But he expects some will reduce forecasts or at least offer very cautious outlooks next month when they report third-quarter results.

Because of generally weaker economic signals,Mr. O'Callaghan this week chopped forecasts for all 12 industrial companies he covers, reducing his call for General Electric Co.'s 2012 earnings to $1.50 a share from a previous$1.65. For 3M Co., he cut his 2012 forecast to $6.10 a share from $6.80.

Jamie Cook of Credit Suisse last week cut her 2012 earnings forecasts for machinery makers by an average of 8.5% and her 2013 projections by about 14%. On Wednesday, Wells Fargo Securities slashed its 2012 forecast for earnings at Caterpillar Inc., the world's largest maker of construction and mining equipment, to $8.75 a share from $9.70, citing deterioration in the U.S. and European economic outlook.

Japan's Komatsu Ltd. said this week that China's demand for hydraulic excavators, among the most widely used types of construction equipment, in recent months has been 30% to 40% below the boom levels of a year ago. That's also bad news for Caterpillar.

A Caterpillar spokesman declined to comment on the company's earnings outlook or Chinese demand.

Continued in article

"Miscellany-2," by David Albrecht, Summa, September 15, 2011 ---
http://profalbrecht.wordpress.com/2011/09/15/miscellany-2/

Update to the SEC document destruction story.  Last week, Broc Romanek (theCorporateCousel.net) reported that the SEC is suspending its policy of shredding MUIs (matters under investigation).  Yesterday, Jessica Holzer of the Wall Street Journal reports, “SEC’s Khuzami: Current Probes Not Hurt by Records Destruction.” I’ve written before that this is a non-issue.

Jensen Comment
What is your evidence that this is a "non-issue" David?
It seems to me to be a very important issue both from a history study standpoint and from the standpoint that some current and past investigations of directly or indirectly related.

"Online Search Ads Hijack Prospective Students, Former Employee Says," by Josh Keller, Chronicle of Higher Education, September 7, 2011 ---
http://chronicle.com/blogs/wiredcampus/online-search-ads-hijack-prospective-students-former-employee-says/33047?sid=at&utm_source=at&utm_medium=en

Last year, James Soloway called hundreds of prospective students per day on behalf of a company that placed advertisements on Google and Bing. The ads promised to help students contact the admissions offices of public colleges if they filled out an online form and included their phone number.

He told the students who responded that they would hear from their preferred public college, even though they almost never did. In the meantime, he said, they should consider attending a for-profit college—such as Kaplan University, Grand Canyon University, or the University of Phoenix.

Most of the prospective students were confused. Some hung up. But sometimes, the pitch worked, he says. Some people, especially high-school students, believed he was an educational counselor and gave weight to his recommendations, he says.

The entire process was designed to redirect students who wanted information on a public college to a for-profit college, Mr. Soloway says. “The expectation was that we were not to allow a call to end with a student until we had created three private-school leads.”

The account offers new details about the practices of lead-generation companies that place misleading search ads to lure prospective students. (Click here to download Mr. Soloway’s full description of the call center’s activities.) In July, The Chronicle found dozens of ads on Google and Bing that falsely implied relationships with public colleges in order to get students to give away information that can be sold to for-profits.

Mr. Soloway made calls on behalf of one of those lead-generation companies, Vantage Media, from March to December 2010. The company contracted with a call center run by Mr. Soloway’s employer, Inspyre Solutions.

Representatives of Vantage, Kaplan, and Westwood College did not respond to requests for comment. Vantage officials have previously said that they provide a free service to both colleges and students, and that the company does not mislead anybody.

Mr. Soloway said he is speaking publicly about his former work because he feels bad that he helped to deceive students. He estimates that Vantage’s online marketing efforts brought in at least 2,000 prospects per week to the Winnipeg, Manitoba, call center where he worked.

After learning that students never heard back from the public colleges they were trying to reach—and realizing that he might soon be fired for poor performance—he quit his job and filed a complaint with the Federal Trade Commission in February about Vantage’s practices.

“I feel bad that I was part of something that took advantage of people, a lot of them kids still in high school,” he says.

Mr. Soloway said he was given a single day of training before starting to work on behalf of Vantage, which made it difficult to advise students on their educational options. For instance, he says he started without knowing the differences between various nursing degrees.

Continued in article

"Colleges Fight Google Ads That Reroute Prospective Students," by Josh Keller, Chronicle of Higher Education, July 31, 2011 ---
http://chronicle.com/article/Colleges-Fight-Google-Ads-That/128414/?sid=wc&utm_source=wc&utm_medium=en

Bob Jensen's threads on for-profit universities operating in the gray zone of fraud ---
http://www.trinity.edu/rjensen/HigherEdControversies.htm#ForProfitFraud

"Obama’s Cap on Tax Deductions: Not What It Seems," by Howard Gleckman, Tax Policy Center, September 13, 2011 ---
http://taxvox.taxpolicycenter.org/2011/09/13/obama%E2%80%99s-cap-on-tax-deductions-not-what-it-seems/ 

It turns out that President Obama’s plan to limit the benefit of itemized deductions is much more than that. Not only would it reduce tax savings for mortgages, charitable gifts, high medical costs, and the like, it would also curb tax breaks for owners of municipal bonds, workers who buy health insurance, and those who earn money overseas. 

The $400 billion plan is the centerpiece of Obama’s $467 billion package of tax increases aimed at paying for the stimulus package he announced on Sept. 8. It would limit to 28 percent the value of many tax preferences for those whose adjusted gross income is more than $200,000 ($250,000 for couples). Today, these tax breaks are worth 35 cents on the dollar for someone in the top tax bracket. Under Obama’s plan they would be worth just 28 cents.  

The plan is often described as a cap on itemized deductions but in fact aims at a number of other politically popular tax breaks as well, including several exclusions that reduce the amount of income subject to tax.        

An across-the-board cap on the benefit of deductions and the like is often seen as rough justice—a way to tackle the Revenue Code’s trillion dollars in tax expenditures without  fighting over each one. The theory: It is an easier political lift to curb such popular breaks as the mortgage interest deduction through a broad reduction of  all subsidies than to fight the powerful housing industry head-on.

But Obama does pick and choose the preferences he wants to target. He nails all itemized deductions, all right, but he also goes after some–but not all–above the line deductions. Of the roughly two dozen write-offs available to those who take the standard deduction, Obama targets just eight, including health insurance for the self-employed, medical savings accounts, health savings accounts, and some higher education expenses.

He also reduces the benefit of two other hot-button breaks—the tax exclusions for municipal bond interest and the value of employer-sponsored health insurance. In other words, for those making more than $200,000, some muni bond interest and some of the value of their medical coverage would be taxed.     

However, Obama would protect other exclusions, including those for retirement savings. Picking winners and losers this way is likely to defeat any claims of rough justice and make passing the plan that much tougher.

And on the merits, some of his choices are dubious. For instance, nearly all mainstream economists believe Congress should fix the tax treatment of health insurance costs. Today, the income tax exclusion perversely gives the biggest benefit to those who make the most money and the smallest to those who earn the least and need the most help paying for insurance.

Continued in article

Jensen Comment
Since higher income taxpayers buy a larger share of tax exempt bonds, this Obama plan could significantly raise the cost of capital for  towns, cities, counties states and school districts. Thus some of the added Federal revenue in reality is taken from towns, cities, counties states and school districts where poor and middle class pay sales taxes and property taxes directly or indirectly when they pay for rental housing. It's naive to think that increases in income taxes of the rich do not, in least in part, come out of the incomes of the poor and the middle class.

Sneaky isn't it!
For example, nearly half the taxpayers in the United States pay no Federal income tax. But they do pay sales and property taxes in one way or another such that creating less demand for tax exempt bonds is a way to transfer part of incomes of the poor to the Federal government even if the poor still pay zero amounts on their Federal tax returns. The outflow is buried in their increased rents and cash register sales taxes. Sneaky isn't it!

Investors who make slightly less than $200,000 but have substantial portions of their portfolios in in long-term tax exempt bonds may benefit from the annual higher returns on rolled-over of matured bonds resulting from this Obama tax-the-rich proposal. Sneaky isn't it! 

Teaching Case
From The Wall Street Journal Accounting Weekly Review on September 16, 2011

Treasury Weighs New Tax Scheme
by: Damian Paletta and John D. McKinnon
Sep 10, 2011
Click here to view the full article on WSJ.com
 

TOPICS: Corporate Tax, Financial Reporting, Financial Statements, Segment Analysis, Tax Laws, Tax Policy, Taxation

SUMMARY: "The Treasury Department is considering a proposal to eliminate some but not all taxes on the overseas profits of U.S. multinational companies...The Treasury plan under consideration would create what officials refer to as a "tough" territorial system...." The plan is designed to solve the problem stemming form the fact that our current "... system of taxing overseas profits has had the unintended consequence of discouraging companies from bringing earnings back to the U.S." the "tough" version of the territorial system is designed to avoid the problem with "...some versions of 'territorial' that simply incentivize multinationals to create jobs overseas instead of here [in the U.S.]...."

CLASSROOM APPLICATION: The article may be used in a corporate tax class to discuss repatriating overseas profits and the policy reasons for our current system of taxing worldwide profits. It also may be used in a financial reporting class discussing segment and geographic earnings disclosures since the article refers to that information--as quoted by the Business Roundtable that, "in 2009, U.S. firms in the S&P 500 that reported foreign earnings had 55% of their income generated overseas." Finally, the related article brings in the implications for U.S. companies' cash balances.

QUESTIONS: 
1. (Advanced) Summarize how U.S. corporate tax law currently taxes profits earned by U.S. multinational firms. In your answer, compare the treatment of foreign branches versus foreign corporations and include a description of the foreign tax credit.

2. (Introductory) Define the terms "global taxation system" and "territorial taxation system" in relation to corporate tax. Which of these terms summarizes the current U.S. tax system you described in answer to question 1 above?

3. (Introductory) What is the unintended consequence of our U.S. tax law provision for a deferral provision on earnings by foreign corporations? You may refer to the related article to answer this question.

4. (Advanced) How would the U.S. Treasury Department proposal relieve some of this unintended consequence of the current U.S. tax law? How might that relief help with the high unemployment in our current U.S. economy?

5. (Introductory) Will this potential change have an impact on total tax revenues paid by corporations with overseas profits? According to the article, how is the answer to this question being assessed?

6. (Advanced) What is the Business Roundtable? What information about overseas earnings does this group report?

7. (Advanced) From where in U.S. companies' financial statements could the Business Roundtable obtain the information about foreign earnings? What authoritive accounting guidance requires this financial statement disclosure? In your answer, provide a reference to your source.

8. (Advanced) Do you think that the objective of the accounting requirements to disclose foreign earnings information is to assess the impact of potential tax law changes such as this one currently being considered? Support your answer with references to authoritative accounting literature.
 

Reviewed By: Judy Beckman, University of Rhode Island
 

RELATED ARTICLES: 
Why Investors Can't Get More Cash Out of U.S. Companies
by Jason Zweig
Feb 19, 2011
Page: A1

"Treasury Weighs New Tax Scheme," by: Damian Paletta and John D. McKinnon, The Wall Street Journal, September 10, 2011 ---
http://online.wsj.com/article/SB10001424053111904103404576561020226498738.html?KEYWORDS=Treasury+Weighs+New+Tax+Scheme

The Treasury Department is considering a proposal to eliminate some but not all taxes on the overseas profits of U.S. multinational companies, a central element of the administration's broader plans to overhaul the corporate-tax code, according to two people familiar with the deliberations.

U.S. businesses have pushed hard to exempt all overseas earnings from U.S. taxes, claiming the current system puts them at a disadvantage to foreign competitors.

The taxation of overseas income is a political hot potato. Liberals and trade unions have warned that eliminating U.S. taxes on overseas earnings could encourage businesses to shift operations and jobs overseas. Conservatives and businesses, meanwhile, could be disappointed that the proposal from the Obama administration, which is still in the discussion stage, doesn't go far enough.

The U.S. is rare among major industrial powers in maintaining a global taxation system, which often subjects the overseas earnings of companies to U.S. levies after they've been taxed by their overseas hosts. Most large countries primarily tax domestic earnings, in what is known as a territorial taxation system.

The Treasury plan under consideration would create what officials refer to as a "tough" territorial system, which would shield some overseas profits from U.S. taxes. A key issue is what kind of profits would be excluded. The details of the plan couldn't be learned.

The provision is part of a broader Treasury rewrite of the corporate-tax code that has been in the works for months. The rewrite could have a major impact on U.S. corporations. It is expected to include a significant cut from the current 35% corporate-tax rate and changes to various deductions that are a staple of American corporate finance.

The White House had hoped to release its overall proposal in May or June, but shelved it after the debt-ceiling debate consumed Washington. Treasury officials intend to go public with the plan sometime in the fall. Any changes would require congressional approval. The chances of enactment as the 2012 election season heats up are slim.

A Treasury Department spokeswoman declined to comment, saying no final decisions have been made.

The system of taxing overseas profits has had the unintended consequence of discouraging companies from bringing earnings back to the U.S. That is because the U.S. allows companies to postpone federal tax on their overseas earnings indefinitely, as long as the money remains offshore. U.S. multinationals have more than $1 trillion in profits parked overseas, according to some estimates.

The goal of the hybrid approach under consideration is to prevent companies from restructuring their businesses in a way that would shift U.S. jobs to other countries by concentrating assets or businesses in countries with lower tax rates.

"There are some versions of 'territorial' that simply incentivize multinationals to create jobs overseas instead of here, and that's a version we want to avoid," said Jared Bernstein, a former economic adviser to Vice President Joe Biden who is now at the liberal-leaning Center on Budget and Policy Priorities.

A territorial tax system would be a big win for U.S. multinationals. That includes many companies in the high-tech and pharmaceutical sectors, as well as consumer-goods makers. Large domestic companies such as utilities and retailers would prefer that overall tax rates be lowered, setting up a clash of priorities within the world of U.S. business.

Because the White House wants any possible revamp to raise the same amount of money as the current system, domestic companies could see their tax breaks crimped to compensate for reduced revenues from taxing overseas profits. But multinationals could be concerned if a tough territorial system raised their tax burdens instead.

"We would favor a territorial system that brings the U.S. in line with those adopted by other developed countries," said David Lewis, vice president of global tax at Eli Lilly & Co. "However, the inclusion of limits or other restrictions in a U.S. territorial regime that disfavor U.S. companies versus their foreign competitors would be counterproductive."

In 2009, U.S. firms in the S&P 500 that reported foreign earnings had 55% of their income generated overseas, according to the Business Roundtable.

On Aug. 12, Barack Obama summoned chief executives from some large U.S. companies to the White House to sound them out on ideas for his jobs proposal. Xerox Corp. chief executive Ursula Burns pressed him to include corporate-tax simplification and a territorial tax system, according to people familiar with the meeting.

A partial move towards a territorial system could be used by the White House as an olive branch to U.S. corporations, who have battled the administration over a range of regulatory and tax issues.

Continued in article

Teaching Case
From The Wall Street Journal Accounting Weekly Review on September 16, 2011

With New Technology, Start-Ups Go Lean
by: Angus Loten
Sep 15, 2011
Click here to view the full article on WSJ.com
 

TOPICS: Accounting, Public Accounting

SUMMARY: So often it is said that, regardless of economic cycles, accounting services are always needed. This article makes it clear that the nature of those services may be changing: one small start up firm's founder, Sam Rogoway of Near Networks, argues that "tasks that used to require extra workers can now be done online. 'You don't need an IT person or an accountant,' Mr. Rogoway says."

CLASSROOM APPLICATION: The questions focus students' thoughts on the implications of the article for their professional development as accountants if they want to work with small businesses or build a private accounting practice.

QUESTIONS: 
1. (Introductory) What proportion of new job creation comes from start-up firms in the U.S. economy? What has happened to the number of those new jobs since 2008?

2. (Introductory) According to the author and sources for this article, what types of jobs do small businesses now do without?

3. (Advanced) What are the implications of this article for the services you can provide if you are an accountant wanting to work with small businesses or to build a private accounting practice?

4. (Advanced) What are the implications of this article for the skills you must develop and continually improve as a professional accountant?
 

Reviewed By: Judy Beckman, University of Rhode Island

"With New Technology, Start-Ups Go Lean," by: Angus Loten, The Wall Street Journal, September 15, 2011 ---
http://online.wsj.com/article/SB10001424053111903927204576570622331620408.html?KEYWORDS=With+New+Technology+Start-Ups+Go+Lean

New businesses are getting off the ground with nearly half as many workers as they did a decade ago, as the spread of online tools and other resources enables start-ups to do more with less.

The change, which began before the recession, may be permanent, according to some analysts. 

"There's something long-term at work here," says Dane Stangler, research director at Ewing Marion Kauffman Foundation, a Kansas City, Mo., research group.

Start-ups are now being launched with an average of 4.9 employees, down from 7.5 in the 1990s, according to a recent Kauffman Foundation study. In 2009, new independent businesses created a total of 2.3 million jobs, more than 700,000 fewer jobs than the annual average through 2008, the study found.

Meanwhile, the overall number of start-ups has "held steady or even edged up since the recession," according to the study.

Led by start-ups, small employers have generated 65% of net new jobs over the past 17 years, says the Small Business Administration. As such, steady declines in start-up size, which stretch back more than a decade, could explain the slow labor market recovery following the previous recession in 2001, as well as today, according to Brian Headd, an economist at the SBA's Office of Advocacy.

"This is a significant change and not necessarily tied to business cycles," says Mr. Headd.

Rather than purchasing the tools and manpower needed to run their companies, more small firms are renting, sharing or outsourcing resources, typically through online services, according to Steve King, a partner at Emergent Research, a research and consulting firm for small businesses.

By tapping into Web-based business tools, Sam Rogoway earlier this month launched Near Networks, a nationwide video production firm, with only four employees. An entrepreneur based in Santa Monica, Calif., Mr. Rogoway says tasks that used to require extra workers can now be done online.

"You don't need an IT person or an accountant. It's become so streamlined and user-friendly," Mr. Rogoway says. "We all wore different hats and collaborated on everything."

Last year, Gil Harel launched BiteHunter, a search engine for restaurant discounts, with just three employees. Based in New York, the site used shared screens and other communications tools to work with developers in Russia, Uruguay and Israel.

"Just to build the infrastructure to get a business off the ground used to take a lot of money and people. But things that you couldn't do in the past, you can no w do on your own," Mr. Harel says.

Most small companies now buy supplies, pay bills and manage payroll on Web-based services, according to the National Small Business Association, a Washington, D.C.-based lobbying group.

A recent survey of more than 500 small firms by Zoomerang, an online polling firm based in San Francisco, found a small but growing number are using shared, network-based applications—or so-called cloud computing—for everything from data storage and email, to customer service, mobile commerce, and finance and administration.

Evan Saks, the founder of online mattress maker Create-a-Mattress, says manufacturing technology that ties orders to production—known as just-in-time manufacturing—and Web-based tools have done away with the need for inventory managers or warehouse staff, among other workers.

Continued in article

CVP:  Sales Mix Teaching Case
From The Wall Street Journal Accounting Weekly Review on September 16, 2011

Goodyear Rides Again
by: Jeff Bennett
Sep 15, 2011
Click here to view the full article on WSJ.com
 

TOPICS: Cost Accounting, Cost Management, Cost-Volume-Profit Analysis, Fixed Costs, Managerial Accounting

SUMMARY: "Five years ago,...Goodyear Tire & Rubber Co. was losing money, feuding with its workers and struggling to compete with foreign imports that undercut its prices at stores across the U.S....Rich Kramer, who took over as chief executive in April 2010 after overseeing operations and finance, says the key to its turnaround has been concentrating on fewer but higher priced products targeted more toward consumers than auto makers."

CLASSROOM APPLICATION: Questions are focused on the management accounting concepts of sales mix, contribution margin, fixed cost, reducing unit costs in a high fixed cost environment through volume, and the accounting for R&D activities. Questions are linked to the Goodyear 10-Q filed on July 28 and available on the SEC's web site at http://www.sec.gov/cgi-bin/browse-edgar?action=getcompany&CIK=0000042582

QUESTIONS: 
1. (Advanced) Compare the operating results for the three and six months periods ended in June 30, 2011, versus 2010. What financial statement are you using to make this assessment? (Hint: you may access the Goodyear financial statements for the quarter ended June 30, 2011 by clicking on the live link to Goodyear Tire & Rubber in the online version of the article, then click on the Financials tab, scroll down the page to see Related Information at the bottom and click on SEC Filings at SEC.gov. Select the Interactive Data tab for the 10-Q filing made on July 28, 2011.)

2. (Advanced) Compare the operating results for the three and six months periods ended in June 30, 2011, versus 2010. What financial statement are you using to make this assessment?

3. (Introductory) What amounts that you discussed above are highlighted in the article to assess Goodyear's performance?

4. (Introductory) According to the article, what factors are driving these dramatic changes? List all that you find.

5. (Advanced) What is sales mix? How does profitability improve with improved sales mix? How does that focus on sales mix compare to the strategy of "being 'a consumer products company and not just an auto supplier company'"?

6. (Advanced) Why does 'running factories at high volume" offset operating costs? How do these costs relate to the costs that are used to analyze potential profit improvement through sales mix?

7. (Advanced) What activities described in the article are research and development (R&D) activities? How are R&D expenditures accounted for under U.S. GAAP? Given Goodyear's poor financial condition, how might decisions about savings on R&D activities have impacted the company's results?
 

Reviewed By: Judy Beckman, University of Rhode Island

 

"Goodyear Rides Again:  Tire Maker Shed Costs, Cheaper Products to Build a Turnaround," by: Jeff Bennett, The Wall Street Journal, September 15, 2011 ---
http://online.wsj.com/article/SB10001424053111904836104576556931352665352.html?KEYWORDS=Goodyear+Rides+Again

Five years ago, the wheels had just about come off Goodyear Tire & Rubber Co. The 113-year-old tire maker was losing money, feuding with its workers and struggling to compete with foreign imports that undercut its prices at stores across the U.S.

Today, this industry icon appears to have regained traction after a painful transformation. It downsized operations, found common ground with union leaders and fought imports by using technology to turn its tires into prized consumer products. Goodyear is now profitable with a smaller, highly skilled work force and selling more premium-priced tires.

In the first half of the year, Goodyear sold 89.7 million tires, just 2% more than the year-ago period, but revenue was up 25% to $11 billion and income soared, to $143 million from a loss of $19 million.

Rich Kramer, who took over as chief executive in April 2010 after overseeing operations and finance, says the key to its turnaround has been concentrating on fewer but higher priced products targeted more toward consumers than auto makers. Almost 75% of its tires now sell for $130 and up. Four years ago, almost 40% of the tires it produced were low-end tires retailing for about $60 apiece.

"Our strategy in the past was based on volume. Now we look only to make the tire consumers want. It's easy to say but hard to do," said Mr. Kramer, 47.

Its former strategy focused on running factories at high volume to offset operating costs. Now, the company is focused on being "a consumer products company and not just an auto supplier company," Mr. Kramer said.

One key to Goodyear's turnaround has been better relations with its union employees. In 2006, it locked horns with the United Steelworkers union in a battle over retiree health care costs that led to a bitter, two-month strike.

Eventually, the two sides reached an agreement that offered Goodyear a two-tiered wage system and more flexible work rules in exchange for putting $1 billion into a fund to cover the cost of health care for retired workers. The company also reduced its U.S. plants to 16 from 29; nine were part of a division that was sold.

Enlarge Image GOODYEAR GOODYEAR

Goodyear also committed to modernize its U.S. plants to produce more advanced, higher-end tires. Since the strike, the company has spent more than $900 million to upgrade its North American plants and equipment.

"For us, it was the promise to invest in their plants and getting the $1 billion needed to cover our retiree health care costs that was the turning point," said USW vice president Tom Conway.

Goodyear recently has begun building on its success with early consumer marketing efforts. Based on technology it developed to reduce rolling resistance on commercial truck tires, Goodyear applied the same materials to consumer tires in 2009, promising they could save as much as 2,600 miles worth of gas over the life of the tires.

Other innovations include one of its early hot sellers, the Assurance TripleTred tire, which came out in 2004. Each tread embedded on the tire was designed to handle a certain road condition—water, ice and dry pavement. The product clicked with consumers and since has helped the Assurance brand sell more than 22 million tires in North America alone.

"There has been some good progress in the last year or so in such areas as rationalizing facilities, eliminating high cost plants, lowering administrative costs and introducing some successful products such as Fuel Max," said Saul Ludwig, managing director of Cleveland-based stock analysts Northcoast Research. He said Goodyear is poised to cut costs further and open its first new factory since 1990 in China.

Continued in article

Sentencing delayed in Madoff case:  Could the Statute of Limitations kick in before this crook finally goes to prison?

Sentencing has been delayed until March for the New City auditor who helped Bernard Madoff hide a $65 billion Ponzi scheme for nearly two decades. David Friehling's sentencing has been rescheduled to March 23, from Sept. 16. Friehling, who is free on bail, has been cooperating with federal investigators. U.S. District Court Judge Alvin K. Hellerstein rescheduled sentencing at the request of the the U.S. Attorney's Office in Manhattan. This marks the fourth postponement since Friehling pleaded guilty to nine federal crimes on Nov. 3, 2009, including securities fraud, investment adviser fraud and obstructing tax law administration.
http://www.lohud.com/article/20110910/NEWS03/109100364/In-brief-Blood-drive-marrow-registration-9-11-more

Bob Jensen's threads on the Bernie Madoff Ponzi Scheme are at
http://www.trinity.edu/rjensen/FraudRotten.htm#Ponzi

"Iran arrests 19 people in $2.6 billion bank fraud described as nation’s biggest financial scam," The Washington Post, September 19, 2011 ---
http://www.washingtonpost.com/world/middle-east/iran-arrests-19-people-in-26-billion-bank-fraud-described-as-nations-biggest-financial-scam/2011/09/19/gIQANmXNeK_story.html

Iran’s state prosecutor says authorities have arrested 19 suspects in a $2.6 billion bank fraud described as the biggest financial corruption scam in Iran’s history.

Several newspapers, including the pro-reform Shargh daily, quote Gholam Hossein Mohseni Ejehei as saying more people will be arrested.

Parliament summoned the finance minister and the central bank governor to discuss the case on Monday.

Officials say the fraud involved the use of forged documents to get credit at one of Iran’s top financial institutions to purchase assets including major state-owned companies.

Continued in article

Bob Jensen's fraud updates are at
http://www.trinity.edu/rjensen/FraudUpdates.htm

Question
What do the U.S. Department of Education's financial responsibility calculations and FASB/IASB fair value accounting standards have in common?

"Education Dept. Miscalculates 'Financial Responsibility' Scores, Private Colleges Say," by Goldie Blumenstyk, Chronicle of Higher Education, September 7, 2011 ---
http://chronicle.com/article/Education-Dept-Miscalculates/128900/

. . .

The critics also contend that aspects of the 14-year-old formula used to calculate the scores are flawed and outdated.

. . .

But Naicu contends that the Education Department's misapplication of its own rules has given a false impression of the number of colleges on the brink. The data for the 2009 fiscal year showed 149 private degree-granting institutions received composite scores of 1.5 or below, the cutoff for passing the test. "There's just not 150 schools that are at the risk of closure, or even close to that," Ms. Flanagan says.

She and other critics say that, for 2009 in particular—a year of significant losses for investors—the department's treatment of endowment declines (it counts a decline in endowment value as if it were an expenditure) improperly put many more colleges on the "failed" list than should have been there.

Continued in article

Jensen Comment
Note that in fair value accounting under FAS 157 or IFRS 9, most unrealized gains and losses in fair value are included along with realized gains and losses in computing bottom-line net income, eps, P/E ratios, etc. This is particularly misleading for items intended to be held to maturity or for a long number of years due to various factors, particularly transactions costs of trading some financial instruments. For example, bond liabilities can have high transactions costs due to call back penalties. Bonds receivable can have high transactions costs due to relatively high commissions of bond traders. Often short-term fluctuations in bond values are due to interest rate fluctuations and have little or nothing to due with changed credit risks.

"We fervently hope that the research pendulum will soon swing back from the narrow lines of inquiry that dominate today's leading journals to a rediscovery of the richness of what accounting research can be. For that to occur, deans and the current generation of academic accountants must give it a push."
Granif and Zeff --- http://www.trinity.edu/rjensen/TheoryTAR.htm#Appendix01
Michael H. Granof is a professor of accounting at the McCombs School of Business at the University of Texas at Austin. Stephen A. Zeff is a professor of accounting at the Jesse H. Jones Graduate School of Management at Rice University.

I admit that I'm just one of those professors heeding the Granof and Zeff call to "give it a push," but it's hard to get accountics professors to give up their monopoly on TAR, JAR, JAE, and in recent years Accounting Horizons. It's even harder to get them to give up their iron monopoly clasp on North American Accountancy Doctoral Programs ---
http://www.trinity.edu/rjensen/Theory01.htm#DoctoralPrograms 

"JSTOR Opens Up U.S. Journal Content From Before 1923," by Jennifer Howard, Chronicle of Higher Education, September 7, 2011 ---
 

Users anywhere now have free access to JSTOR’s Early Journal Content, a corpus of scholarly articles published in the United States before 1923 and elsewhere before 1870. That’s about 500,000 articles from 200 journals, according to JSTOR’s announcement.

The digital archive said it encourages “broad use” of the material but asked that users not use “robots or other devices to systematically download these works as this may be disruptive to our systems.” In the announcement, Laura Brown, JSTOR’s managing director, said the move was not prompted by a much-publicized incident this year involving Aaron Swartz, a hacktivist charged with violations related to making unauthorized downloads of millions of JSTOR files.

Continued in article

Jensen Comment
This is good news for historians, although most faculty and students have "free" access due to their college library subscriptions. It won't open up The Accounting Review oldies since, as I recall, TAR commenced in 1925 after a heated dispute over accountics. Accountics lost until about 1960 when it's takeover of TAR commenced (former TAR Senior Editor's Steve Kachelmeiers rough estimated percentage on the AECM for recent years was a 99% quantitative methods  dominance).

A great listing of TAR articles (throughout its history) and other AAA publications is provided by James Martin in MAAW ---
http://maaw.info/AAAMain.htm

 Here's a brief history of the early years of TAR ---
http://www.trinity.edu/rjensen/395wpTAR/Web/TAR395wp.htm

TAR BETWEEN 1926 AND 1955: IGNORING ACCOUNTICS

Accountics is the mathematical science of values.
Charles Sprague [1887] as quoted by McMillan [1998, p. 1][NH1]

 

Accounting professor Charles Sprague of Columbia University (then called Columbia College) coined the word "accountics" in 1887. The word is not used today in accounting and has some alternative meanings outside our discipline. However, in the early 20^th century, accountics was the centerpiece of some unpublished lectures by Sprague. McMillan [1998, p. 11] stated the following:

These claims were not a pragmatic strategy to legitimize the development of sophisticated bookkeeping theories. Rather, this development of a science was seen as revealing long-hidden realities within the economic environment and the double-entry bookkeeping system itself. The science of accounts, through systematic mathematical analysis, could discover hidden thrust of the reality of economic value. The term “accountics” captured the imagination of the members of the IA, connoting advances in bookkeeping that all these men were experiencing.

 

By 1900, there was a journal called Accountics [Forrester, 2003]. Both the journal and the term “accountics” had short lives, but the belief that mathematical analysis and empirical research can “discover hidden thrust of the reality of economic value” (see above)  underlies much of what has been published in TAR over the past three decades. Hence, we propose reviving the term “accountics” to describe the research methods and quantitative analysis tools that have become popular in TAR and other leading accounting research journals. We essentially define accountics as equivalent to the scientific study of values in what Zimmerman [2001, p. 414] called “agency problems, corporate governance, capital asset pricing, capital budgeting, decision analysis, risk management, queuing theory, and statistical audit analysis.”

The American Association of University Instructors of Accounting, which in December 1935 became the American Accounting Association, commenced unofficially in 1915 [Zeff, 1966, p. 5]. It was proposed in October of 1919 that the Association publish a Quarterly Journal of Accountics. This proposed accountics journal never got off the ground as leaders in the Association argued heatedly and fruitlessly about whether accountancy was a science. A quarterly journal called The Accounting Review was subsequently born in 1925, with its first issue being published in March of 1926. Its accountics-like attributes did not commence in earnest until the 1960s.

Practitioner involvement, in a large measure, was the reason for changing the name of the Association by removing the words “of University Instructors.” Practitioners interested in accounting education participated actively in AAA meetings. TAR articles in the first several decades were devoted heavily to education issues and accounting issues in particular industries and trade groups. Research methodologies were mainly normative (without mathematics), case study, and archival (history) methods. Anecdotal evidence and hypothetical illustrations ruled the day. The longest serving editor of TAR was a practitioner named Eric Kohler, who determined what was published in TAR between 1929 and 1943. In those years, when the AAA leadership mandated that TAR focus on the development of accounting principles, publications were oriented to both practitioners and educators, Chatfield [1975, p. 4].

Following World War II, practitioners outnumbered educators in the AAA [Chatfield 1975, p. 4]. Leading partners from accounting firms took pride in publishing papers and books intended to inspire scholarship among professors and students. Over the years, some practitioners, particularly those with scholarly publications, were admitted into the Accounting Hall of Fame founded by The Ohio State University. Prior to the 1960s, accounting educators were generally long on practical experience and short on academic credentials such as doctoral degrees.

A major catalyst for change in accounting research occurred when the Ford Foundation poured millions of dollars into the study of collegiate business schools and the funding of doctoral programs and students in business studies. Gordon and Howell [1959] reported that business faculty in colleges lacked research skills and academic esteem when compared to their colleagues in the sciences. The Ford Foundation thereafter provided funding for doctoral programs and for top quality graduate students to pursue doctoral degrees in business and accountancy. The Foundation even funded publication of selected doctoral dissertations to give doctoral studies in business more visibility. Great pressures were also brought to bear on academic associations like the AAA to increase the scientific standards for publications in journals like TAR.

 

TAR BETWEEN 1956 AND 1985: NURTURING OF ACCOUNTICS

A perfect storm for change in accounting research arose in the late 1950s and early1960s. First came the critical Pierson Carnegie Report [1959] and the Gordon and Howell Ford Foundation Report [1959]. Shortly thereafter, the AACSB introduced a requirement requiring that a certain percentage of faculty possess doctoral degrees for business education programs seeking accreditation [Bricker and Previts, 1990]. Soon afterwards, both a doctorate and publication in top accounting research journals became necessary for tenure [Langenderfer, 1987].

A second component of this perfect storm for change was the proliferation of mainframe computers, the development of analytical software (e.g., early SPSS for mainframes), and the dawning of management and decision “sciences.” The third huge stimulus for changed research is rooted in portfolio theory discovered by Harry Markowitz in1952 that became the core of his dissertation at Princeton University, which  was published in book form in 1959. This theory eventually gave birth to the Nobel Prize winning Capital Asset Pricing Model (CAPM) and a new era of capital market research. A fourth stimulus was when the CRSP stock price tapes became available from the University of Chicago. The availability of CRSP led to a high number of TAR articles on capital market event studies (e.g., earnings announcements on trading prices and volumes) covering a period of nearly 40 years.

This “perfect storm” roared into nearly all accounting and finance research and turned academic accounting research into an accountics-centered science of values and mathematical/statistical analysis. After 1960, there was a shift in TAR, albeit slow at first, toward preferences for quantitative model building --- econometric models in capital market studies, time series models in forecasting, advanced calculus information science, information economics, analytical models, and psychometric behavioral models. Chatfield [1975, p. 6] wrote the following:

Beginning in the 1960s the Review published many more articles by non-accountants, whose contribution involved showing how ideas or methods from their own discipline could be used to solve particular accounting problems. The more successful adaptations included matrix theory, mathematical model building, organization theory, linear programming, and Bayesian analysis.

 

TAR was not alone in moving toward a more quantitative focus. Accountics methodologies accompanied similar quantitative model building preferences in finance, marketing, management science, decision science, operations research, information economics, computer science, and information systems. Early changes along these lines began to appear in other leading research journals between 1956-1965, with some mathematical modeling papers noted by Dyckman and Zeff [1984, p. 229]. Fleming, Graci and Thompson [2000, p. 43] documented additional emphasis on quantitative methodology between 1966 and 1985. In particular, they note how tenure requirements began to change and asserted the following:

The Accounting Review evolved into a journal with demanding acceptance standards whose leading authors were highly educated accounting academics who, to a large degree, brought methods and tools from other disciplines to bear upon accounting issues.

 

A number of new academic accountancy journals were launched in the early 1960s, including the Journal of Accounting Research (1963), Abacus (1965) and The International Journal of Accounting Education and Research (1965). Clinging to its traditional normative roots and trade-article style would have made TAR appear to be a journal for academic luddites. Actually, many of the new mathematical approaches to theory development were fundamentally normative, but they were couched in the formidable language and rigors of mathematics. Publication of papers in traditional normative theory, history, and systems slowly ground to almost zero in the new age of accountics.

These new spearheads in accountics were not without problems. It is both humorous and sad to go back and discover how naïve and misleading some of TAR’s bold and high risk thrusts were in quantitative methods. Statistical models were employed without regard to underlying assumptions of independence, temporal stationarity, multicollinearity, homoscedasticity, missing variables, and departures from the normal distribution. Mathematical applications were proposed for real-world systems that failed to meet continuity and non-convexity assumptions inherent in models such as linear programming and calculus optimizations. Some proposed applications of finite mathematics and discrete (integer) programming failed because the fastest computers in the world, then and now, could not solve most realistic integer programming problems in less than 100 years.

After financial databases provided a beta covariance of each security in a portfolio with the market portfolio, many capital market events studies were published by TAR and other leading accounting journals. In the early years, accounting researchers did not challenge the CAPM’s assumptions and limitations --- limitations that, in retrospect, cast doubt upon many of the findings based upon any single index of market risk [Fama and French, 1992].

Leading accounting professors lamented TAR’s preference for rigor over relevancy [Zeff, 1978; Lee, 1997; and Williams, 1985 and 2003]. Sundem [1987] provides revealing information about the changed perceptions of authors, almost entirely from academe, who submitted manuscripts for review between June 1982 and May 1986. Among the 1,148 submissions, only 39 used archival (history) methods; 34 of those submissions were rejected. Another 34 submissions used survey methods; 33 of those were rejected. And 100 submissions used traditional normative (deductive) methods with 85 of those being rejected. Except for a small set of 28 manuscripts classified as using “other” methods (mainly descriptive empirical according to Sundem), the remaining larger subset of submitted manuscripts used methods that Sundem [1987, p. 199] classified these as follows:

292          General Empirical

172          Behavioral

135          Analytical modeling

119          Capital Market

  97          Economic modeling

  40          Statistical modeling

  29          Simulation

 

It is clear that by 1982, accounting researchers realized that having mathematical or statistical analysis in TAR submissions made accountics virtually a necessary, albeit not sufficient, condition for acceptance for publication. It became increasingly difficult for a single editor to have expertise in all of the above methods. In the late 1960s, editorial decisions on publication shifted from the TAR editor alone to the TAR editor in conjunction with specialized referees and eventually associate editors [Flesher, 1991, p. 167]. Fleming et al. [2000, p. 45] wrote the following:

The big change was in research methods. Modeling and empirical methods became prominent during 1966-1985, with analytical modeling and general empirical methods leading the way. Although used to a surprising extent, deductive-type methods declined in popularity, especially in the second half of the 1966-1985 period.

 

We were surprised that there was no reduction in accountics dominance in TAR since 1986 in spite of changes in the environment such as the explosion of communications networking, interacting relational databases, and sophisticated accounting information systems (AIS).Virtually no AIS papers were published in TAR between 1986 and 2005. This practice was changed in 2006 by the appointment of a new AIS associate editor to encourage publication of some AIS papers that often do not fit neatly into the accountics mold. In an interesting aside, we note that the AAA has become a leading international association of accounting educators. Sundem [1987] reported that about 12 percent of the manuscripts submitted came from outside of North America. The American Accounting Association is an international association that provides publication opportunities to all members, and manuscripts are submitted from many parts of the world. In our opinion, this contributed significantly to the rise in accountics studies worldwide.

A major change at TAR took place in the 1980s with the creation of new AAA journals to relieve TAR of publishing articles that were less accountics-oriented. Prior to 1983, TAR was the leading academic journal for teachers of accounting as well as practitioners. Numerous TAR papers appeared on how to improve accounting education and teaching. In an effort to better serve educators, the AAA created a specialty journal called Issues in Accounting Education, first published in 1983. A journal aimed more at issues facing practitioners was inaugurated in 1987 under the name Accounting Horizons. Around this time, the AAA also granted permission for specialty “sections” to be formed for sub-disciplines of accounting, which resulted in additional new journals. These new journals allowed TAR to focus more heavily on quantitative papers that became increasingly difficult for practitioners and many teachers of accounting to comprehend.

Continued in article

"We fervently hope that the research pendulum will soon swing back from the narrow lines of inquiry that dominate today's leading journals to a rediscovery of the richness of what accounting research can be. For that to occur, deans and the current generation of academic accountants must give it a push."
Granif and Zeff --- http://www.trinity.edu/rjensen/TheoryTAR.htm#Appendix01
Michael H. Granof is a professor of accounting at the McCombs School of Business at the University of Texas at Austin. Stephen A. Zeff is a professor of accounting at the Jesse H. Jones Graduate School of Management at Rice University.

I admit that I'm just one of those professors heeding the Granof and Zeff call to "give it a push," but it's hard to get accountics professors to give up their monopoly on TAR, JAR, JAE, and in recent years Accounting Horizons. It's even harder to get them to give up their iron monopoly clasp on North American Accountancy Doctoral Programs ---
http://www.trinity.edu/rjensen/Theory01.htm#DoctoralPrograms

Calvin Ball

Accountics science is defined at http://www.trinity.edu/rjensen/395wpTAR/Web/TAR395wp.htm
One of the main reasons Bob Jensen contends that accountics science is not yet a real science is that lack of exacting replications of accountics science findings. By exacting replications he means reproducibility as defined in the IAPUC Gold Book  ---
http://www.trinity.edu/rjensen/TheoryTAR.htm#Replication

The leading accountics science (an indeed the leading academic accounting research journals) are The Accounting Review (TAR), the Journal of Accounting Research (JAR), and the Journal of Accounting and Economics (JAE). Publishing accountics science in these journals is a necessary condition for nearly all accounting researchers at top R1 research universities in North America.

On the AECM listserv, Bob Jensen and former TAR Senior Editor Steven Kachelmeier have had an ongoing debate about accountics science relevance and replication for well over a year in what Steve now calls a game of CalvinBall. When Bob Jensen noted the lack of exacting replication in accountics science, Steve's CalvinBall reply was that replication is the name of the game in accountics science:

The answer to your question, "Do you really think accounting researchers have the hots for replicating their own findings?" is unequivocally YES, though I am not sure about the word "hots." Still, replications in the sense of replicating prior findings and then extending (or refuting) those findings in different settings happen all the time, and they get published regularly. I gave you four examples from one TAR issue alone (July 2011). You seem to disqualify and ignore these kinds of replications because they dare to also go beyond the original study. Or maybe they don't count for you because they look at their own watches to replicate the time instead of asking to borrow the original researcher's watch. But they count for me.

To which my CalvinBall reply to Steve is --- "WOW!" In the past four decades of all this unequivocal replication in accountics science there's not been a single scandal. Out of the thousands of accountics science papers published in TAR, JAR, and JAE there's not been a single paper withdrawn after publication, to my knowledge, because of a replication study discovery. Sure there have been some quibbles about details in the findings and some improvements in statistical significance by tweaking the regression models, but there's not been a replication finding serious enough to force a publication retraction or serious enough to force the resignation of an accountics scientist.

In real science, where more exacting replications really are the name of the game, there have been many scandals over the past four decades. Nearly all top science journals have retracted articles because independent researchers could not exactly replicate the reported findings. And it's not all that rare to force a real scientist to resign due to scandalous findings in replication efforts.

The most serious scandals entail faked data or even faked studies. These types of scandals apparently have never been detected among thousands of accountics science publications. The implication is that accountics scientists are more honest as a group than real scientists. I guess that's either good news or bad replicating.

Given the pressures brought to bear on accounting faculty to publish accountics science articles, the accountics science scandal may be that accountics science replications have never revealed a scandal --- to my knowledge at least.

One of the most recent scandals arose when a very well-known psychologist named Mark Hauser.
"Author on leave after Harvard inquiry Investigation of scientist’s work finds evidence of misconduct, prompts retraction by journal," by Carolyn Y. Johnson, The Boston Globe, August 10, 2010 ---
http://www.boston.com/news/education/higher/articles/2010/08/10/author_on_leave_after_harvard_inquiry/

Harvard University psychologist Marc Hauser — a well-known scientist and author of the book “Moral Minds’’ — is taking a year-long leave after a lengthy internal investigation found evidence of scientific misconduct in his laboratory.

The findings have resulted in the retraction of an influential study that he led. “MH accepts responsibility for the error,’’ says the retraction of the study on whether monkeys learn rules, which was published in 2002 in the journal Cognition.

Two other journals say they have been notified of concerns in papers on which Hauser is listed as one of the main authors.

It is unusual for a scientist as prominent as Hauser — a popular professor and eloquent communicator of science whose work has often been featured on television and in newspapers — to be named in an investigation of scientific misconduct. His research focuses on the evolutionary roots of the human mind.

In a letter Hauser wrote this year to some Harvard colleagues, he described the inquiry as painful. The letter, which was shown to the Globe, said that his lab has been under investigation for three years by a Harvard committee, and that evidence of misconduct was found. He alluded to unspecified mistakes and oversights that he had made, and said he will be on leave for the upcoming academic year.

Continued in article

Update:  Hauser resigned from Harvard in 2011 after the published research in question was retracted by the journals.

Not only have there been no similar reported accountics science scandals called to my attention, I'm not aware of any investigations of impropriety that were discovered among all those "replications" claimed by Steve.

What is an Exacting Replication?
I define an exacting replication as one in which the findings are reproducible by independent researchers using the IAPUC Gold Book standards for reproducibility. Steve makes a big deal about time extensions when making such exacting replications almost impossible in accountics science. He states:

By "exacting replication," you appear to mean doing exactly what the original researcher did -- no more and no less. So if one wishes to replicate a study conducted with data from 2000 to 2008, one had better not extend it to 2009, as that clearly would not be "exacting." Or, to borrow a metaphor I've used earlier, if you'd like to replicate my assertion that it is currently 8:54 a.m., ask to borrow my watch -- you can't look at your watch because that wouldn't be an "exacting" replication.

That's CalvinBall bull since in many of these time extensions it's also possible to conduct an exacting replication. Richard Sansing pointed out the how he conducted an exacting replication of the findings in Dhaliwal, Li and R. Trezevant (2003), "Is a dividend tax penalty incorporated into the return on a firm’s common stock?," Journal of Accounting and Economics 35: 155-178. Although Richard and his coauthor extend the Dhaliwal findings they first conducted an exacting replication in their paper published  in The Accounting Review 85 (May 2010): 849-875.

My quibble with Richard is mostly that conducting an exacting replication of the Dhaliwal et al. paper was not exactly a burning (hot) issue if nobody bothered to replicate that award winning JAE paper for seven years.

This begs the question of why there are not more frequent and timely exacting replications conducted in accountics science if the databases themselves are commercially available like the CRSP, Compustat, and AuditAnalytics databases. Exacting replications from these databases are relatively easy and cheap to conduct. My contention here is that there's no incentive to excitedly conduct exacting replications if the accountics journals will not even publish commentaries about published studies. Steve and I've played CalvinBall with the commentaries issue before. He contends that TAR editors do not prevent commentaries from being published in TAR. The barriers to validity questioning commentaries in TAR are the 574 referees who won't accept submitted commentaries ---
http://www.trinity.edu/rjensen/TheoryTAR.htm#ColdWater

Exacting replications of behavioral experiments in accountics science is more difficult and costly because the replicators must conduct their own experiments by collecting their own data. But it seems to me that it's no more difficult in accountics science than in performing exacting replications that are reported in the research literature of psychology. However, psychologists often have more incentives to conduct exacting replications for the following reasons that I surmise:

1. Practicing psychologists are more demanding of validity tests of research findings. Practicing accountants seem to pretty much ignore behavioral experiments published in TAR, JAR, and JAE such that there's not as much pressure brought to bear on validity testing of accountics science findings. One test of practitioner lack of interest is the lack of citation of accountics science in practitioner journals.
    
2. Psychology researchers have more incentives to replicate experiments of others since there are more outlets for publication credits of replication studies, especially in psychology journals that encourage commentaries on published research ---
   http://www.trinity.edu/rjensen/TheoryTAR.htm#TARversusJEC

My opinion remains that accountics science will never be a real science until exacting replication of research findings become the name of the game in accountics science. This includes exacting replications of behavioral experiments as well as analysis of public data from CRSP, Compustat, AuditAnalytics, and other commercial databases. Note that willingness of accountics science authors to share their private data for replication purposes is a very good thing (I fought for this when I was on the AAA Executive Committee), but conducting replication studies of such data does not hold up well under the IAPUC Gold Book.

Note, however, that lack of exacting replication and other validity testing in general are only part of the huge problems with accountics science. The biggest problem, in my judgment, is the way accountics scientists have established monopoly powers over accounting doctoral programs, faculty hiring criteria, faculty performance criteria, and pay scales. Accounting researchers using other methodologies like case and field research become second class faculty.

Since the odds of getting a case or field study published are so low, very few of such studies are even submitted for publication in TAR in recent years. Replication of these is a non-issue in TAR.

"Annual Report and Editorial Commentary for The Accounting Review," by Steven J. Kachelmeier The University of Texas at Austin, The Accounting Review, November 2009, Page 2056.

Insert Table

There's not much hope for case, field, survey, and other non-accountics researchers to publish in the leading research journal of the American Accounting Association.

What went wrong with accountics research?
http://www.trinity.edu/rjensen/theory01.htm#WhatWentWrong

"We fervently hope that the research pendulum will soon swing back from the narrow lines of inquiry that dominate today's leading journals to a rediscovery of the richness of what accounting research can be. For that to occur, deans and the current generation of academic accountants must give it a push."
Granif and Zeff --- http://www.trinity.edu/rjensen/TheoryTAR.htm#Appendix01
Michael H. Granof is a professor of accounting at the McCombs School of Business at the University of Texas at Austin. Stephen A. Zeff is a professor of accounting at the Jesse H. Jones Graduate School of Management at Rice University.

I admit that I'm just one of those professors heeding the Granof and Zeff call to "give it a push," but it's hard to get accountics professors to give up their monopoly on TAR, JAR, JAE, and in recent years Accounting Horizons. It's even harder to get them to give up their iron monopoly clasp on North American Accountancy Doctoral Programs ---
http://www.trinity.edu/rjensen/Theory01.htm#DoctoralPrograms 

September 9, 2011 reply from Paul Williams

Bob,
I have avoided chiming in on this thread; have gone down this same road and it is a cul-de-sac.  But I want to say that this line of argument is a clever one.  The answer to your rhetorical question is, No, they aren't more ethical than other "scientists."   As you tout the Kaplan speech I would add the caution that before he raised the issue of practice, he still had to praise the accomplishments of "accountics" research by claiming numerous times that this research has led us to greater understanding about analysts, markets, info. content, contracting, etc.  However, none of that is actually true.  As a panelist at the AAA meeting I juxtaposed Kaplan's praise for what accountics research has taught us with Paul Krugman's observations about Larry Summer's 1999 observation that GAAP is what makes US capital markets so stable and efficient.  Of course, as Krugman noted, none of that turned out to be true.  And if that isn't true, then Kaplan's assessment of accountics research isn't credible, either.  If we actually did understand what he claimed we now understand much better than we did before, the financial crisis of 2008 (still ongoing) would not have happened.  The title of my talk was (the panel was organized by Cheryl McWatters) "The Epistemology of Ignorance."  An obsessive preoccupation with method could be a choice not to understand certain things-- a choice to rigorously understand things as you already think they are or want so desperately to continue to believe for reasons other than scientific ones. 

Paul

September 10, 2011 message from Bob Jensen

Hi Raza,
 

Please don't get me wrong. As an old accountics researcher myself, I'm all in favor of continuing accountics research full speed ahead. The younger mathematicians like Richard Sansing are doing it better these days. What I'm upset about is the way the accountics science quants took over TAR, AH, accounting faculty performance standards in R1 universities, and virtually all accounting doctoral programs in North America.

Monopolies are not all bad --- they generally do great good they for mankind. The problem is that monopolies shut out the competition. In the case of accountics science, the accountics scientists have shut out competing research methods to a point where accounting doctoral students must write accountics science dissertations, and TAR referees will not open the door to case studies, field studies, accounting history studies, or commentaries critical of accountics science findings in TAR.

The sad thing is that even if we open up our doctoral programs to other research methodologies, the students themselves may prefer accountics science research. It's generally easier to apply regression models to CRSP, Compustat, and Audit Analytics databases than have to go off campus to collect data and come up with clever ideas to improve accounting practice in ways that will amaze practitioners.

Another problem with accountics science is that this monopoly has not created incentives for validity checking of accountics science findings. This has prevented accountics science from being real science where validity checking is a necessary condition for research and publication. If TAR invited commentaries on validity testing of TAR publications, I think there would be more replication efforts.

If TAR commenced a practitioners' forum where practitioners were "assigned" to discuss TAR articles, perhaps there would be more published insights into possible relevance of accountics science to the practice of accountancy. I put "assign" in quotations since practitioners may have to be nudged in some ways to get them to critique accountics science articles.

There are some technical areas where practitioners have more expertise than accountics scientists, particularly in the areas of insurance accounting, pension accounting, goodwill impairment testing, accounting for derivative financial instruments, hedge accounting, etc. Perhaps these practitioner experts might even publish a "research needs" forum in TAR such that our very bright accountics scientists would be inspired to focus their many talents on some accountancy practice technical problems.

My main criticism of accountics scientists is that the 600+ TAR referees have shut down critical commentaries of their works and the recent editors of TAR have been unimaginative when in thinking of ways to motivate replication research, TAR article commentaries, and focus of accountics scientists on professional practice problems.

Some ideas for improving TAR are provided at
http://www.trinity.edu/rjensen/TheoryTAR.htm

Particularly note the module on
TAR versus AMR and AMJ

 

September 10, 2011 reply from Bob Jensen (known on the AECM as Calvin of Calvin and Hobbes)
This is a reply to Steve Kachelmeier, former Senior Editor of The Accounting Review (TAR)

I agree Steve and will not bait you further in a game of Calvin Ball.

It is, however, strange to me that exacting replication (reproducibility)  is such a necessary condition to almost all of real science empiricism and such a small part of accountics science empiricism.

My only answer to this is that the findings themselves in science seem to have greater importance to both the scientists interested in the findings and the outside worlds affected by those findings.
It seems to me that empirical findings that are not replicated with as much exactness as possible are little more than theories that have only been tested once but we can never be sure that the tests were not faked or contain serious undetected errors for other reasons.
It is sad that the accountics science system really is not designed to guard against fakers and careless researchers who in a few instances probably get great performance evaluations for their hits in TAR, JAR, and JAE. It is doubly sad since internal controls play such an enormous role in our profession but not in our accoutics science.

I thank you for being a noted accountics scientist who was willing to play Calvin Ball.with me for a while. I want to stress that this is not really a game with me. I do want to make a difference in the maturation of accountics science into real science. Exacting replications in accountics science would be an enormous giant step in the real-science direction.

Allowing validity-questioning commentaries in TAR would be a smaller start in that direction but nevertheless a start. Yes I know that it was your 574 TAR referees who blocked the few commentaries that were submitted to TAR about validity questions. But the AAA Publications Committees and you as Senior Editor could've done more to encourage both submissions of more commentaries and submissions of more non-accountics research papers to TAR --- cases, field studies, history studies, AIS studies, and (horrors) normative research.

I would also like to bust the monopoly that accountics scientists have on accountancy doctoral programs. But I've repeated my arguments here far to often ---
http://www.trinity.edu/rjensen/Theory01.htm#DoctoralPrograms

In any case thanks for playing Calvin Ball with me. Paul Williams and Jagdish Gangolly played Calvin Ball with me for a while on an entirely different issue --- capitalism versus socialism versus bastardized versions of both that evolve in the real world.

Hopefully there's been some value added on the AECM in my games of Calvin Ball.

Even though my Calvin Ball opponents have walked off the field, I will continue to invite others to play against me on the AECM.

And I'm certain this will not be the end to my saying that accountics farmers are more interested in their tractors than their harvests. This may one day be my epitaph.

Respectfully,
Calvin

Of One Thing We Can Be Sure: He did not publish in TAR, JAR, or JAE
We've yet to see an accountics researcher suspended for fabricating data
"Dutch University Suspends Prominent Social Psychologist," Inside Higher Ed, September 12, 2011 ---
http://www.insidehighered.com/news/2011/09/12/qt#270113

Tilburg University, in the Netherlands, announced last week that it was suspending D.A. Stapel from his positions as professor of cognitive social psychology and dean of the School of Social and Behavioral Sciences because he "has committed a serious breach of scientific integrity by using fictitious data in his publications." The university has convened a panel to determine which of Stapel's papers were based on false data. Science noted that Stapel's work -- in that publication and elsewhere -- was known for attracting attention. Science reported that Philip Eijlander, Tilburg's rector, told a Dutch television station that Stapel had admitted to the fabrications. Eijlander said that junior researchers in Stapel's lab came forward with concerns about the honesty of his data, setting off an investigation by the university.

Jensen Comment
Actually I'm being somewhat unfair here. It was not exacting replication studies that upended Professor Stapel in this instance. There are, of course, other means of testing internal controls in scientific research. But the most common tool is replication of reproducible experiments.

Replication researchers did upend Marc Hauser at Harvard ---
http://www.trinity.edu/rjensen/TheoryTAR.htm
 

Enterprise Resource Planning (ERP) --- http://en.wikipedia.org/wiki/Enterprise_resource_planning

"North Carolina State University: Implementing ERP Student Modules," by Marianne Bradford, Issues in Accounting Education, 2011, Vol. 26, No. 3, pp. 507–520 --- (access requires a paid subscription)
http://aaapubs.aip.org/getpdf/servlet/GetPDFServlet?filetype=pdf&id=IAEXXX000026000003000507000001&idtype=cvips&prog=normal

ABSTRACT:
The purpose of this case is to describe the benefits and challenges of an Enterprise Resource Planning (ERP) system at a higher education institution (HEI). The case also focuses on IT risk and systems security issues inherent in an ERP system. The case begins with the implementation of financials and HR modules at North Carolina State University, a land-grant institution with 33,000 students. This background sets the stage for the main focus of the case: the implementation of the ERP Student modules, which required a major overhaul of information systems, including admissions, student financials, and registration and records. Concluding the case is a recent dilemma facing NCSU—the potential merging of ERP systems with The University of North Carolina at Chapel Hill. Students have the opportunity to practice problem-solving skills with regards to this dilemma, as well as offer their opinions on the strengths and weaknesses of the Student implementations.

. . .

THE NEXT STEPS FOR NCSU
Fresh off the heels of the rollout of Student Records will be the implementation of the undergraduate portion of Academic Advising and Financial Aid, and upgrades to the PeopleSoft modules planned for early 2011.

To further complicate matters, beginning in 2008, North Carolina faced a major budget crisis and had twice frozen state spending. Fifteen miles away in Chapel Hill, NCSU’s longtime rival, The University of North Carolina at Chapel Hill (UNC-CH), was implementing their first-ever ERP system. They had also chosen PeopleSoft (all other NC public universities used the Banner ERP system). The new Vice Chancellors for Information Technology at each school, along with the NC Board of Governors, were putting pressure on the two HEIs to reduce spending and find ways to work together (see Exhibit 4 for Triangle-area newspaper announcement). For many, it did not make sense to have separate PeopleSoft systems for two very similar schools a few miles apart.

Projected and actual ERP-related expenses were exorbitant. NCSU had already spent over $31 million on ERP implementations and upgrades since 1998 ($11.6 million of that on the Student modules), which consisted of software licenses (23 percent), hardware purchases (9 percent), implementation consulting (38 percent), additional staffing costs and training (5 percent), recurring software maintenance (22 percent), and recurring hardware maintenance (3 percent). UNC-CH’s initial ERP implementation of Financials, HR, and Student was projected to run $75 million. NCSU had years invested in PeopleSoft, while UNC-CH was just starting. But UNC-CH had deeper pockets with the money to buy hardware, one thing lacking at NCSU under the current budget crisis.

In June of 2009, ERP project teams from the two HEIs met to discuss sharing part, or all, of their ERP systems. There were many obstacles to overcome before moving forward. For instance, the two HEIs have different Charts of Accounts and would need to develop a common one that would meet the needs of both institutions—a major task. Also, NCSU’s HR system is largely customized, and in some areas the two universities use different payroll cycles. Student processes are also likely dissimilar, although the teams were hesitant to divulge these to each other.

Sitting in an office looking back on a decade of ERP implementations and upgrades, Connie, Ron, and Gwen reflected on the work they and the project team had accomplished. With all these issues on the forefront, NCSU OIT staff had much to think about.

Bob Jensen's sadly neglected threads on ERP in academia are at
http://www.trinity.edu/rjensen/245glosap.htm

"A Philosophy of Teaching," by Rob Jenkins, Chronicle of Higher Education, September 20, 2011 ---
http://chronicle.com/article/A-Philosophy-of-Teaching/129060/

Most teaching statements are written by people who—let's be honest—don't really know that much about teaching. Usually the writers are first-time job seekers with, at best, a year or two as a graduate assistant or an adjunct under their belts.

Battle-scarred classroom veterans, unless they happen to be going on the market, rarely write a statement of teaching philosophy. But maybe they should.

My philosophy of teaching has been forged over more than 32 years, 26 of those as an instructor. As a student, I attended a private liberal-arts college and a midsized regional university. I've taught at a large land-grant university, a small rural community college, a large metropolitan community college, and a suburban technical college.

Like everyone in the profession, I came to the job with a number of preconceived notions, based partly on observations of my own teachers, both good and bad, and partly on my perception of how things should operate in a perfect world. Most of those notions proved false or impractical, and the jury is still out on the rest.

In addition, since I also spent 11 years supervising faculty members, my teaching philosophy has been profoundly influenced by my experiences with colleagues. I've had the great good fortune to observe and learn from some of the best teachers in the world. I've also known a few faculty members whose chief contribution to my development was to strengthen my resolve never—ever—to do certain things.

Please note that in sharing my philosophy, I'm not suggesting that it's the definitive approach or encouraging anyone else to adopt it. I'm simply sharing what I've come to believe.

College students are adults. I wrote about that truism in some depth back in August of 2010 ("Welcome to My Classroom"), but it bears revisiting as one element of a more comprehensive philosophy.

People tend to rise or fall to the level that is expected of them. Make it clear that you think students are stupid and, odds are, they will underperform. Act like you expect them to misbehave, and your classroom will probably resemble a war zone. But if you tell students upfront that you consider them to be adults, and then treat them accordingly, most will attempt to live up to the label. That's certainly been the case in my classroom over the years.

Treating students like adults means you allow them the freedoms that adults enjoy—to be late for class, for instance, to miss it altogether, or to leave early if that's what they need to do. At the same time, you make it clear that, as adults, they are responsible for all the material in the course, whether or not they were in class on a particular day.

That approach has profound implications for every aspect of classroom management, from discipline to attendance to late papers. Students like it because they think of themselves as adults and appreciate being viewed that way. (College students despise few things more than being treated as though they were still in high school.) And it's good for professors because it shifts the responsibility for "keeping up" onto the students, where it belongs.

Teaching is performance art. I wish I had coined that phrase, or at least knew who did. I just know that it has become one of my foundational beliefs.

The concept of the teacher as performer, as "the sage on the stage," has fallen out of favor in recent years. But the fact is, we are sages and we are on a stage. How we perform—that is, how we teach—is every bit as important as what we teach.

Moreover, how our students respond to us—and by extension, to our subject matter—depends largely on the quality of the performance we give in class, day in and day out. Want to engage your students, capture their interest, motivate them to do more and be more? Then pay attention to voice inflection and body language, just as an actor would. Practice your timing. Play to your audience. Inject some humor. Entertain.

That doesn't mean you have to make yourself the focal point of the classroom all the time. Class discussions, group work, and other non-teacher-centric strategies can also be effective. But when the curtain goes up and it's your time to shine, go out there and knock 'em dead.

Great teachers may be born, but good teachers are made. The ability to become a great teacher—one who inspires students and seems to connect with them effortlessly—is a gift, an innate talent like musical ability or athletic prowess.

Just like any other gift, it can either be squandered or put to good use. The very best teachers are those who have the gift and have worked hard over many years to further develop it—although we often overlook the hard work because they make being a great teacher look so easy.

Continued in article

Differences between "popular teacher" versus "master teacher" versus "mastery learning" versus "master educator" ---
http://www.trinity.edu/rjensen/assess.htm#Teaching

Bob Jensen's threads on metacognitive teaching and learning ---
http://www.trinity.edu/rjensen/265wp.htm

"Who Are YOU (as a teacher)?" by Joe Hoyle, Teaching Blog, September 14, 2011 ---
http://joehoyle-teaching.blogspot.com/2011/09/who-are-you.html

Joe lists some famous persons in history that you might try to emulate --- but that might not be you.

There are also the best of the best according to RateMyProfessor ---
http://www.ratemyprofessors.com/topLists11/topLists.html

Accounting Professor Lawrie Gardner comes in at Rank 21 among community college teachers ---
http://www.ratemyprofessors.com/ShowRatings.jsp?tid=390728

Video of how "You" might improve your image with new pairs of shoes
Dr. Kimora of John Jay College, the #2 Highest Rated Professor on RateMyProfessors.com, responds to your comments on Professors Strike Back! ---
http://blog.ratemyprofessors.com/professor-kimora-john-jay-college/#more-2192

Mary Schapiro --- http://en.wikipedia.org/wiki/Mary_Schapiro

It (the Report) says Ms. Schapiro agreed with a decision to keep Mr. Becker from testifying before Congress, where he would have disclosed his financial interest in the Madoff account.
See below

"S.E.C. Hid Its Lawyer’s Madoff Ties," by Louise Story and Gretchen Morgenson, The New York Times, September 20, 2011 ---
http://www.nytimes.com/2011/09/21/business/sec-refers-ex-counsels-actions-on-madoff-to-justice-dept.html?_r=1&ref=business

After Bernard L. Madoff’s giant Ponzi scheme was revealed, the Securities and Exchange Commission went to great lengths to make sure that none of its employees working on the case posed a conflict of interest, barring anyone who had accepted gifts or attended a Madoff wedding.

But as a new report made clear on Tuesday, one top official received a pass: David M. Becker, the S.E.C.’s general counsel, who went on to recommend how the scheme’s victims would be compensated, despite his family’s $2 million inheritance from a Madoff account.

Mr. Becker’s actions were referred by H. David Kotz, the inspector general of the S.E.C., to the Justice Department, on the advice of the Office of Government Ethics, which oversees the ethics of the executive branch of government.

The report by Mr. Kotz provides fresh details about the weakness of the agency’s ethics office and reveals that none of its commissioners, except for Mary L. Schapiro, its chairwoman, had been advised of Mr. Becker’s conflict.

It says Ms. Schapiro agreed with a decision to keep Mr. Becker from testifying before Congress, where he would have disclosed his financial interest in the Madoff account.

Mr. Kotz’s inquiry also produced evidence that at least one S.E.C. employee had been barred from working on Madoff-related matters because of a conflict, suggesting there was a double standard at the agency.

The findings are another black eye for an agency that has tried to be more aggressive in recent years after failing to uncover the Madoff fraud. More recently, the S.E.C. has been criticized for routine destruction of some enforcement documents that might have been useful in later investigations.

The agency has also been criticized for its slow pace in writing new financial regulations mandated by the Dodd-Frank law and for the dearth of cases brought against individuals at major financial companies that were involved in the mortgage crisis.

Federal conflict of interest law requires government employees to be disqualified from participating in a matter “if it would have a direct and predictable effect on the employee’s own financial interests.”

Nevertheless, Mr. Becker “participated personally and substantially in particular matters in which he had a personal financial interest,” Mr. Kotz wrote in his report.

Though the referral was made to the Justice Department’s criminal division, it could be handled as a civil matter. A Justice Department spokeswoman declined to comment, other than confirming the referral.

Mr. Becker’s tie to the Madoff situation came from a Madoff account held by his mother, who died in 2004. Her three sons inherited the account and closed it shortly thereafter, with a $1.5 million profit, based on Mr. Madoff’s fraud.

Mr. Madoff carried out an enormous Ponzi scheme for more than a decade, costing investors more than $20 billion in actual losses. He is now serving a 150-year sentence in a prison in North Carolina.

Mr. Becker’s lawyer, William R. Baker III, said in a statement that the report confirmed that Mr. Becker had notified seven senior S.E.C. officials about his late mother’s Madoff account, including Ms. Schapiro and the agency’s designated ethics officer.

“The inspector general concluded that ‘none of these individuals recognized a conflict or took any action to suggest that Becker consider recusing himself from the Madoff liquidation,’ “ wrote Mr. Baker, a lawyer at Latham & Watkins who worked at the S.E.C. for 15 years, working alongside Mr. Becker at times. He said the report contained “a number of critical factual and legal errors,” but declined to enumerate them. Mr. Becker left the S.E.C. last February.

Continued in article

"The SEC's Ethics:  Washington's double standard on conflicts of interest," The Wall Street Journal, September 23, 2011 ---
http://online.wsj.com/article/SB10001424053111903703604576584620319633188.html#mod=djemEditorialPage_t

Who says partisanship rules Washington? House Republicans showed remarkable forbearance yesterday toward SEC Chairman Mary Schapiro over an ethics flap involving the Bernie Madoff case and conflict-of-interest laws.

"What is clear about this situation is that you did make a mistake. You admitted such and you said had you known then what you now know, you would have acted differently," Rep. Patrick McHenry (R., N.C.) told Ms. Schapiro at a public hearing. We doubt Ms. Schapiro and her SEC cops would have been so forgiving toward someone in private life who made the same "mistake."

We're referring to this week's remarkable report from SEC Inspector General David Kotz disclosing how the SEC's former top lawyer, David Becker, directly handled matters relating to the Madoff fraud case despite his mother's $2 million investment with the firm, to which he and his brothers were heirs.

Mr. Becker's involvement potentially influenced whether investors who got money out of the Madoff operation before it was exposed could be shielded from so-called "clawback" lawsuits brought by those liquidating the Madoff estate. Mr. Kotz says Mr. Becker "participated personally and substantially in particular matters in which he had a personal financial interest" through his inheritance of his mother's estate.

The conflict here would seem to be obvious, and Mr. Becker did at least disclose it—to Ms. Schapiro shortly after arriving at the SEC in February 2009. "I did precisely what I was supposed to do," he told Congress yesterday. "I identified a matter that required legal advice from the SEC's Ethics Office. I sought that advice, received it and followed it."

But that still leaves the role played by Ms. Schapiro, who never told her fellow commissioners about the conflict, going so far as to let them vote on how to divide up the Madoff assets, a change from which Mr. Becker stood to benefit. Only in February, after Mr. Becker was named in a clawback lawsuit by Madoff trustee Irving Picard, did the commissioners learn of the conflicts by reading the press.

Ms. Schapiro declined our request for an explanation this week, but she has said she would have had Mr. Becker recused if she had "understood that he had any financial interest in how this was resolved." But then why did she think he had informed her of his family's Madoff connection? She also said she would have wanted to disclose the Madoff connection if Mr. Becker had testified on the issue "so that we were completely forthcoming with Congress."

Hmmm. The same IG report also highlights that the SEC decided not to have Mr. Becker testify to Congress on Madoff issues lest his conflict become public. Mr. Becker told the IG under oath that after he mentioned the need to disclose the inheritance up front if he did go before Congress, the SEC's Office of Intergovernmental and Legislative Affairs Director Eric Spitler wrote that "now that I think about it, I think it would be better if someone else testified. My concern is not that there's anything wrong with it," but "when you're in a political environment . . . it would be a distraction."

Mr. Spitler has said that Ms. Schapiro agreed that Mr. Becker shouldn't appear before Congress, though she says she does not recall how the matter was settled.

The only word for all of this is astonishing. We don't think all conflicts-of-interest are disqualifying, and they can be managed to avoid trouble. But this one isn't a close call. Imagine how the SEC's enforcement cops would handle a private company that let a general counsel play such a role. For such a conflict to be passed off as inconsequential, and then covered up, by the agency that is supposed to investigate bad financial actors is more than a mistake. It's faulty judgment that suggests an ethical blind spot.

Continued in article

Bob Jensen's threads on the Madoff Ponzi Scandal ---
http://www.trinity.edu/rjensen/FraudRotten.htm#Ponzi

Jensen Comment
I just do not have an ounce of respect for any of the previous SEC directors who sold their souls to and integrity to protecting the tycoons by letting them off easy when they stole billions from investors.Mary Schapiro is no exception.

These two items say a lot (bad) about Mary Shapiro's SEC --- http://en.wikipedia.org/wiki/Mary_Shapiro

"Clawbacks Without Claws," by Gretchen Morgenson, The New York Times, September 10, 2011 ---
http://www.nytimes.com/2011/09/11/business/clawbacks-without-claws-in-a-sarbanes-oxley-tool.html?_r=2&emc=tnt&tntemail1=y

AFTER the grand frauds at Enron, WorldCom and Adelphia, Congress set out to hold executives accountable if their companies cook the books.

Fair Game Clawbacks Without Claws By GRETCHEN MORGENSON Published: September 10, 2011

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AFTER the grand frauds at Enron, WorldCom and Adelphia, Congress set out to hold executives accountable if their companies cook the books. Add to Portfolio

Diebold Inc New Century Financial Corp NutraCea

Go to your Portfolio »

Under the Sarbanes-Oxley Act of 2002, the Securities and Exchange Commission was encouraged to hit executives where it hurts — in the wallet — if they certified financial results that turned out to be, in a word, bogus.

SarbOx was supposed to keep managers honest. They would have to hand back incentive pay like bonuses, even if they didn’t fudge the accounts themselves.

That, anyway, was the idea. The record suggests a bark decidedly worse than its bite. The S.E.C. brought its first case under Section 304 of SarbOx in 2007. Since then, it has filed cases demanding that only 31 executives at only 20 companies return some pay.

In 2007 and 2008, most of the cases involved shenanigans with stock options and produced some big recoveries. In the wake of the financial crisis, the dollars recouped have amounted to an asterisk. Since the beginning of 2009, the S.E.C. has pursued 18 executives at 10 companies. So far, it has recovered a total of $12.2 million from nine former executives at five. The other cases are pending.

“It seems like a dormant enforcement tool,” Jack T. Ciesielski, president of R. G. Associates and editor of The Analyst’s Accounting Observer, says of the SarbOx provision. “It was supposed to be a deterrent, but it’s only really a deterrent if they use it.”

How assiduously the S.E.C. enforces this aspect of Sarbanes-Oxley is important. Only the S.E.C. can bring cases under Section 304. Companies can’t. Nor, it appears, can shareholders. In 2009, the Court of Appeals for the Ninth Circuit ruled that there was no private cause of action for violations of Section 304.

Half the companies pursued by the S.E.C. during the past three years have been small and relatively obscure.

For example, the commission sued executives at SpongeTech Delivery Systems (2008 revenue: $5.6 million), contending that the company had booked $4.6 million in phony sales that year. NutraCea, a maker of dietary supplements with 2008 sales of $35 million, was sued along with Bradley D. Edson, its former chief executive, over what the S.E.C. called its recording of $2.6 million in false revenue. An executive at Isilon Systems, a data storage company, was pursued because, the S.E.C. maintained, the company had inflated sales by $4.8 million during 2007.

No money has been recovered in the SpongeTech or Isilon matters, which are still pending. Mr. Edson, who could not be reached for comment, returned his 2008 bonus of $350,000.

In all cases when executives have returned money, they have neither admitted nor denied allegations.

The S.E.C. typically recovers more money from executives at bigger companies. But top executives are rarely compelled to return all their incentive pay.

In a case brought last year against Navistar, for example, the S.E.C. contended that the company had overstated its income by $137 million from 2001 through 2005. Daniel C. Ustian, who is Navistar’s chief executive and who was not charged with wrongdoing, returned common stock worth $1.32 million. He had received $2.2 million in incentive pay and restricted stock during the time that the S.E.C. says Navistar inflated its accounting. A company spokeswoman said Mr. Ustian would not comment.

Robert C. Lannert, Navistar’s former chief financial officer, who also was not charged, gave back stock worth $1.05 million. His incentive pay consisted of only $828,555 during the years that the S.E.C. said the company misstated its results. He didn’t return a phone call seeking comment.

ANOTHER case brought by the S.E.C. last year involved Diebold, a maker of automated teller machines. Contending that Diebold had overstated its results by $127 million between 2002 and 2007, the commission sued to recover money from three former executives. Walden W. O’Dell, who is a former C.E.O. and who was not charged, repaid $470,000 in cash, and 30,000 Diebold shares and 85,000 stock options. During the years that the S.E.C. alleged that results were overstated, he received bonuses totaling $1.9 million, in addition to restricted stock worth $261,000 and 295,000 stock options. Mr. O’Dell didn’t return a message seeking comment. The cases against the other Diebold executives are pending. A company spokesman said it had settled with regulators and declined to comment further.

Continued in article

"U.S. Alleges Poker Site Stacked Deck," by Alexandra Berzon, The Wall Street Journal, September 21, 2011 ---
http://online.wsj.com/article/SB10001424053111904106704576582741398633386.html?grcc=88888&mod=WSJ_hps_sections_business

As professional poker players, Howard Lederer, Chris Ferguson and Rafael Furst got rich by bluffing players out of their money in televised tournaments. Now, the U.S. government alleges that they and their colleagues used this same approach in running one of the world's largest online poker sites.

On Tuesday, the U.S. Justice Department in a civil suit accused Messrs. Lederer, Ferguson and Furst, and another director of the company behind the Full Tilt Poker website, of defrauding thousands of online poker players out of more than $300 million that is still owed to them. The government said that, in total, the 23 owners of the site had taken out $444 million in distributions over the years.

The Justice Department's civil suit against Full Tilt alleges that in 2010, Full Tilt began having trouble accepting new bets from players, thanks to U.S. efforts to crack down on payment-processing services for online gambling. But the U.S. says that Full Tilt's owners kept paying themselves millions of dollars anyway, fraudulently depleting the player funds on deposit with the company.

"Full Tilt was not a legitimate poker company, but a global Ponzi scheme," said Manhattan U.S. Attorney Preet Bharara in a statement Tuesday. The U.S. government views online poker operations, at least those that cross state lines, as illegal.

In its civil suit filed in U.S. District Court in New York, the government alleged that Messrs. Lederer and Ferguson received $38 million and $24 million, respectively, in distributions from Full Tilt. It also alleged that a third poker player involved in the site, Mr. Furst, received $12 million and Raymond Bitar, who helped manage Full Tilt, got $40 million.

"Mr. Furst hasn't done anything wrong," said David Angeli, Mr. Furst's attorney. "He always acted in what he believed was the best interest of players and anyone associated with Full Tilt." Attorneys for Mr. Ferguson and for Mr. Bitar had no comment. Attempts to reach Mr. Lederer weren't successful.

In a statement in August, Full Tilt acknowledged that it was having problems processing player money and said it lost $115 million to government seizure and $42 million it says was stolen by a third-party payment processor.

"While the company was on the way to addressing the problems caused by these processors, Full Tilt Poker never anticipated that the DOJ would proceed as it did by seizing our global domain name and shutting down the site worldwide," the company said. It said it was seeking outside investment and was committed to paying players in full.

The accusations against Full Tilt are part of a crackdown that began in April when the Justice Department indicted executives at three major online poker companies, including Full Tilt, on charges of illegal gambling, bank fraud and money laundering. The government sought $3 billion from the companies, shut down their sites and stopped much of the online poker played in the U.S. It also filed a civil suit at the time, which it amended Tuesday to include much more detailed allegations against Full Tilt.

The Wall Street Journal has examined how the owners of Full Tilt played a cat-and-mouse game around the globe to process money from U.S. Internet poker players outside the purview of U.S. authorities.

The government charges have upended an industry that in the past decade became a behemoth online business as Full Tilt and other websites fueled a global poker boom. Full Tilt once hosted 54,000 people in a single online tournament.

The crackdown has shaken the large universe of poker fans. Before the April crackdown, researcher H2 Gambling Capital estimated there were 1.7 million active poker player accounts in the U.S. from players wagering around $14 billion a year online.

In London, Sebastian Fox, an aspiring music producer, said he could earn around $1,200 a month playing poker online. He racked up $8,000 in an account on Full Tilt. On June 29, he said that he tried to withdraw around $2,400 to pay for rent and other living expenses and discovered Full Tilt's website had been closed down, following the U.S. suit and a subsequent raid by authorities in the U.K.'s Channel Islands where Full Tilt is licensed to operate its website.

"I didn't even consider such a big company would be able to go bust just like that," Mr. Fox said.

The U.S. government has long argued that online gambling, including poker, is illegal under the Wire Act, a 1961 law that explicitly prohibits sports betting conducted over electronic communication. The law is less clear about other types of gambling that are outlawed by the Wire Act, say legal experts.

Online poker sites started popping up over a decade ago but took off in 2003 when an accountant named Chris Moneymaker entered an online tournament and later won $2.5 million in the World Series of Poker. His success enticed thousands of new players online and lured entrepreneurs hoping to capitalize on the boom.

Among them was a lanky poker player, Chris Ferguson, nicknamed "Jesus." Mr. Ferguson, who sported a thick, shaggy haircut and had a Ph.D in software engineering, and his colleague Mr. Bitar tinkered with their concept for web poker while they traded stocks in Los Angeles. The idea: recruit stars from the poker world to lure players to a new site.

Continued in article

Jensen Comment
It's hard for me to feel sorry for people that are ignorant enough to play online poker. That's just asking to be ripped off!

Bob Jensen's Fraud Updates are at
http://www.trinity.edu/rjensen/FraudUpdates.htm

As seen on Paul Caron's TaxProf Blog, September 21, 2011 ---
http://taxprof.typepad.com/
Perhaps you have to remember Nixon and Kissinger to appreciate this one.

The New Yorker's Advice for Dating a Tax Lawyer

When I’m on a first date, alarm bells always go off if the woman says, “Let’s play Nixon.” This happened a few weeks ago when I was out with a tax attorney from one of the big midtown firms whom I met on OkCupid. I can understand why she wanted to play, because she was totally great at it. She looked scary with her shoulders hunched over, growling about the press and vowing revenge against the people on her enemies list. But as she started screaming about Jane Fonda and Joe Namath, I thought, Did it even occur to her that maybe I wanted to be Nixon and she could be Kissinger? That set off major alarm bells for me, because the last thing I need in my life is someone who’s inconsiderate.

Modern Portfolio Theory --- http://en.wikipedia.org/wiki/Portfolio_theory

Capital Asset Pricing Model (CAPM) --- http://en.wikipedia.org/wiki/CAPM

'Modern Portfolio Theory video," Jim Mahar, Finance Professor Blog, September 11, 2011 ---
http://financeprofessorblog.blogspot.com/2011/09/modern-portfolio-theory-video.html

Jensen Comment
Avoids controversial issues such as limitations of the CAPM ---
Where capital market research in accounting made a huge mistake by relying on CAPM
http://www.trinity.edu/rjensen/theory01.htm#AccentuateTheObvious

Capital Asset Pricing Model (CAPM) --- http://en.wikipedia.org/wiki/CAPM

This is a Must Read
Dartmouth Professor Ken French comes in for the rescue of CAPM!
"How to use the Fama French Model," Empirical Finance Blog, August 1, 2011 ---
http://blog.empiricalfinancellc.com/2011/08/how-to-use-the-fama-french-model/

The CAPM is prolific, but doesn’t appear to work!

For example, in the figures below I’ve plotted the Fama-French 25 (portfolios ranked on size and book-to-market) against beta.

In the first figure, I plot the average excess return to the FF 25 against the average excess return one would expect, given beta.

If you’d like to see how I calculated the charts above, please reference the excel file here.

Given such a poor track record, is anyone still using the CAPM?

Lot’s of people, apparently…

Welch (2008) finds that ~75% of professors recommend the use of the model when estimating the cost of capital, and Graham and Harvey (2001) find that ~74% of CFOs use the CAPM in their work.

A few quotes from Graham and Harvey 2001 sum up common sentiment regarding the CAPM:

“While the CAPM is popular, we show later that it is not clear that the model is applied properly in practice. Of course, even if it is applied properly, it is not clear that the CAPM is a very good model [see Fama and French (1992)].

“…practitioners might not apply the CAPM or NPV rule correctly. It is also interesting that CFOs pay very little attentionto risk factors based on momentum and book-to-market-value.”

Of course, there are lots of arguments to consider before throwing out the CAPM. Here are a few:

• Everyone learns about it and knows how to use it (although, Graham and Harvey suggest that many practitioners don’t even apply the CAPM theory correctly)
• Data is easy to obtain on betas.
• Roll’s critique–maybe the CAPM isn’t a junk theory, rather, the empirical tests showing the CAPM doesn’t work are bogus.

Regardless, being that this blog is dedicated to empirical data and evidence, and not about ‘mentally masturbating about theoretical finance models,’ we’ll operate under the assumption that the CAPM is dead until new data comes available.

The Fama French Alternative?

Given the CAPM doesn’t work that well in practice, perhaps we should look into the Fama French model (which isn’t perfect or cutting edge, but a solid workhorse nonetheless). And while the FF model inputs are highly controversial, one thing is clear: the FF 3-factor model does a great job explaining the variability of returns. For example, according to Fama French 1993, the 3-factor model explains over 90% of the variability in returns, whereas the CAPM can only explain ~70%!

The 3-factor model is great, but how the heck does one estimate the FF factors?

Dartmouth Professor Ken French comes in for the rescue!

Continued in article

Ken French's Link
http://mba.tuck.dartmouth.edu/pages/faculty/ken.french/data_library.html

"The Impact of Asymmetry on Expected Stock Returns: An Investigation of Alternative Risk Measures," by Stephen P. Huffman and Cliff Moll, SSRM, September 7, 2011 ---
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1924048

Abstract:     
We investigate the relation between various alternative risk measures and future daily returns using a sample of firms over the 1988-2009 time period. Previous research indicates that returns are not normally distributed and that investors seem to care more about downside risk than total risk. Motivated by these findings and the lack of research on upside risk, we model the relation between future returns and risk measures and investigate the following questions: Are investors compensated for total risk? Is the compensation for downside risk different than the compensation for upside risk? and which measure of risk (i.e., upside, downside, or total) is most important to investors? We find that, although investors seem to be compensated for total risk, measures of downside risk, such as the lower partial moment, better explain future returns. Further, when downside and upside risk are modeled simultaneously, investors seem to care only about downside risk. Our findings are robust to the addition of control variables, including prior returns, size, book-to-market ratio of equity (B/M), and leverage. We also find evidence of short-run mean reversals in daily returns. Our findings are important because we document a positive risk-return relationship, using both total and downside risk measures; however, we find that investors are concerned more with downside risk than total risk.

Bob Jensen's criticisms of accounting studies based on misuse of the CAPM
Slow Loading ---
http://www.trinity.edu/rjensen/theory01.htm#AccentuateTheObvious

"Traders Gone Rogue: A Greatest-Hits Album," by Thomas Kaplan, The New York Times, September 15, 2011 ---
http://dealbook.nytimes.com/2011/09/15/traders-gone-rogue-a-greatest-hits-album/

Traders run amok are often sentenced to pay restitution, in addition to serving jail time or forgoing any future dealings in the securities industry. But few have been held responsible for an I.O.U. as large as the one a French court pinned on Jérôme Kerviel on Tuesday: $6.7 billion.

That works out to the amount his rogue trades ultimately cost Société Générale, The New York Times’s Nicola Clark reports. But how does it equate to other famous (or infamous) traders gone rogue through the years?

It depends how you look at it, said William K. Black, a professor of economics and law at the University of Missouri-Kansas City, who specializes in financial fraud.

“In terms of dollar losses caused, he’s No. 1,” Professor Black told DealBook. “In terms of crushing institutions, he’s not No. 1.”

That’s because Mr. Kerviel did not actually bring down his firm, which other rogue traders have done. While only four people in all of France would be rich enough to pay what Mr. Kerviel’s owes in restitution — according to Forbes magazine’s list of the world’s billionaires, at least — his bank lives on.

So, too, do several other famous miscreant traders.

¶Indeed, while Mr. Kerviel may have succeeded in amassing a fraud of historic magnitude, his rogue counterparts have brought distinction (or shame) upon themselves in other creative ways:.

¶¶ Creating fake identities. John M. Rusnak pleaded guilty in 2002 to faking trades in order to hide nearly $700 million in losses through rogue trades of Japanese yen for Allfirst Financial, which was then a subsidiary of Allied Irish Banks.

¶Mr. Rusnak worked hard to keep his wrongdoing a secret. At one point, in order to trick auditors, he was said to have posed as a fictitious trader, David Russell, with whom he supposedly had dealings. He pulled it off by renting a box at a Mail Boxes Etc. on the Upper West Side in Manhattan; when bank auditors wanted to verify his trades with the supposed Mr. Russell, Mr. Rusnak had them write to that mailbox, where he then replied as if he were the fictitious trader.

¶Allied Irish Banks sold Allfirst Financial to the M&T Bank Corporation of Buffalo shortly after the scandal came to light. Mr. Rusnak, for his part, was released from federal prison last year and has remained out of the headlines since then.

¶¶ Earning clever nicknames.The Sumitomo Corporation of Japan in 1996 lost $2.6 billion because of a rogue trader, Yasuo Hamanaka, the chief of the company’s copper trading operations. Before his rogue trades became public, he had earned the nickname “Mr. 5 Percent” — referring to the share of the world’s copper market he was said to control.

¶Mr. Hamanaka pleaded guilty to forgery and fraud and was jailed until 2005. Paying homage to what made him famous, he told Bloomberg News upon his release that he was “amazed” at how the price of copper had risen while he was incarcerated.

¶Making the best-seller list. In the mid-1990s, Daiwa Bank lost more than $1 billion as a result of a rogue New York-based bond trader, Toshihide Iguchi. Mr. Iguchi was sentenced to four years in prison, which he told The Wall Street Journal was less painful than the life of deceit he was living as a rogue trader trying to cover his tracks.

¶While in prison, he wrote a memoir, “The Confession,” that was widely read in Japan. But after settling in Georgia upon his release, the only work Mr. Iguchi could find was a $10-an-hour job at a furniture-building shop, so he eventually headed back to Japan, where he opened an English school, The Journal reported in 2008.

¶But Mr. Kerviel’s case brought back bad memories. Mr. Iguchi told The Journal that shortly after the French trader was accused, he had nightmares about his own rogue trading.

¶Going Hollywood. Nicholas W. Leeson, a trader for the British investment bank Barings, managed to topple his bank in 1995 as a result of his rogue trading. Based in Singapore, Mr. Leeson lost more than $1 billion through ill-fated bets on Japanese stock prices and interest rates.

¶Mr. Leeson pleaded guilty in Singapore to fraud and forgery and served four years in prison. He is now the chief executive of an Irish soccer club, Galway United.

¶But perhaps best of all, Mr. Leeson managed to carve for himself a place in popular culture. He commanded a reported $700,000 advance for a ghostwritten memoir, “Rogue Trader” (1997), and more recently published a self-help book, “Back from the Brink: Coping With Stress” (2005).

¶His first book was made into a 1999 film starring Ewan McGregor. The film, like Mr. Leeson’s trading practices, was widely panned.

Continued in article

Bob Jensen's threads on securities and trader fraud ---
http://www.trinity.edu/rjensen/FraudRotten.htm#InvestmentBanking

"Groupon: Comedy or Drama?"  by Grumpy Old Accountants  Anthony H. Catanach Jr. and J. Edward Ketz, SmartPros, July 2011 ---
http://accounting.smartpros.com/x72233.xml 

"Trust No one, Particularly Not Groupon's Accountantns," by Anthony H. Catanach Jr. and J. Edward Ketz, Grumpy Old Accountants Blog, August 24, 2011 ---
http://blogs.smeal.psu.edu/grumpyoldaccountants/ 

"Is Groupon "Cooking Its Books?"  by Grumpy Old Accountants  Anthony H. Catanach Jr. and J. Edward Ketz, SmartPros, September  2011 ---
http://accounting.smartpros.com/x72233.xml 

Teaching Case
When Rosie Scenario waved goodbye "Adjusted Consolidated Segment Operating Income"

From The Wall Street Journal Weekly Accounting Review on August 19, 2011

Groupon Bows to Pressure
by: Shayndi Raice and Lynn Cowan
Aug 11, 2011
Click here to view the full article on WSJ.com
 

TOPICS: Advanced Financial Accounting, SEC, Securities and Exchange Commission, Segment Analysis

SUMMARY: In filing its prospectus for its initial public offering (IPO), Groupon has removed from its documents "...an unconventional accounting measurement that had attracted scrutiny from securities regulators [adjusted consolidated segment operating income]. The unusual measure, which the e-commerce had invented, paints a more robust picture of its performance. Removal of the measure was in response to pressure from the Securities and Exchange Commission...."

CLASSROOM APPLICATION: The article is useful to introduce segment reporting and the weaknesses of the required management reporting approach.

QUESTIONS: 
1. (Introductory) What is Groupon's business model? How does it generate revenues? What are its costs? Hint, to answer this question you may access the Groupon, Inc. Form S-1 Registration Statement filed on June 2, 011 available on the SEC web site at http://www.sec.gov/Archives/edgar/data/1490281/000104746911005613/a2203913zs-1.htm

2. (Advanced) Summarize the reporting that must be provided for any business's operating segments. In your answer, provide a reference to authoritative accounting literature.

3. (Advanced) Why must the amounts disclosed by operating segments be reconciled to consolidated totals shown on the primary financial statements for an entire company?

4. (Advanced) Access the Groupon, Inc. Form S-1 Registration Statement filed on June 2, 011 and proceed to the company's financial statements, available on the SEC web site at http://www.sec.gov/Archives/edgar/data/1490281/000104746911005613/a2203913zs-1.htm#dm79801_selected_consolidated_financial_and_other_data Alternatively, proceed from the registration statement, then click on Table of Contents, then Selected Consolidated Financial and Other Data. Explain what Groupon calls "adjusted consolidated segment operating income" (ACSOI). What operating segments does Groupon, Inc., show?

5. (Introductory) Why is Groupon's "ACSOI" considered to be a "non-GAAP financial measure"?

6. (Advanced) How is it possible that this measure of operating performance could be considered to comply with U.S. GAAP requirements? Base your answer on your understanding of the need to reconcile amounts disclosed by operating segments to the company's consolidated totals. If it is accessible to you, the second related article in CFO Journal may help answer this question.
 

Reviewed By: Judy Beckman, University of Rhode Island
 

RELATED ARTICLES: 
Groupon's Accounting Lingo Gets Scrutiny
by Shayndi Raice and Nick Wingfield
Jul 28, 2011
Page: A1

CFO Report: Operating Segments Remain Accounting Gray Area
by Emily Chasan
Aug 15, 2011
Page: CFO

 

"Groupon Bows to Pressure," by: Shayndi Raice and Lynn Cowan, The Wall Street Journal, August 11, 2011 ---
https://mail.google.com/mail/?shva=1#inbox/131e06c48071898b

Groupon Inc. removed from its initial public offering documents an unconventional accounting measurement that had attracted scrutiny from securities regulators.

The unusual measure, which the e-commerce had invented, paints a more robust picture of its performance. Removal of the measure was in response to pressure from the Securities and Exchange Commission, a person familiar with the matter said.

In revised documents filed Wednesday with the SEC, the company removed the controversial measure, which had been highlighted in the first three pages of its previous filing. But Groupon's chief executive defended the term Wednesday. [GROUPON] Getty Images

Groupon, headquarters above, expects to raise about $750 million.

Groupon had highlighted something it called "adjusted consolidated segment operating income", or ACSOI. The measurement, which doesn't include subscriber-acquisitions expenses such as marketing costs, doesn't conform to generally accepted accounting principles.

Investors and analysts have said ACSOI draws attention away from Groupon's marketing spending, which is causing big net losses.

The company also disclosed Wednesday that its loss more than doubled in the second quarter from a year ago, even as revenue increased more than ten times.

By leaving ACSOI out of its income statements, the company hopes to avoid further scrutiny from the SEC, the person familiar with the matter said. The commission declined comment.

Groupon in June reported ACSOI of $60.6 million for last year and $81.6 million for the first quarter of 2011. Under generally accepted accounting principles, the company generated operating losses of $420.3 million and $117.1 million during those periods.

Wednesday's filing included a letter from Groupon Chief Executive Andrew Mason defending ACSOI. The company excludes marketing expenses related to subscriber acquisition because "they are an up-front investment to acquire new subscribers that we expect to end when this period of rapid expansion in our subscriber base concludes and we determine that the returns on such investment are no longer attractive," the letter said.

There was no mention of when that expansion will end, but the person familiar with the matter said the company reevaluates the figures weekly.

Groupon said it spent $345.1 million on online marketing initiatives to acquire subscribers in the first half and that it expects "to continue to expend significant amounts to acquire additional subscribers."

The latest SEC filing also contains new financial data. Groupon on Wednesday reported second-quarter revenue of $878 million, up 36% from the first quarter. While the company's growth is still rapid, the pace has slowed. Groupon's revenue jumped 63% in the first quarter from the fourth.

The company's second-quarter loss was $102.7 million, flat sequentially and wider than the year-earlier loss of $35.9 million.

Groupon expects to raise about $750 million in a mid-September IPO that could value the company at $20 billion.

The path to going public hasn't been easy. The company had to file an amendment to its original SEC filing after a Groupon executive told Bloomberg News the company would be "wildly profitable" just three days after its IPO filing. Speaking publicly about the financial projections of a company that has filed to go public is barred by SEC regulations. Groupon said the comments weren't intended for publication.

Continued in article

"Groupon, Zynga and Krugman's Frothy Valuations," by Jeff Carter, Townhall, September 2011 ---
http://finance.townhall.com/columnists/jeffcarter/2011/09/13/groupon,_zynga_and_krugmans_frothy_valuations

Jensen Comment
In the 1990s, high tech companies resorted to various accounting gimmicks to increase the price and demand for their equity shares ---
http://www.trinity.edu/rjensen/ecommerce/eitf01.htm

Bob Jensen's threads about cooking the books ---
http://www.trinity.edu/rjensen/Theory02.htm#Manipulation

Teaching Case
From The Wall Street Journal Accounting Weekly Review on September 9, 2011

Yahoo: From Bartz to Sum of the Parts
by: Martin Peers
Sep 08, 2011
Click here to view the full article on WSJ.com
Click here to view the video on WSJ.com 
 

TOPICS: Intangible Assets, Interim Financial Statements, Investments, Mark-to-Market Accounting

SUMMARY: The underlying accounting issues in Bartz's ouster as CEO of Yahoo! Inc. stem from comments about her inability to "create value from Asian assets." As noted in the related article, "despite having virtually no enterprise value, Yahoo maintains a $17 billion market cap due to its Asian assets and cash," said Doug Anmuth, a J.P. Morgan analyst, in a note on Wednesday. He values Yahoo 's Asian assets currently at about $7.55 a share, and estimates that Taobao has a current valuation of around $16 billion.

CLASSROOM APPLICATION: Questions relate to the accounting for brands and for intangible assets arising from business combinations; accounting for equity method investments; and the usefulness of the fair value option given the discussion of options available to Yahoo! Inc. to generate value from its Asian investments. Links to Yahoo!'s SEC filings are provided.

QUESTIONS: 
1. (Introductory) What factors led to Ms. Bartz's ouster as CEO of Yahoo! Inc.?

2. (Introductory) According to discussion in the related video, Carol Bartz managed to boost profits-she pushed them for 2010 over $1billion, but sales were stagnating. Explain the difference between these two items.

3. (Introductory) What actions likely made this result come about? What comments in the article and video support your answer?

4. (Advanced) Also noted in the video is that the company has great brand recognition in Asia. Does the value of the Yahoo! Inc brand show on its corporate balance sheet? Explain your answer.

5. (Advanced) Access the Yahoo! Inc quarterly financial statements for the period ended June 30, 2011, filed with the SEC on August 8, 2011 and available at http://www.sec.gov/cgi-bin/viewer?action=view&cik=1011006&accession_number=0001193125-11-214306&xbrl_type=v On the left side of the page, click on Financial Statements, then Condensed Consolidated Balance Sheets. Where do you think the value of the Yahoo! Inc. brand name in Asia might be included in the balance sheet? Proceed to the Notes to Financial Statements to further investigate the balance sheet item "Intangible Assets." From what type of transactions do you think these balances arise? What accounting standard requires recording specific intangible assets for customer relationships, developed technologies, and tradenames and trademarks? Give specific reference to authoritative accounting literature in your answer.

6. (Advanced) Based on the discussion in the article, how do you think that Yahoo! accounts for its investments in Alibaba and Yahoo! Japan? Return to the Yahoo! Inc. filing accessed above and proceed to the footnote on linked to "Investments in Equity Interests." Does the information confirm your answer to the question above? Explain.

7. (Advanced) By how much does Yahoo's Investment Account balance for Alibaba Group exceed the book value of the underlying investment? What types of items generate this difference? How is this difference accounted for in Yahoo!'s financial statements?

8. (Advanced) The related articles add to the information in the main article on the investment holdings in Asia and indicates that shareholders' and analysts estimate the value of Yahoo's Asian Assets at about $7.55 per share. Explain generally how you think this value was estimated. Can analysts simply use the invesment account balances for these asset in calculating this component of Yahoo!'s share price value? Explain.

9. (Advanced) What is the fair value option in accounting for equity method investments? Do you think this option might be considered a good accounting policy choice by Yahoo! Inc. financial statement users? Explain your answer.
 

Reviewed By: Judy Beckman, University of Rhode Island
 

RELATED ARTICLES: 
TECH VIEW: Yahoo Still Has Its Alibaba Issue
by Therese Poletti
Sep 08, 2011
Online Exclusive

"Yahoo: From Bartz to Sum of the Parts, by Martin Peers, The Wall Street Journal, September 8, 2011 ---
http://professional.wsj.com/article/SB10001424053111904836104576556841031708736.html?mod=djem_jiewr_AC_domainid

If ever there was a moment when investment bankers could prove their value to society, or at least to the business world, this is it.

Yahoo's overdue firing of Carol Bartz as chief executive, without a successor in place, puts Yahoo even more firmly in play. Co-founder Jerry Yang might believe Yahoo is "not for sale" — as AllThingsD reported he told some employees on Wednesday — but he only owns 3.6% of the stock.

The board's initiation of a "comprehensive strategic review" suggests it is open to ideas from outsiders.

The only question is whether given all the complexities involved, anyone is likely to be interested. After all, speculation of private equity firms or media companies contemplating a move on Yahoo have swirled over the past 12 months, with nothing concrete emerging.

And even at its current depressed price, buying Yahoo requires writing a hefty check. The company has an enterprise value of about $14.5 billion — more than a private equity firm or most media companies would likely want to spend.

Of course, a big chunk of Yahoo's value is tied up in its Asian assets: a 40% stake in Chinese e-commerce firm Alibaba Group and 35% of Yahoo Japan. The big snag is that selling those likely would involve big tax hits and, in the case of Alibaba, would mean giving up an asset of immense strategic value. Yahoo has been looking for months at ways of unwinding the Yahoo Japan stake tax-effectively, so far without success.

It's time to break the stalemate. Certainly the business can't afford another protracted period of drifting. Second-quarter results showed a serious deceleration in Yahoo's display advertising revenue growth rate, while the search alliance with Microsoft hasn't produced the results expected of it.

Yahoo should start the process of tax-effectively selling the Asian assets in order to smooth the way for a sale of the core business. After all, the Alibaba stake at least likely will get sold as a result of any deal: A change in control of Yahoo could trigger a right for Alibaba's other shareholders to buy back Yahoo's stake in the company. And tax expert Robert Willens says that while there are tax-effective structures that can be utilized, such deals need to be done before an overall sale of Yahoo is seriously discussed.

The big problem is realizing the best possible price for the assets, particularly if Yahoo is a clear seller and potential buyers limited.

Continued in article

Bob Jensen's threads on accounting for intangibles and contingencies disputes ---
http://www.trinity.edu/rjensen/theory01.htm#TheoryDisputes

Video
"Debt: The First 5,000 Years," by Paul Kedrosky , Kedrosky.com, September 10, 2011 --- Click Here
http://paul.kedrosky.com/archives/2011/09/debt-the-first-5000-years.html?utm_source=feedburner&utm_medium=feed&utm_campaign=Feed%3A+InfectiousGreed+%28Paul+Kedrosky%27s+Infectious+Greed%29

Jensen Questions
How did the accounting system account for debt 5,000 years ago?
Does care and nurturing human children create debt to parents?

"When Debt Gets in the Way of Growth," Harvard Business Review Blog, September 13, 2011 --- Click Here
http://blogs.hbr.org/hbr/hbreditors/2011/09/when_debt_gets_in_the_way_of_g.html?referral=00563&cm_mmc=email-_-newsletter-_-daily_alert-_-alert_date&utm_source=newsletter_daily_alert&utm_medium=email&utm_campaign=alert_date

Bob Jensen's threads on accounting history ---
http://www.trinity.edu/rjensen/Theory01.htm#AccountingHistory

Humor Between September 1 and September 30, 2011

Why Target Stores are so happy that a retired Bob Jensen spends so much time on the Internet

Forwarded by Paula

RETIRED HUSBAND

After I retired, my wife insisted that I accompany her on her trips to Target.

Unfortunately, like most men, I found shopping boring and preferred to get in and get out. Equally unfortunate, my wife is like most women - she loves to browse.

Yesterday my dear wife received the following letter from the local Target:

Dear Mrs. Harris,

Over the past six months, your husband has caused quite a commotion in our store. We cannot tolerate this behavior and have been forced to ban both of you from the store. Our complaints against your husband, Mr. Harris, are listed below and are documented by our video surveillance cameras:

1. June 15: He took 24 boxes of condoms and randomly put them in other people's carts when they weren't looking.

2. July 2: Set all the alarm clocks in Housewares to go off at 5-minute intervals.

3. July 7: He made a trail of tomato juice on the floor leading to the women's restroom.

4. July 19: Walked up to an employee and told her in an official voice, 'Code 3 in Housewares. Get on it right away'. This caused the employee to leave her assigned station and receive a reprimand from her Supervisor that in turn resulted with a union grievance, causing management to lose time and costing the company money.

5. August 4: Went to the Service Desk and tried to put a bag of M&Ms on layaway.

6. August 14: Moved a 'CAUTION - WET FLOOR' sign to a carpeted area.

7. August 15: Set up a tent in the camping department and told the children shoppers he'd invite them in if they would bring pillows and blankets from the bedding department to which twenty children obliged.

8. August 23: When a clerk asked if they could help him he began crying and screamed, 'Why can't you people just leave me alone?' EMTs were called.

9.. September 4: Looked right into the security camera and used it as a mirror while he picked his nose.

10. September 10: While handling guns in the hunting department, he asked the clerk where the antidepressants were.

11. October 3: Darted around the store suspiciously while loudly humming the ' Mission Impossible' theme.

12. October 6: In the auto department, he practiced his 'Madonna look' by using different sizes of funnels.

13. October 18: Hid in a clothing rack and when people browsed through, yelled 'PICK ME! PICK ME!'

14. October 21: When an announcement came over the loud speaker, he assumed a fetal position and screamed 'OH NO! IT'S THOSE VOICES AGAIN!'

And last, but not least:

15. October 23: Went into a fitting room, shut the door, waited awhile, then yelled very loudly, 'Hey! There's no toilet paper in here.' One of the clerks passed out.

Forwarded by Debbie (who likes a good party)

LIVING WILL FORM.

I, ____________, being of sound mind and body, do not wish to be kept alive indefinitely by artificial means. Under no circumstances should my fate be put in the hands of pinhead partisan politicians who couldn’t pass ninth-grade biology if their lives depended on it, or lawyers/doctors/hospitals interested in simply running up the bills.

If a reasonable amount of time passes, and I fail to ask for at least one of the following:
______a Cold Beer____ a Scotch and soda ______a Bloody Mary ______a Gin and Tonic _______a Glass of Chardonnay ______a Steak ______Lobster or crab legs ______the remote control ______a bowl of ice cream ______the sports page______Sex ______or Chocolate: It should be presumed that I won’t ever get any better.

When such a determination is reached, I hereby instruct my appointed person and attending physicians to pull the plug, reel in the tubes, and call it a day. At this point, it is time to call the New Orleans Jazz Funeral Band to come do their thing at my funeral, and ask all of my friends to raise their glasses to toast the good times we have had.

Signature:__________________________ Date: _____

 

 

Whose Line Is It Anyway? The Complete Improv Series Now Free Online --- Click Here
http://www.openculture.com/2011/09/whose_line_is_it_anyway_improv_series_free_online.html?utm_source=feedburner&utm_medium=email&utm_campaign=Feed%3A+OpenCulture+%28Open+Culture%29

Remote Control Roundup (why cowboys are now unemployed) --- http://www.youtube.com/embed/NA-ST8nXl4U?rel=0

Forwarded by Jim Martin
This 80 year old woman was arrested for shop lifting. When she went before the judge he asked her, "What did you steal?" She said, "A can of peaches."

The judge asked her why she had stolen the can peaches and she replied that she was hungry. The judge asked her how many peaches were in the can. She replied 6.

The judge said, "Then I will give you 6 days in jail".

Before the judge could pronounce the punishment, the woman's husband spoke up and asked the judge if he could say something.

The judge said, "What is it?"
The husband said, "She also stole a can of peas."

Forwarded by Maureen

When I bought my Blackberry, I thought about the thirty-year business I ran with 1800 employees, all without a cell phone that plays music, takes videos, pictures, and communicates with Facebook and Twitter. I signed up under duress for Twitter and Facebook , so my seven kids, their spouses, 13 grandkids and 2 great-grand kids could communicate with me in the modern way. I figured I could handle something as simple as Twitter with only 140 characters of space.

That was before one of my grandkids hooked me up for Tweeter, Tweetree, Twhirl, Twitterfon, Tweetie and Twittererific Tweetdeck, Twitpix and something that sends every message to my cell phone and every other program within the texting world.

My phone was beeping every three minutes with the details of everything except the bowel movements of the entire next generation. I am not ready to live like this. I keep my cell phone in the garage in my golf bag.

The kids bought me a GPS for my last birthday because they say I get lost every now and then going over to the grocery store or library. I keep that in a box under my tool bench with the Blue Tooth [it's red] phone I am supposed to use when I drive. I wore it once and was standing in line at Barnes and Noble talking to my wife and everyone in the nearest 50 yards was glaring at me. I had to take my hearing aid out to use it, and I got a little loud.

I mean the GPS looked pretty smart on my dash board, but the lady inside that gadget was the most annoying, rudest person I had run into in a long time. Every 10 minutes, she would sarcastically say, "Re-calc-u-lating." You would think that she could be nicer. It was like she could barely tolerate me. She would let go with a deep sigh and then tell me to make a U-turn at the next light. Then if I made a right turn instead. Well, it was not a good relationship. When I get really lost now, I call my wife and tell her the name of the cross streets and while she is starting to develop the same tone as Gypsy the GPS lady, at least she loves me.

To be perfectly frank, I am still trying to learn how to use the cordless phones in our house. We have had them for 4 years, but I still haven't figured out how I can lose three phones all at once and have to run around digging under chair cushions and checking bathrooms and the dirty laundry baskets when the phone rings.

The world is just getting too complex for me. They even mess me up every time I go to the grocery store. You would think they could settle on something themselves but this sudden "Paper or plastic?" every time I check out just knocks me for a loop. I bought some of those cloth reusable bags to avoid looking confused, but I never remember to take them in with me.

Now I toss it back to them. When they ask me, "Paper or plastic?" I just say, "Doesn't matter to me. I am bi-sacksual." Then it's their turn to stare at me with a blank look. I was recently asked if I tweet. I answered, "No, but I do toot a lot."

P.S. I know some of you are not over 50. I sent it to you to allow you to forward it to those who are.

We senior citizens don't need anymore gadgets. The TV remote and the garage door remote are about all we can handle.

As seen on Paul Caron's TaxProf Blog, September 21, 2011 ---
http://taxprof.typepad.com/
Perhaps you have to remember Nixon and Kissinger to appreciate this one.

The New Yorker's Advice for Dating a Tax Lawyer

When I’m on a first date, alarm bells always go off if the woman says, “Let’s play Nixon.” This happened a few weeks ago when I was out with a tax attorney from one of the big midtown firms whom I met on OkCupid. I can understand why she wanted to play, because she was totally great at it. She looked scary with her shoulders hunched over, growling about the press and vowing revenge against the people on her enemies list. But as she started screaming about Jane Fonda and Joe Namath, I thought, Did it even occur to her that maybe I wanted to be Nixon and she could be Kissinger? That set off major alarm bells for me, because the last thing I need in my life is someone who’s inconsiderate.

Forwarded by my friend Dick Haar

Bad news for you

To save the economy on September 18, 2011, Obama announced that he is ordering the immigration department to start deporting old people (instead of illegals) in order to lower Social Security and Medicare costs.

Old people are easier to catch, and will not remember how to get back home!

I started crying when I thought of you.

.....see you on the bus.

I think I had some of these students in class after they went to college

Forwarded by Maureen

Forwarded by Maureen

Trader Joe behind on the job --- http://www.youtube.com/embed/-icgySC4e2c

Forwarded by Paula

Humor Between September 1 and September 30, 2011 --- http://www.trinity.edu/rjensen/book11q3.htm#Humor093011

Humor Between August 1 and August 31, 2011 --- http://www.trinity.edu/rjensen/book11q3.htm#Humor083111 

Humor Between July 1 and July 31, 2011 --- http://www.trinity.edu/rjensen/book11q3.htm#Humor073111

Humor Between May 1 and June 30, 2011 --- http://www.trinity.edu/rjensen/book11q2.htm#Humor063011 

Humor Between April 1 and April 30, 2011 --- http://www.trinity.edu/rjensen/book11q2.htm#Humor043011  

Humor Between February 1 and March 31, 2011 --- http://www.trinity.edu/rjensen/book11q1.htm#Humor033111 

Humor Between January 1 and January 31, 2011 --- http://www.trinity.edu/rjensen/book11q1.htm#Humor013111 

And that's the way it was on September 30, 2011 with a little help from my friends.

Bob Jensen's gateway to millions of other blogs and social/professional networks ---
http://www.trinity.edu/rjensen/ListservRoles.htm

Bob Jensen's Threads --- http://www.trinity.edu/rjensen/threads.htm

Bob Jensen's Blogs --- http://www.trinity.edu/rjensen/JensenBlogs.htm
Current and past editions of my newsletter called New Bookmarks --- http://www.trinity.edu/rjensen/bookurl.htm
Current and past editions of my newsletter called Tidbits --- http://www.trinity.edu/rjensen/TidbitsDirectory.htm
Current and past editions of my newsletter called Fraud Updates --- http://www.trinity.edu/rjensen/FraudUpdates.htm
Bob Jensen's past presentations and lectures --- http://www.trinity.edu/rjensen/resume.htm#Presentations   

Free Online Textbooks, Videos, and Tutorials --- http://www.trinity.edu/rjensen/ElectronicLiterature.htm#Textbooks
Free Tutorials in Various Disciplines --- http://www.trinity.edu/rjensen/Bookbob2.htm#Tutorials
Edutainment and Learning Games --- http://www.trinity.edu/rjensen/000aaa/thetools.htm#Edutainment
Open Sharing Courses --- http://www.trinity.edu/rjensen/000aaa/updateee.htm#OKI

Bob Jensen's Resume --- http://www.trinity.edu/rjensen/Resume.htm
 

Bob Jensen's Homepage --- http://www.trinity.edu/rjensen/

Concerns That Academic Accounting Research is Out of Touch With Reality

Accountancy, Tax, IFRS, XBRL, and Accounting History News Sites  --- http://www.trinity.edu/rjensen/AccountingNews.htm

Accounting Professors Who Blog --- http://www.trinity.edu/rjensen/ListservRoles.htm

Cool Search Engines That Are Not Google --- http://www.wired.com/epicenter/2009/06/coolsearchengines

Free (updated) Basic Accounting Textbook --- search for Hoyle at
http://www.trinity.edu/rjensen/ElectronicLiterature.htm#Textbooks

CPA Examination --- http://en.wikipedia.org/wiki/Cpa_examination
Free CPA Examination Review Course Courtesy of Joe Hoyle --- http://cpareviewforfree.com/
 

Bob Jensen's Pictures and Stories
http://www.trinity.edu/rjensen/Pictures.htm

Bob Jensen's Homepage --- http://www.trinity.edu/rjensen/

August 31, 2011

Bob Jensen's New Bookmarks August 1-August 31, 2011
Bob Jensen at Trinity University 

For earlier editions of Fraud Updates go to http://www.trinity.edu/rjensen/FraudUpdates.htm
For earlier editions of Tidbits go to http://www.trinity.edu/rjensen/TidbitsDirectory.htm
For earlier editions of New Bookmarks go to http://www.trinity.edu/rjensen/bookurl.htm 

Click here to search Bob Jensen's web site if you have key words to enter --- Search Box in Upper Right Corner.
For example if you want to know what Jensen documents have the term "Enron" enter the phrase Jensen AND Enron. Another search engine that covers Trinity and other universities is at http://www.searchedu.com/

Bob Jensen's Blogs --- http://www.trinity.edu/rjensen/JensenBlogs.htm
Current and past editions of my newsletter called New Bookmarks --- http://www.trinity.edu/rjensen/bookurl.htm
Current and past editions of my newsletter called Tidbits --- http://www.trinity.edu/rjensen/TidbitsDirectory.htm
Current and past editions of my newsletter called Fraud Updates --- http://www.trinity.edu/rjensen/FraudUpdates.htm

Bob Jensen's Pictures and Stories
http://www.trinity.edu/rjensen/Pictures.htm

All my online pictures --- http://www.cs.trinity.edu/~rjensen/PictureHistory/

Hasselback Accounting Faculty Directory --- http://www.hasselback.org/

Humor Between August 1 and August 31, 2011 --- http://www.trinity.edu/rjensen/book11q3.htm#Humor083111 

Humor Between July 1 and July 31, 2011 --- http://www.trinity.edu/rjensen/book11q3.htm#Humor073111

Humor Between May 1 and June 30, 2011 --- http://www.trinity.edu/rjensen/book11q2.htm#Humor063011   

Humor Between April 1 and April 30, 2011 --- http://www.trinity.edu/rjensen/book11q2.htm#Humor043011  

Humor Between February 1 and March 31, 2011 --- http://www.trinity.edu/rjensen/book11q1.htm#Humor033111 

Humor Between January 1 and January 31, 2011 --- http://www.trinity.edu/rjensen/book11q1.htm#Humor013111 

Some of Bob Jensen's Pictures and Stories
http://www.trinity.edu/rjensen/Pictures.htm

Steven J. Kachelmeier's July 2011 Editorial as Departing Senior Editor of The Accounting Review (TAR)

"Introduction to a Forum on Internal Control Reporting and Corporate Debt," by Steven J. Kachelmeier, The Accounting Review, Vol. 86, No. 4, July 2011 pp. 1129–113 (not free online) ---
http://aaapubs.aip.org/getpdf/servlet/GetPDFServlet?filetype=pdf&id=ACRVAS000086000004001129000001&idtype=cvips&prog=normal

One of the more surprising things I have learned from my experience as Senior Editor of The Accounting Review is just how often a ‘‘hot topic’’ generates multiple submissions that pursue similar research objectives. Though one might view such situations as enhancing the credibility of research findings through the independent efforts of multiple research teams, they often result in unfavorable reactions from reviewers who question the incremental contribution of a subsequent study that does not materially advance the findings already documented in a previous study, even if the two (or more) efforts were initiated independently and pursued more or less concurrently. I understand the reason for a high incremental contribution standard in a top-tier journal that faces capacity constraints and deals with about 500 new submissions per year. Nevertheless, I must admit that I sometimes feel bad writing a rejection letter on a good study, just because some other research team beat the authors to press with similar conclusions documented a few months earlier. Research, it seems, operates in a highly competitive arena.

Fortunately, from time to time, we receive related but still distinct submissions that, in combination, capture synergies (and reviewer support) by viewing a broad research question from different perspectives. The two articles comprising this issue’s forum are a classic case in point. Though both studies reach the same basic conclusion that material weaknesses in internal controls over financial reporting result in negative repercussions for the cost of debt financing, Dhaliwal et al. (2011) do so by examining the public market for corporate debt instruments, whereas Kim et al. (2011) examine private debt contracting with financial institutions. These different perspectives enable the two research teams to pursue different secondary analyses, such as Dhaliwal et al.’s examination of the sensitivity of the reported findings to bank monitoring and Kim et al.’s examination of debt covenants.

Both studies also overlap with yet a third recent effort in this arena, recently published in the Journal of Accounting Research by Costello and Wittenberg-Moerman (2011). Although the overall ‘‘punch line’’ is similar in all three studies (material internal control weaknesses result in a higher cost of debt), I am intrigued by a ‘‘mini-debate’’ of sorts on the different conclusions reache  by Costello and Wittenberg-Moerman (2011) and by Kim et al. (2011) for the effect of material weaknesses on debt covenants. Specifically, Costello and Wittenberg-Moerman (2011, 116) find that ‘‘serious, fraud-related weaknesses result in a significant decrease in financial covenants,’’ presumably because banks substitute more direct protections in such instances, whereas Kim et al. Published Online: July 2011 (2011) assert from their cross-sectional design that company-level material weaknesses are associated with more financial covenants in debt contracting.

In reconciling these conflicting findings, Costello and Wittenberg-Moerman (2011, 116) attribute the Kim et al. (2011) result to underlying ‘‘differences in more fundamental firm characteristics, such as riskiness and information opacity,’’ given that, cross-sectionally, material weakness firms have a greater number of financial covenants than do non-material weakness firms even before the disclosure of the material weakness in internal controls. Kim et al. (2011) counter that they control for risk and opacity characteristics, and that advance leakage of internal control problems could still result in a debt covenant effect due to internal controls rather than underlying firm characteristics. Kim et al. (2011) also report from a supplemental change analysis that, comparing the pre- and post-SOX 404 periods, the number of debt covenants falls for companies both with and without material weaknesses in internal controls, raising the question of whether the

Costello and Wittenberg-Moerman (2011) finding reflects a reaction to the disclosures or simply a more general trend of a declining number of debt covenants affecting all firms around that time period. I urge readers to take a look at both articles, along with Dhaliwal et al. (2011), and draw their own conclusions. Indeed, I believe that these sorts . . .

Continued in article

Jensen Comment
Without admitting to it, I think Steve has been embarrassed, along with many other accountics researchers, about the virtual absence of validation and replication of accounting science (accountics) research studies over the past five decades. For the most part, accountics articles are either ignored or accepted as truth without validation. Behavioral and capital markets empirical studies are rarely (ever?) replicated. Analytical studies make tremendous leaps of faith in terms of underlying assumptions that are rarely challenged (such as the assumption of equations depicting utility functions of corporations).

Accounting science thereby has become a pseudo science where highly paid accountics professor referees are protecting each others' butts ---
"574 Shields Against Validity Challenges in Plato's Cave" --- http://www.trinity.edu/rjensen/TheoryTAR.htm
The above link contains Steve's rejoinders on the replication debate.

In the above editorial he's telling us that there is a middle ground for validation of accountics studies. When researchers independently come to similar conclusions using different data sets and different quantitative analyses they are in a sense validating each others' work without truly replicating each others' work.

I agree with Steve on this, but I would also argue that these types of "validation" is too little to late relative to genuine science where replication and true validation are essential to the very definition of science. The types independent but related research that Steve is discussing above is too infrequent and haphazard to fall into the realm of validation and replication.

When's the last time you witnesses a TAR author criticizing the research of another TAR author (TAR does not publish critical commentaries)?
Are TAR articles really all that above criticism?
Even though I admire Steve's scholarship, dedication, and sacrifice, I hope future TAR editors will work harder at turning accountics research into real science!

What Went Wrong With Accountics Research? --- http://www.trinity.edu/rjensen/theory01.htm#WhatWentWrong

"574 Shields Against Validity Challenges in Plato's Cave" --- http://www.trinity.edu/rjensen/TheoryTAR.htm

Bayes' Theorem --- http://en.wikipedia.org/wiki/Bayes_theorem

"A History of Bayes' Theorem," LessWrong, August 29, 2011 ---
http://lesswrong.com/lw/774/a_history_of_bayes_theorem/

Jensen Comment
Some of the classic Bayesian statistics books in business education came out of Harvard in the 1950s, I was weined on Robert Schlaifer's classic ---
http://en.wikipedia.org/wiki/Robert_Schlaifer

Business education has gone through various cycles of academic fad. A lot of us in the 1960s pinned our hopes on the Bayesian revolution that proved to be just that --- a passing fad in many ways while most accountics statistical analysis is still rooted in classical inference works of earlier history. Reverend Bayes disappeared from The Accounting Review about the time that case studies and field studies went by the boards, or should I say under the Boards.

From Deloitte (over many years)
Trueblood Cases at the AAA Annual Meetings in Denver
The following is an excerpt from the AAA Announcements message, August 2. 2011

"Mini" Trueblood Case Study Seminar
One of the concurrent sessions offered at this year's Annual Meeting will be a session entitled "Effective Learning through Cases:  Examples from the Trueblood Case Study Series." Three financial accounting cases from the current series of approximately fifty cases on the Deloitte Foundation's website will be used to demonstrate how these cases can be used effectively in the classroom. Participants will be encouraged to actively participate in discussions and will benefit from exposure to situations dealt with in public practice. All session participants will receive the cases & solutions as takeaways. This concurrent session will be led by James Fuehrmeyer, retired Deloitte & Touche LLP audit partner (and current faculty member at the University of Notre Dame), who will discuss three cases from our Trueblood Accounting & Auditing Case Study Series. The session will be held on Monday, August 8, from 10:15 - 11:45 am. Please refer to your Annual Meeting program when you arrive in Denver for further details.

The Trueblood Case Materials --- Click Here
http://www.deloitte.com/view/en_US/us/About/university-relations/Deloitte-Foundation/0ac1264f0b0fb110VgnVCM100000ba42f00aRCRD.htm

Jim Fuehrmeyer is now a full-time PQ auditing professor at Notre Dame.---
http://business.nd.edu/jamesfuehrmeyer/

Jensen Comment
One of the most important initiatives ever undertaken in academic accountancy history is the Deloitte (and Touche) initiative and funding to join accounting professors and practitioners in the writing of case studies. For many years the format has been to bring professors and practitioners together face-to-face in resorts for the purpose of working intensely (night and day) in writing cases and case solutions. These were then published in volumes available from the Deloitte Foundation and  in accounting history centers such as the Accounting Libraries at the University if Mississippi ---
http://www.olemiss.edu/depts/accountancy/libraries.html
See
http://umiss.lib.olemiss.edu/search/?searchtype=X&SORT=D&searcharg=Trueblood

I suspect that many university libraries and faculty offices have shelved these case studies over the years.

Professors can obtain copies of cases and case solutions from the Deloitte Foundation ---
http://www.deloitte.com/view/en_US/us/press/Press-Releases/0ac1264f0b0fb110VgnVCM100000ba42f00aRCRD.htm

Of course for teaching purposes many of these cases are now dated because they were based on standards that have been replaced and amended. One possible student project would be have students update selected cases and case solutions in light of changed standards.

August 3, 2011 reply from Jim Fuehrmeyer

Bob

While cases from prior years are certainly outdated in many respects, the "live" cases on the Foundation website are updated every summer. All the professor's solutions are tied to the Codification and include discussion of pending pronouncements. A lot of the cases are also set up to be worked with both US GAAP and IFRS. Normally five cases get replaced with new cases every year.

Jim

Bob Jensen's threads on case research, case writing, and case teaching are at
http://www.trinity.edu/rjensen/000aaa/thetools.htm#Cases

Comment Letter: SEC Staff Paper on possible method of incorporating IFRS into US financial reporting system

Today we issued a comment letter to the SEC staff regarding a possible method of incorporating IFRS into the financial reporting system for US issuers. We support the approach described in the Staff Paper and believe it is a thoughtful and balanced way of moving closer to achieving the ultimate goal of a single set of high-quality globally accepted accounting standards. Although we support the approach described in the Staff Paper, we believe it is unlikely that method would allow US issuers (following a transition period) to assert compliance with IFRS as issued by the IASB.

Bob Jensen's threads on accounting standard setting controversies ---
http://www.trinity.edu/rjensen/Theory01.htm#MethodsForSetting

From Ernst & Young, August 24, 2011

Hedge accounting - The FASB discussed feedback on its February 2011 discussion paper soliciting comment on the IASB’s hedge accounting proposal. The FASB staff said auditors and preparers generally support the IASB’s "principles-based, risk management strategy-oriented" approach, with some reservations about aspects of the IASB model that might be operationally challenging. Many auditors and preparers also urged the Boards to try to converge their models, using the "positive aspects" of each. Some respondents said the best approach is to make targeted changes to the current FASB model, saying it is "not fundamentally flawed."

From a user's perspective, concerns were raised that the IASB model offered "subjective guidance tied to management intent" and would give companies too much leeway to use hedge accounting.

Disclosure framework - The Board discussed a first draft of a decision process that would be used to establish disclosure requirements for financial statement line items, one of three parts of the disclosure framework project.

For additional details of the Board's discussions, see the FASB Action Alert.

Jensen Comment
The results conform pretty much to what I've been saying all along about IASB revisions to IAS 39 (Now IFRS 9). The international standards just give too much leeway to the point where two companies will account for identical transactions is different ways. One of my best examples is in the area of testing for hedge effectiveness as a condition for being eligible for hedge accounting. Tests for hedge effectiveness are just too subjective in the revised international standards.

Derivative financial instruments are becoming more popular for managing risk since the 2009 economic crash. Now is not a good time to water down accounting standards for derivative financial instruments and hedging activities. But the IASB seems dead set on simplifying the accounting for very complicated contracts. Rather than having real standards for such complicated contracts, the IASB message is to use subjective judgment. Yeah right! If any two companies are to be compared, we need to be able to rely on more consistency in their bases of accounting.

I also consider the subjectivity of IFRS 9 a disaster from the standpoint of teaching our students and examining them in certification examinations. A good strategy in a multiple choice question on IFRS is to choose "All of the Above."

"Guest Post: Fraud Girl – Can We Detect Lying From Nonverbal Cues?" Simoleon Sense, June 20, 2010 ---
 http://www.simoleonsense.com/guest-post-fraud-girl-can-we-detect-lying-from-nonverbal-cues/
 This includes a video of Jeff Skilling's testimony:  Can you detect his lies?

Of course it's not always easy to detect lies using statistics.
 

"Spotting a hoax using statistics," Understanding Uncertainty, August 3, 2011 --- Click Here
http://understandinguncertainty.org/spotting-hoax-using-statistics?utm_source=feedburner&utm_medium=feed&utm_campaign=Feed%3A+UnderstandingUncertainty+%28Understanding+Uncertainty%29

"What Ever Happened to the Top MBAs of 1991?," Business Week, August 31, 2011 --- Click Here
http://www.businessweek.com/business-schools/what-ever-happened-to-the-top-mbas-of-1991-08312011_page_3.html

Jensen Comment
I could care less whether you read the above "promo" for elite MBA programs. Sadly, it's articles like this that motivate thousands of college graduates to go deeply into lifetime debt for prestigious MBA degrees that end up having, for them at least, a very negative rate of return.

What I do recommend is that you read the comments following the above article.

I suppose those of us that have been on the inside of administration (in my case only four years as a department chair in a large state university). We've all been guilty of lavishing praise on our successful graduates and never mentioning the ones that are homeless alcoholic embezzlers, syphilitic prostitutes, and/or showing off their motorcycle gang tattoos in prison. In my case, I authored a departmental annual report in which I had a centerfold praising the year's outstanding alumnus, usually one who just pledged the most money that year for our program.

One year I got a the best pledge from an alumnus who owned a horse ranch in Florida. Shortly after I ran a centerfold on him his first pledge check bounced. Soon thereafter a grand jury elected to prosecute him. I think he ended up with a 10-year felony conviction. He never sent us a nickel from the slammer.

"An Idea from My Boss" (former AAA President Nancy Bagranoff), by Joe Hoyle, Teaching-Getting the Most from Your Students. September 2, 2011 ---
http://joehoyle-teaching.blogspot.com/2011/09/idea-from-my-boss.html

Bob Jensen's threads on Tools and Tricks of the Trade ---
http://www.trinity.edu/rjensen/000aaa/thetools.htm

"Big4 Video:  News: PwC, Accenture, KPMG, Ernst & Young," Big Four Blog, August 26, 2011 ---
http://www.big4.com/capgemini/big4-video-news-pwc-accenture-kpmg-ernst-young

Bob Jensen's threads on accounting news ---
http://www.trinity.edu/rjensen/AccountingNews.htm

"How would students grade their law schools? The notion lingers that teaching practical skills is somehow not their business," by Sheldon M. Bonovitz," The National Law Journal, September 05, 2011 ---
http://www.law.com/jsp/nlj/PubArticleNLJ.jsp?id=1202513363358&slreturn=1&hbxlogin=1

Jensen Comment
Whereas accounting majors want more help in passing the CPA examination, law students want more help in passing a BAR examination. Teaching to such examinations seems to be negatively correlated with average GMAT and LSAT scores in each graduating class. Schools with the highest admission standards generally do not have to compete as hard to fill their admissions quotas (due to prestige of their universities) and tend to assume their students have the ability to pass the certification examinations without as much certification examination hand holding as schools with lower admission standards that do more bottom feeding to meet admissions quotas. For example, the University of Texas Law School takes pride in having a more philosophical curriculum than a BAR examination curriculum.

Prestigious accounting programs like the one at the University of Illinois at one time taught more toward the CPA examination, including having one of the most popular CPA review courses in the nation. Now the U of I purportedly teaches much less toward this examination ---
http://aaahq.org/AECC/changegrant/chap9.htm

Other change experiments (some of which failed) ---
http://aaahq.org/AECC/changegrant/index.htm

Competency-Based Assessment --- http://www.trinity.edu/rjensen/competency.htm

There are a few really noteworthy competency-based distance education programs including Western Governors University (WGU) and the Chartered Accountancy School of Business (CASB)  in Canada. But these compentency-based programs typically have assigned instructors and bear the costs of those instructors. The instructors, however, do not assign grades to students.

It appears that the Southern New Hampshire University (a private institution) is taking competency-based distance education to a new level by eliminating the instructors. It should be noted that SNHU has both an onsite campus and online degree programs.

"Online Education Is Everywhere. What’s the Next Big Thing?" by Marc Parry, Chronicle of Higher Education, August 31, 2011 ---
http://chronicle.com/blogs/wiredcampus/online-education-is-everywhere-whats-the-next-big-thing/32898?sid=wc&utm_source=wc&utm_medium=en

. . .

The vision is that students could sign up for self-paced online programs with no conventional instructors. They could work at their own speeds through engaging online content that offers built-in assessments, allowing them to determine when they are ready to move on. They could get help through networks of peers who are working on the same courses; online discussions could be monitored by subject experts. When they’re ready, students could complete a proctored assessment, perhaps at a local high school, or perhaps online. The university’s staff could then grade the assessment and assign credit.

And the education could be far cheaper, because there would be no expensive instructor and students could rely on free, open educational resources rather than expensive textbooks. Costs to the student might include the assessment and the credits.

“The whole model hinges on excellent assessment, a rock-solid confidence that the student has mastered the student-learning outcomes,” the memo says. “If we know with certainty that they have, we should no longer care if they raced through the course or took 18 months, or if they worked on their courses with the support of a local church organization or community center or on their own. The game-changing idea here is that when we have assessment right, we should not care how a student achieves learning. We can blow up the delivery models and be free to try anything that shows itself to work.”

Continued in article

"A Russian University Gets Creative Against Corruption:  With surveillance equipment and video campaigns, rector aims to eliminate bribery at Kazan State," by Anna Nemtsova, Chronicle of Higher Education, January 17, 2010 ---
http://chronicle.com/article/A-Russian-University-Gets/63522/

Jensen Comment
In its early history, the University of Chicago had competency-based programs where grades were assigned solely on the basis of scores on final examinations. Students did not have to attend class.

Bob Jensen's threads on competency-based assessment ---
http://www.trinity.edu/rjensen/competency.htm 

Bob Jensen's threads on distance education alternatives are at
http://www.trinity.edu/rjensen/Crossborder.htm

Bob Jensen's threads on higher education controversies are at
http://www.trinity.edu/rjensen/HigherEdControversies.htm

I should point out that this is very similar to the AAA's Innovation in Accounting Education Award Winning BAM Pedagogy commenced at the University of Virginia (but there were instructors who did not teach) ---
http://www.trinity.edu/rjensen/265wp.htm

"Defunct Colonial Bank Sues The Sh*t Out of Its Former Auditors, Including PwC," by Adrienne Gonzalez, Jr. Deputy Accountant Blog, August 26, 2011 ---
http://www.jrdeputyaccountant.com/2011/08/defunct-colonial-bank-sues-sht-out-of.html

A-ha! I hate to say I told you so (no I don't) but, uh, I told you so.

In August of 2009, I caught PwC digging around on my site to find out more about the Colonial Bank failure, a failure which PwC itself oversaw and maybe just participated in (if indirectly, naturally). The year before Colonial's epic failure, PwC auditors gave the bank the all clear.

"In our opinion, the consolidated financial statements listed in the accompanying index present fairly, in all material respects, the financial position of The Colonial BancGroup, Inc. and its subsidiaries at December 31, 2008 and 2007 and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2008 in conformity with accounting principles generally accepted in the United States of America," read the opinion.

Anyway, fast-forward two years and here we are:

Continued in article

Bob Jensen's threads on accounting firm litigation woes ---
http://www.trinity.edu/rjensen/Fraud001.htm

"FREQUENCY OF ACCOUNTING REPORTS," by Anthony H. Catanach Jr. and J. Edward Katz, Grumpy Old Accountants Blog, August 29, 2011 ---
http://blogs.smeal.psu.edu/grumpyoldaccountants/archives/287#more-287

. . .

Even if there are benefits, there also are hardware and software costs, as well as communication and and personnel issues to be addressed.  Cisco is not going to supply its product for free!  With tangible costs and intangible benefits, it certainly isn’t clear that society should push for continuous financial reports.

We also should keep in mind that even if sales and cash flows could be reported on the day they occur, many other things could not be assessed so quickly, including the value of intangible assets and goodwill and any financial instruments employing Level 3 measurements (remember Wall Street in 2008!).  If we cannot efficiently conduct impairment tests on a daily basis, then we can never produce meaningful daily income statements.  And even if we could, any such financial statement probably will not be consistent from one period to another if for no other reason that accruals and deferrals likely will not be applied on a daily basis.

Even if one could produce daily financial statements, there remains the problem of comparability.  It is hard enough now to compare quarterly statements of different firms whose seasonal effects vary, but now let’s try to compare daily financial statements of CBS with Ford.  This is nonsense.  Even restricting such analysis to firms in the same industry will not guarantee comparability as there is too much daily variability.

Let’s now consider auditing this “moment-by-moment” report generating machine.  It isn’t clear to us that the reports are auditable, except for the cash flows.  Worse, how does a business concern construct viable internal controls to handle the transactions and events in such an environment?  Given the pitiful state of some firms’ internal control systems, the extra strain would make a mockery of the audit process.

Having the technical skills and the technical machinery to allow daily or hourly financial reports is not sufficient for enabling continuous financial statements.  No, either the accounting reports become dumbed-down or we toss accrual accounting out of the window.  And audit firms have too much trouble auditing corporations now—witness the scores of restatements and accounting scandals—that they would have no chance of ever doing it right in a continuous reporting environment.

We pity the SEC if this day ever comes.  The SEC does not have the resources to effectively monitor the reports by registrants now, nor vigorously enforce the reporting rules.  We foresee near impotence of the SEC in a continuous reporting environment.

Finally, we emphasize our earlier concern.  Even if all of these problems could be adequately resolved to the satisfaction of all, would society be better off having a constant barrage of accounting data supplied to the investment community?  We seriously doubt it, as the factoids would not constitute actionable information and would clog the system with a lot of clutter.  If you are not convinced, just ask any manager how much they enjoy and value the hundreds of emails that add daily clutter to their inboxes!

Bob Jensen's threads on accounting theory are at
http://www.trinity.edu/rjensen/Theory01.htm

Jensen Comment
Aside from issues mentioned in the above article, there are tremendous opportunities for from that arise from daily reporting. For example, in annual reporting it's possible to sort out bad revenue and expense reporting such as channel stuffing, bill and hold fraud, sale-leaseback, bad debts estimation error, etc. This is much, much more difficult under daily reporting ---
http://www.trinity.edu/rjensen/ecommerce/eitf01.htm

I vote no! This could be even worse than the way pro forma reporting became riddled with fraud.

"Social Networking Threats to Security," by Jerry Trites, IS Assurance Blog, August 25, 2011 ---
http://uwcisa-assurance.blogspot.com/

This article links to
"Social networking security threats by the numbers," IT World of Canada, August 15, 2011 --- Click Here
http://www.itworldcanada.com/news/social-networking-security-threats-by-the-numbers/143741?sub=1520550&utm_source=1520550&utm_medium=top5&utm_campaign=TD+

Bob Jensen's threads on computer and networking security ---
http://www.trinity.edu/rjensen/ecommerce/000start.htm#SpecialSection

Question
Why are investors so leery about technology stocks?

Answer
Perhaps too many investors are still remembering how they lost their savings in the late 1990s when the last great technology bubble burst when technology companies that were not earning profits were trying to sell their shares with accounting gimmicks ---
http://www.trinity.edu/rjensen/ecommerce/eitf01.htm

Billionaire Marc Andreessen founded Netscape --- http://en.wikipedia.org/wiki/Marc_Andreessen

But too much of the debate is still around financial valuation, as opposed to the underlying intrinsic value of the best of Silicon Valley's new companies. My own theory is that we are in the middle of a dramatic and broad technological and economic shift in which software companies are poised to take over large swathes of the economy.
"Why Software Is Eating The World," by Marc Andreessen , The Wall Street Journal, August 20, 2011 ---
http://online.wsj.com/article/SB10001424053111903480904576512250915629460.html?mod=WSJ_hps_sections_lifestyle

This week, Hewlett-Packard (where I am on the board) announced that it is exploring jettisoning its struggling PC business in favor of investing more heavily in software, where it sees better potential for growth. Meanwhile, Google plans to buy up the cellphone handset maker Motorola Mobility. Both moves surprised the tech world. But both moves are also in line with a trend I've observed, one that makes me optimistic about the future growth of the American and world economies, despite the recent turmoil in the stock market.

In short, software is eating the world.

More than 10 years after the peak of the 1990s dot-com bubble, a dozen or so new Internet companies like Facebook and Twitter are sparking controversy in Silicon Valley, due to their rapidly growing private market valuations, and even the occasional successful IPO. With scars from the heyday of Webvan and Pets.com still fresh in the investor psyche, people are asking, "Isn't this just a dangerous new bubble?"

I, along with others, have been arguing the other side of the case. (I am co-founder and general partner of venture capital firm Andreessen-Horowitz, which has invested in Facebook, Groupon, Skype, Twitter, Zynga, and Foursquare, among others. I am also personally an investor in LinkedIn.) We believe that many of the prominent new Internet companies are building real, high-growth, high-margin, highly defensible businesses. [SOFTWARE1] QuickHoney

Today's stock market actually hates technology, as shown by all-time low price/earnings ratios for major public technology companies. Apple, for example, has a P/E ratio of around 15.2—about the same as the broader stock market, despite Apple's immense profitability and dominant market position (Apple in the last couple weeks became the biggest company in America, judged by market capitalization, surpassing Exxon Mobil). And, perhaps most telling, you can't have a bubble when people are constantly screaming "Bubble!"

But too much of the debate is still around financial valuation, as opposed to the underlying intrinsic value of the best of Silicon Valley's new companies. My own theory is that we are in the middle of a dramatic and broad technological and economic shift in which software companies are poised to take over large swathes of the economy.

More and more major businesses and industries are being run on software and delivered as online services—from movies to agriculture to national defense. Many of the winners are Silicon Valley-style entrepreneurial technology companies that are invading and overturning established industry structures. Over the next 10 years, I expect many more industries to be disrupted by software, with new world-beating Silicon Valley companies doing the disruption in more cases than not.

Why is this happening now?

Six decades into the computer revolution, four decades since the invention of the microprocessor, and two decades into the rise of the modern Internet, all of the technology required to transform industries through software finally works and can be widely delivered at global scale.

Over two billion people now use the broadband Internet, up from perhaps 50 million a decade ago, when I was at Netscape, the company I co-founded. In the next 10 years, I expect at least five billion people worldwide to own smartphones, giving every individual with such a phone instant access to the full power of the Internet, every moment of every day.

On the back end, software programming tools and Internet-based services make it easy to launch new global software-powered start-ups in many industries—without the need to invest in new infrastructure and train new employees. In 2000, when my partner Ben Horowitz was CEO of the first cloud computing company, Loudcloud, the cost of a customer running a basic Internet application was approximately $150,000 a month. Running that same application today in Amazon's cloud costs about $1,500 a month.

With lower start-up costs and a vastly expanded market for online services, the result is a global economy that for the first time will be fully digitally wired—the dream of every cyber-visionary of the early 1990s, finally delivered, a full generation later.

Perhaps the single most dramatic example of this phenomenon of software eating a traditional business is the suicide of Borders and corresponding rise of Amazon. In 2001, Borders agreed to hand over its online business to Amazon under the theory that online book sales were non-strategic and unimportant.

Oops.

Today, the world's largest bookseller, Amazon, is a software company—its core capability is its amazing software engine for selling virtually everything online, no retail stores necessary. On top of that, while Borders was thrashing in the throes of impending bankruptcy, Amazon rearranged its web site to promote its Kindle digital books over physical books for the first time. Now even the books themselves are software.

Today's largest video service by number of subscribers is a software company: Netflix. How Netflix eviscerated Blockbuster is an old story, but now other traditional entertainment providers are facing the same threat. Comcast, Time Warner and others are responding by transforming themselves into software companies with efforts such as TV Everywhere, which liberates content from the physical cable and connects it to smartphones and tablets.

Today's dominant music companies are software companies, too: Apple's iTunes, Spotify and Pandora. Traditional record labels increasingly exist only to provide those software companies with content. Industry revenue from digital channels totaled $4.6 billion in 2010, growing to 29% of total revenue from 2% in 2004.

Today's fastest growing entertainment companies are videogame makers—again, software—with the industry growing to $60 billion from $30 billion five years ago. And the fastest growing major videogame company is Zynga (maker of games including FarmVille), which delivers its games entirely online. Zynga's first-quarter revenues grew to $235 million this year, more than double revenues from a year earlier. Rovio, maker of Angry Birds, is expected to clear $100 million in revenue this year (the company was nearly bankrupt when it debuted the popular game on the iPhone in late 2009). Meanwhile, traditional videogame powerhouses like Electronic Arts and Nintendo have seen revenues stagnate and fall.

. . .

Still, we face several challenges.

First of all, every new company today is being built in the face of massive economic headwinds, making the challenge far greater than it was in the relatively benign '90s. The good news about building a company during times like this is that the companies that do succeed are going to be extremely strong and resilient. And when the economy finally stabilizes, look out—the best of the new companies will grow even faster.

Secondly, many people in the U.S. and around the world lack the education and skills required to participate in the great new companies coming out of the software revolution. This is a tragedy since every company I work with is absolutely starved for talent. Qualified software engineers, managers, marketers and salespeople in Silicon Valley can rack up dozens of high-paying, high-upside job offers any time they want, while national unemployment and underemployment is sky high. This problem is even worse than it looks because many workers in existing industries will be stranded on the wrong side of software-based disruption and may never be able to work in their fields again. There's no way through this problem other than education, and we have a long way to go.

Finally, the new companies need to prove their worth. They need to build strong cultures, delight their customers, establish their own competitive advantages and, yes, justify their rising valuations. No one should expect building a new high-growth, software-powered company in an established industry to be easy. It's brutally difficult.

I'm privileged to work with some of the best of the new breed of software companies, and I can tell you they're really good at what they do. If they perform to my and others' expectations, they are going to be highly valuable cornerstone companies in the global economy, eating markets far larger than the technology industry has historically been able to pursue.

Instead of constantly questioning their valuations, let's seek to understand how the new generation of technology companies are doing what they do, what the broader consequences are for businesses and the economy and what we can collectively do to expand the number of innovative new software companies created in the U.S. and around the world.

That's the big opportunity. I know where I'm putting my money.

Continued in article

Jensen Comment
Perhaps too many investors are still remembering how they lost their savings in the late 1990s when the last great technology bubble burst when technology companies that were not earning profits were trying to sell their shares with accounting gimmicks ---
http://www.trinity.edu/rjensen/ecommerce/eitf01.htm

"Embezzling Accountant Will Pay Back Stolen Money and Pay For the Audit That Caught Him," by Adrienne Gonzalez, Going Concern, August 23, 2011 ---
http://goingconcern.com/2011/08/embezzling-accountant-will-pay-back-stolen-money-and-pay-for-the-audit-that-caught-him/

Jensen Comment
This guy's employers must've had zero internal controls.

August 26, 2011 reply from Anne Oppegard

Bob, On Tuesday you posted

"*Embezzling Accountant Will Pay Back Stolen Money and Pay For the Audit That Caught Him*," by Adrienne Gonzalez, Going Concern, August 23, 2011 --- http://goingconcern.com/2011/08/embezzling-accountant-will-pay-back-stolen-money-and-pay-for-the-audit-that-caught-him/  on the AECM board. I chucked to myself when I read your comment that "This guy's employer must've had zero internal controls."

Well ... if your employee serves in a volunteer capacity as the chair of the local municipality's audit committee and is on record speaking strongly in support of the city establishing a "1-800 whistle blower line" , and has exhibited concern for the continual strengthening of controls then you might think you have the paragon of accounting propriety working for you....

I'm painfully close to this situation here in Sioux Falls, South Dakota. I sit on that that City Audit Committee which Mr. Whitsell chaired! As they say ... "Could have knocked me over with a feather." when the news of his embezzlement broke. I'm pondering whether I should take my senior auditing class on a field trip to the local court house on the date of Mr. Whitsell's sentencing...

Best regards, Anne Oppegard

Anne M. Oppegard, Ph.D.
Associate Professor
Business Administration Department
Augustana College Sioux Falls, SD 57197

http://www.augie.edu/academics/business-accounting

Bob Jensen's Fraud Updates are at
http://www.trinity.edu/rjensen/FraudUpdates.htm

"Crooked CFO: KPMG knows nothing about the character traits of criminals,” by Calib Newquist, Going Concern, August 19, 2011 ---
http://goingconcern.com/2011/08/crooked-cfo-kpmg-knows-nothing-about-the-character-traits-of-criminals/

Earlier this week we shared with you the latest analysis from KPMG that listed “key fraudster traits” and some of them seemed to describe a lot of the people you have worked or are currently working for. Things like “volatile,” “unreliability,” “unhappy,” and “self-interested” describes everyone I’ve ever been in around in the corporate world to one extent or another.

Since I was skeptical of this list, I asked Sam Antar what he thought of it. If you’ve been reading us for awhile, you’re familiar with Sam. If you’re new, I’ll do a quick refresher. Sam was the CFO of Crazy Eddie’s and was one of the masterminds behind one of the biggest financial frauds of the 1980s. While you (and I) were eating cereal in front of the TV on Saturday morning, Sam and his cousin Eddie were selling electronics and home appliances to our parents for rock bottom prices, while ripping off the government and investors for untold millions of dollars. In other words, the guy is a crook and knew/knows lots of crooks and knows their hopes (read: money), their dreams (read: money) all that crap (read: more money) and what they’ll do to get them. With that, Sam told me what he thought of KPMG’s analysis:

Continued in article

"Guest Post: Fraud Girl – Can We Detect Lying From Nonverbal Cues?" Simoleon Sense, June 20, 2010 ---
 http://www.simoleonsense.com/guest-post-fraud-girl-can-we-detect-lying-from-nonverbal-cues/
 This includes a video of Jeff Skilling's testimony:  Can you detect his lies?

"Spotting a hoax using statistics," Understanding Uncertainty, August 3, 2011 --- Click Here
http://understandinguncertainty.org/spotting-hoax-using-statistics?utm_source=feedburner&utm_medium=feed&utm_campaign=Feed%3A+UnderstandingUncertainty+%28Understanding+Uncertainty%29

Bob Jensen's threads on fraud are at
http://www.trinity.edu/rjensen/Fraud.htm

"A Value-Added Tax Fuels Big Government:  In Europe the VAT hasn't substituted for income taxation. It's merely added to the tax burden," by Ernest S. Christian and Gary Robbins, The Wall Street Journal, August 24, 2011 ---
http://online.wsj.com/article/SB10001424053111903596904576518274100145458.html?mod=djemEditorialPage_t

Jensen Comment
It's hard to get extreme liberals and extreme conservatives to agree on much of anything, but one thing they equally despise as the VAT tax. But they hate it for different reasons. Conservatives hate it because it raises prices and reduces demand for products and services. Liberals hate it because, like sales taxes in general, the VAT tax is regressive in that prices are higher for the poor as well as the rich.

I personally am an advocate of the VAT tax. At a minimum it should replace the corporate income tax which simply is not working in the United States. The corporations making the most profits, like General Electric, are paying no corporate income taxes. I like the VAT tax for the same reason business firms hate it --- it's very easy and cheap to collect just as the sales tax is much easier to collect than income taxes and property taxes.

The conservative protests that a VAT tax will simply fuel bigger government are arguable. Congress could both reduce government and collect a VAT tax to reduce the some of the need for borrowing from China and elsewhere in the world. The liberal protests that it is regressive are hard to refute. But there are steps that can be taken just as many states now take some steps to make sales taxes less regressive. And since nearly half the taxpayers in the United States do not pay any income tax, I think it's time to force people at all income levels to pay for some of the government services that benefit them personally. For example, even the poor people in Canada pay something towards basic services such as health care.

How to Lie With Statistics
"On Economy, Raw Data Gets a Grain of Salt," by Binyamin Appelbaum, The New York Times, August 16. 2011 ---
http://www.nytimes.com/2011/08/17/business/economy/raw-data-on-economic-growth-paints-fuzzy-picture.html?_r=2&pagewanted=all

“People want the best information that we have right now. But people need to understand that the best information that we have right now isn’t necessarily very informative,” said Tara M. Sinclair, an assistant professor of economics and international affairs at George Washington University. “It’s just the best information that we have.”

¶ The growth rate that the government announces roughly one month after the end of each quarter — news much anticipated in Washington and on Wall Street — has been off the mark over the period from 1983 to 2009 by an average of 1.3 percentage points, compared with more fully analyzed figures released years later, according to federal data.

Continued in article

Jensen Comment
There is great pressure on audit firms and clients to produce financial statement numbers more quickly since the typical annual financial statements are so delayed. But increasing the frequency of audited financial statement numbers is very costly and perhaps will suffer from the same reporting problems as are faced with monthly economic growth numbers versus long-delayed corrections of those numbers.

"Was Buffett Right? Do Workers Pay More Tax than Their Bosses?," by Roberton Williams, Tax Policy Center, August 23, 2011 --- Click Here
http://taxvox.taxpolicycenter.org/2011/08/23/was-buffett-right-do-workers-pay-more-tax-than-their-bosses/?utm_source=feedburner&utm_medium=feed&utm_campaign=Feed%3A+taxpolicycenter%2Fblogfeed+%28TaxVox%3A+the+Tax+Policy+Center+blog%29&utm_content=Netvibes

. . .

Warren Buffett may be right when he says that high-income taxpayers could pay more, especially given the extremely rapid rate of income growth at the top of the distribution. And he’s certainly correct when he says that the low tax rate on investment income cuts his tax bill well below that of many Americans. But he’s off base when he suggests that all high-income taxpayers pay a smaller share of their income in taxes than their middle-income coworkers.

Continued in article

Jensen Comment
Especially note the graph in this article.

Fair Use Section 107 of the DMCA --- http://en.wikipedia.org/wiki/Fair_Use
Note that many nations such as Canada do not have Fair Use safe harbors for educators

"Last Round of Filings Made in Georgia State U. Fair-Use Lawsuit," Chronicle of Higher Education, August 4, 2011 ---
http://chronicle.com/blogs/ticker/last-round-of-filings-made-in-georgia-state-u-fair-use-lawsuit/35088?sid=wc&utm_source=wc&utm_medium=en

The plaintiffs and the defendants in the fair-use lawsuit that has pitted three academic publishers against Georgia State University have now filed their final post-trial briefs. That was the last opportunity for each side to make its case before the federal judge overseeing the case in Atlanta delivers a ruling. No date has been set for a decision in the closely watched case, but observers say one is likely by early fall. Cambridge U. Press, Oxford U. Press, and SAGE Publications have alleged that the use of copyrighted material in e-reserves and on faculty Web sites has exceeded the bounds of fair use. (See here for different opinions on what’s at stake for higher education.)

Bob Jensen's threads on Section 107 of the dreaded DMCA ---
http://www.trinity.edu/rjensen/000aaa/theworry.htm#Copyright

Capital Asset Pricing Model (CAPM) --- http://en.wikipedia.org/wiki/CAPM

This is a Must Read
Dartmouth Professor Ken French comes in for the rescue of CAPM!
"How to use the Fama French Model," Empirical Finance Blog, August 1, 2011 ---
http://blog.empiricalfinancellc.com/2011/08/how-to-use-the-fama-french-model/

The CAPM is prolific, but doesn’t appear to work!

For example, in the figures below I’ve plotted the Fama-French 25 (portfolios ranked on size and book-to-market) against beta.

In the first figure, I plot the average excess return to the FF 25 against the average excess return one would expect, given beta.

If you’d like to see how I calculated the charts above, please reference the excel file here.

Given such a poor track record, is anyone still using the CAPM?

Lot’s of people, apparently…

Welch (2008) finds that ~75% of professors recommend the use of the model when estimating the cost of capital, and Graham and Harvey (2001) find that ~74% of CFOs use the CAPM in their work.

A few quotes from Graham and Harvey 2001 sum up common sentiment regarding the CAPM:

“While the CAPM is popular, we show later that it is not clear that the model is applied properly in practice. Of course, even if it is applied properly, it is not clear that the CAPM is a very good model [see Fama and French (1992)].

“…practitioners might not apply the CAPM or NPV rule correctly. It is also interesting that CFOs pay very little attentionto risk factors based on momentum and book-to-market-value.”

Of course, there are lots of arguments to consider before throwing out the CAPM. Here are a few:

• Everyone learns about it and knows how to use it (although, Graham and Harvey suggest that many practitioners don’t even apply the CAPM theory correctly)
• Data is easy to obtain on betas.
• Roll’s critique–maybe the CAPM isn’t a junk theory, rather, the empirical tests showing the CAPM doesn’t work are bogus.

Regardless, being that this blog is dedicated to empirical data and evidence, and not about ‘mentally masturbating about theoretical finance models,’ we’ll operate under the assumption that the CAPM is dead until new data comes available.

The Fama French Alternative?

Given the CAPM doesn’t work that well in practice, perhaps we should look into the Fama French model (which isn’t perfect or cutting edge, but a solid workhorse nonetheless). And while the FF model inputs are highly controversial, one thing is clear: the FF 3-factor model does a great job explaining the variability of returns. For example, according to Fama French 1993, the 3-factor model explains over 90% of the variability in returns, whereas the CAPM can only explain ~70%!

The 3-factor model is great, but how the heck does one estimate the FF factors?

Dartmouth Professor Ken French comes in for the rescue!

Continued in article

Ken French's Link
http://mba.tuck.dartmouth.edu/pages/faculty/ken.french/data_library.html

Bob Jensen's criticisms of accounting studies based on misuse of the CAPM
Slow Loading ---
http://www.trinity.edu/rjensen/theory01.htm#AccentuateTheObvious

Video Lectures in Finance from Yale
Financial Markets Course with Yale
Finance and Economics Professor Robert Shiller
Click Here
http://www.openculture.com/2011/08/robert_shiller_course.html?utm_source=feedburner&utm_medium=email&utm_campaign=Feed%3A+OpenCulture+%28Open+Culture%29

Bob Jensen's threads on free video lectures and courses from prestigious universities
http://www.trinity.edu/rjensen/000aaa/updateee.htm#OKI

Questions
Why is Moody's in big trouble?
Why is it unlikely that Moody's will have the guts to downgrade U.S. Debt?

Answers (SEC Comment S7-18-11-33, August 8, 2011) by
http://www.sec.gov/comments/s7-18-11/s71811-33.pdf

SSRN Top 700 Law Schools --- http://hq.ssrn.com/rankings/Ranking_Display.cfm?TMY_gID=2&TRN_gID=1

SSRN Tax Professor Rankings --- http://hq.ssrn.com/Rankings/Ranking_display.cfm?TRN_gID=6&TMY_gID=2

Jensen Comment
From a reputational standpoint it pays to open share scholarship and research.

Teaching Case:  For Deloitte CEO, Hard Times Are Nothing New

From The Wall Street Journal Accounting Weekly Review on August 26, 2011

For Deloitte CEO, Hard Times Are Nothing New
by: Dana Mattioli
Aug 22, 2011
Click here to view the full article on WSJ.com
 

TOPICS: Public Accounting, Public Accounting Firms

SUMMARY: This interview with Joe Echevarria, CEO of Deloitte LLP, highlights how the accounting profession attracted him purely for the opportunity to increase his economic standing. He is just about to complete his first 100 days as CEO.

CLASSROOM APPLICATION: The article is useful to highlight the attractiveness of the accounting profession and for students to understand the effort required to make it to the top of the organization. The article also is useful to spur discussion of public accounting firm strategies that may help students form questions that will be useful during interviews in the fall recruiting season.

QUESTIONS: 
1. (Introductory) What attracted Mr. Echevarria to the accounting profession?

2. (Introductory) What kind of effort was required of Mr. Echevarria to make his way to the top of Deloitte LLP?

3. (Advanced) How is Mr. Echevarria's experience different from what you might expect in entering the public accounting profession? How is it similar?

4. (Advanced) How do the similarities and differences you described above impact your potential progress in the public accounting profession?

5. (Introductory) Suppose you are interviewing for a position in a public accounting firm. What questions would you ask of the office or firm CEO in a position such as Mr. Echevarria's? How should those questions differ from those you would ask of a staff person just beginning at the firm?

6. (Advanced) Consider Mr. Echevarria's statement that he thinks the "probabilities [of an economic] rebound are diminishing and the probability of a double dip is increasing." How does that assessment impact your interviewing possibilities?
 

Reviewed By: Judy Beckman, University of Rhode Island

"For Deloitte CEO, Hard Times Are Nothing New," by: Dana Mattioli, The Wall Street Journal, August 22, 2011 ---
http://professional.wsj.com/article/SB10001424053111904070604576518511755839664.html?mod=djem_jiewr_AC_domainid

During his teen years, Joe Echevarria says that he wanted to get as far away from his South Bronx neighborhood as he could. When it was time to choose a college, Mr. Echevarria opted for University of Miami, which he attended on scholarship.

These days, Mr. Echevarria is back in New York—but he is worlds away from where he began: The 54-year-old took the helm at Deloitte LLP in June.

The CEO still has pressing matters on his mind. As the largest professional services firm in the world by revenue, Deloitte specializes in tax, audit, consulting and advisory businesses—areas that clients cut back on during the last recession.

Deloitte's revenue for fiscal-year 2010, which ended last June, was $10.9 billion. In its 2008 fiscal year revenue hit a little over $11 billion. The closely held company hasn't yet released 2011 figures.

Mr. Echevarria, whose start in accounting involved fetching mail and coffee, still comes across as a neighborhood guy, with a hint of a Bronx accent behind his polished corporate speak.

He lives by a "three-feet rule," he says, making a practice of introducing himself and striking up a conversation with anyone who comes within three feet. "The culture is terrific, my only desire is to make it more approachable," Mr. Echevarria says.

In an interview with The Wall Street Journal at the company's New York headquarters last week, Mr. Echevarria spoke about the economic climate, Deloitte's buttoned-up culture and his rise up the corporate ladder.

Edited excerpts:

WSJ: You followed an interesting path to the top at Deloitte. What attracted you to accounting?

Mr. Echevarria: I worked at a gas station in the Bronx and there was somebody there who was an accountant. What stood out to me was I worked all day and I was making whatever minimum wage was at the time. The accountant came into the gas station once a month, did something, and walked out with a lot more money than I made in a week. I didn't quite understand accounting, but I understood it was an opportunity to perhaps do something different and escape from the poverty I grew up in as a kid.

WSJ: What were your early days at Deloitte like?

Mr. Echevarria: After college, I started at Haskins & Sells, the predecessor to Deloitte. I started in the audit practice. All the tasks were hierarchical in those days, so you had to work your way up. We weren't in an environment where everything is electronic. We had to get mail. It didn't just come over some laptop. So guess who got those responsibilities? There wasn't a Starbucks on every corner.

WSJ: You're approaching your first 100 days as CEO. What goals have you been able to accomplish?

Mr. Echevarria: One of the goals we're beginning to accomplish is having a conversation. We opened up a communication vehicle with our partners and our directors that I call Social CEO. It gets the partners to engage, open dialogue, ask survey questions and ask questions of me or others. I get every comment. It's about coming up with lots of ideas and how to better direct our recruiting resources.

WSJ: Many companies are being conservative about hiring, given the bleak economic outlook. What are Deloitte's plans?

Mr. Echevarria: We're going to hire 18,000 people this [fiscal] year across all of our businesses. Plus, we're opening Deloitte University in Texas in October. That's a $300 million commitment to learning and development of our people that we're making.

WSJ: Companies are starting to make layoffs again and cut back on spending. In the last recession, one of the first cuts businesses made was to services. How are you planning around the possibility of that happening again?

Mr. Echevarria: Once upon a time there was a view that there would be a rebound. I would say now the probabilities of a rebound are diminishing and the probability of a double dip is increasing. We have a set of plans that we would undertake for any of those scenarios. This isn't new for us.

WSJ: What would you do in the event of a double dip?

Mr. Echevarria: We have a broad degree of options. The first thing is we look at the costs that we incur and how much ahead we're hiring. Maybe 18,000 [new hires] becomes 17,000.

Continued in article

Bob Jensen's threads on auditor professionalism and independence are at
http://www.trinity.edu/rjensen/fraud001.htm#Professionalism

"Success Comes From Better Data, Not Better Analysis," by Daryl Morey, Harvard Business Review Blog, August 8, 2011 --- Click Here
http://blogs.hbr.org/cs/2011/08/success_comes_from_better_data.html?referral=00563&cm_mmc=email-_-newsletter-_-daily_alert-_-alert_date&utm_source=newsletter_daily_alert&utm_medium=email&utm_campaign=alert_date

Jensen Comment
I think accountics researchers often use purchased databases (e.g., Compustat, AuditAnalytics, and CRSP) without questioning the possibility of data errors and limitation. For example, we recently took a look at the accounting litigation database of AuditAnalytics and found many serious omissions.

These databases are used by multiple accountics researchers, thereby compounding the felony,.

Bob Jensen's threads on what went wrong with accountics research are at
http://www.trinity.edu/rjensen/theory01.htm#WhatWentWrong

Hi Barbara,
 

August 12, 2011 message from Edith Orenstein

I thought this group may find a couple FEI blog posts of interest on the anti-fraud front.
Thank you,
Edith

COSO Exposure Draft, Updating Internal Control Framework, Expected Oct/Nov.

SEC’s New Whistleblower Program Open For Business; Takes Effect Today

Bob Jensen's threads on fraud are at
http://www.trinity.edu/rjensen/Fraud.htm

"For Female Faculty, a B-School Glass Ceiling:  Work-life issues, lack of mentorship programs, and sexual discrimination are preventing many women from obtaining tenure and full professorships," by Allison Damast, Business Week, August 8, 2011 ---
http://www.businessweek.com/business-schools/for-female-faculty-a-bschool-glass-ceiling-08082011.html

SEC Waste of Time and Money:  The government builds new warehouses to store useless minted presidential coins nobody wants
but destroys potentially valuable fraud files
"SEC Destroys 9000 Fraud Files," by Mike Shedlock, Townhall, August 18, 2011 ---
http://finance.townhall.com/columnists/mikeshedlock/2011/08/18/sec_destroys_9000_fraud_files

Senator Chuck Grassley, Republican of Iowa, says SEC may have destroyed documents

“From what I’ve seen, it looks as if the SEC might have sanctioned some level of case-related document destruction,” said Sen. Chuck Grassley, Republican of Iowa, in a letter to the agency’s chairman, Mary Schapiro.

“It doesn’t make sense that an agency responsible for investigations would want to get rid of potential evidence. If these charges are true, the agency needs to explain why it destroyed documents, how many documents it destroyed over what timeframe, and to what extent its actions were consistent with the law.”

Agency staff “destroyed over 9,000 files” related to preliminary agency investigations, according to a letter sent in July to Grassley, the top Republican on the Senate Judiciary Committee, and obtained by MarketWatch.

The allegations were made by SEC enforcement attorney, Darcy Flynn, in a letter to Grassley. Flynn is a current employee, and according to the letter, received a bonus for his past year’s work.

Flynn alleges the SEC destroyed files related to matters being examined in important cases such as Bernard Madoff and a $50 billion Ponzi scheme he operated as well as an investigation involving Goldman Sachs Group Inc. trading in American International Group credit-default swaps in 2009.

Flynn also alleged that the agency destroyed documents and information collected for preliminary investigations at Wells Fargo, Bank of America,, Citigroup, Credit Suisse, Deutsche Bank, Morgan Stanley, and the now-bankrupt Lehman Brothers.

The letter goes into particular detail about Deutsche Bank, the former employer of current SEC enforcement chief Robert Khuzami as well as former enforcement chiefs Gary Lynch and Richard Walker.

The allegations that the SEC destroyed documents were first reported by the Rolling Stone magazine in a report Wednesday.

Senator Grassley's Letter to the SEC --- http://grassley.senate.gov/about/upload/2011-08-17-CEG-to-SEC-MUI.pdf

Bob Jensen's threads on fraud ---
http://www.trinity.edu/rjensen/Fraud.htm

"Groupon: Comedy or Drama?"  by Grumpy Old Accountants  Anthony H. Catanach Jr. and J. Edward Ketz, SmartPros, July 2011 ---
http://accounting.smartpros.com/x72233.xml 

"Trust No one, Particularly Not Groupon's Accountantns," by Anthony H. Catanach Jr. and J. Edward Ketz, Grumpy Old Accountants Blog, August 24, 2011 ---
http://blogs.smeal.psu.edu/grumpyoldaccountants/ 

"Is Groupon "Cooking Its Books?"  by Grumpy Old Accountants  Anthony H. Catanach Jr. and J. Edward Ketz, SmartPros, September  2011 ---
http://accounting.smartpros.com/x72233.xml 

Teaching Case
When Rosie Scenario waved goodbye "Adjusted Consolidated Segment Operating Income"

From The Wall Street Journal Weekly Accounting Review on August 19, 2011

Groupon Bows to Pressure
by: Shayndi Raice and Lynn Cowan
Aug 11, 2011
Click here to view the full article on WSJ.com
 

TOPICS: Advanced Financial Accounting, SEC, Securities and Exchange Commission, Segment Analysis

SUMMARY: In filing its prospectus for its initial public offering (IPO), Groupon has removed from its documents "...an unconventional accounting measurement that had attracted scrutiny from securities regulators [adjusted consolidated segment operating income]. The unusual measure, which the e-commerce had invented, paints a more robust picture of its performance. Removal of the measure was in response to pressure from the Securities and Exchange Commission...."

CLASSROOM APPLICATION: The article is useful to introduce segment reporting and the weaknesses of the required management reporting approach.

QUESTIONS: 
1. (Introductory) What is Groupon's business model? How does it generate revenues? What are its costs? Hint, to answer this question you may access the Groupon, Inc. Form S-1 Registration Statement filed on June 2, 011 available on the SEC web site at http://www.sec.gov/Archives/edgar/data/1490281/000104746911005613/a2203913zs-1.htm

2. (Advanced) Summarize the reporting that must be provided for any business's operating segments. In your answer, provide a reference to authoritative accounting literature.

3. (Advanced) Why must the amounts disclosed by operating segments be reconciled to consolidated totals shown on the primary financial statements for an entire company?

4. (Advanced) Access the Groupon, Inc. Form S-1 Registration Statement filed on June 2, 011 and proceed to the company's financial statements, available on the SEC web site at http://www.sec.gov/Archives/edgar/data/1490281/000104746911005613/a2203913zs-1.htm#dm79801_selected_consolidated_financial_and_other_data Alternatively, proceed from the registration statement, then click on Table of Contents, then Selected Consolidated Financial and Other Data. Explain what Groupon calls "adjusted consolidated segment operating income" (ACSOI). What operating segments does Groupon, Inc., show?

5. (Introductory) Why is Groupon's "ACSOI" considered to be a "non-GAAP financial measure"?

6. (Advanced) How is it possible that this measure of operating performance could be considered to comply with U.S. GAAP requirements? Base your answer on your understanding of the need to reconcile amounts disclosed by operating segments to the company's consolidated totals. If it is accessible to you, the second related article in CFO Journal may help answer this question.
 

Reviewed By: Judy Beckman, University of Rhode Island
 

RELATED ARTICLES: 
Groupon's Accounting Lingo Gets Scrutiny
by Shayndi Raice and Nick Wingfield
Jul 28, 2011
Page: A1

CFO Report: Operating Segments Remain Accounting Gray Area
by Emily Chasan
Aug 15, 2011
Page: CFO

 

"Groupon Bows to Pressure," by: Shayndi Raice and Lynn Cowan, The Wall Street Journal, August 11, 2011 ---
https://mail.google.com/mail/?shva=1#inbox/131e06c48071898b

Groupon Inc. removed from its initial public offering documents an unconventional accounting measurement that had attracted scrutiny from securities regulators.

The unusual measure, which the e-commerce had invented, paints a more robust picture of its performance. Removal of the measure was in response to pressure from the Securities and Exchange Commission, a person familiar with the matter said.

In revised documents filed Wednesday with the SEC, the company removed the controversial measure, which had been highlighted in the first three pages of its previous filing. But Groupon's chief executive defended the term Wednesday. [GROUPON] Getty Images

Groupon, headquarters above, expects to raise about $750 million.

Groupon had highlighted something it called "adjusted consolidated segment operating income", or ACSOI. The measurement, which doesn't include subscriber-acquisitions expenses such as marketing costs, doesn't conform to generally accepted accounting principles.

Investors and analysts have said ACSOI draws attention away from Groupon's marketing spending, which is causing big net losses.

The company also disclosed Wednesday that its loss more than doubled in the second quarter from a year ago, even as revenue increased more than ten times.

By leaving ACSOI out of its income statements, the company hopes to avoid further scrutiny from the SEC, the person familiar with the matter said. The commission declined comment.

Groupon in June reported ACSOI of $60.6 million for last year and $81.6 million for the first quarter of 2011. Under generally accepted accounting principles, the company generated operating losses of $420.3 million and $117.1 million during those periods.

Wednesday's filing included a letter from Groupon Chief Executive Andrew Mason defending ACSOI. The company excludes marketing expenses related to subscriber acquisition because "they are an up-front investment to acquire new subscribers that we expect to end when this period of rapid expansion in our subscriber base concludes and we determine that the returns on such investment are no longer attractive," the letter said.

There was no mention of when that expansion will end, but the person familiar with the matter said the company reevaluates the figures weekly.

Groupon said it spent $345.1 million on online marketing initiatives to acquire subscribers in the first half and that it expects "to continue to expend significant amounts to acquire additional subscribers."

The latest SEC filing also contains new financial data. Groupon on Wednesday reported second-quarter revenue of $878 million, up 36% from the first quarter. While the company's growth is still rapid, the pace has slowed. Groupon's revenue jumped 63% in the first quarter from the fourth.

The company's second-quarter loss was $102.7 million, flat sequentially and wider than the year-earlier loss of $35.9 million.

Groupon expects to raise about $750 million in a mid-September IPO that could value the company at $20 billion.

The path to going public hasn't been easy. The company had to file an amendment to its original SEC filing after a Groupon executive told Bloomberg News the company would be "wildly profitable" just three days after its IPO filing. Speaking publicly about the financial projections of a company that has filed to go public is barred by SEC regulations. Groupon said the comments weren't intended for publication.

Continued in article

Jensen Comment
In the 1990s, high tech companies resorted to various accounting gimmicks to increase the price and demand for their equity shares ---
http://www.trinity.edu/rjensen/ecommerce/eitf01.htm

Bob Jensen's threads about cooking the books ---
http://www.trinity.edu/rjensen/Theory02.htm#Manipulation

"New Web Site Offers Career ‘Resilience’ Advice for Female Academics," by Paige Chapman, Chronicle of Higher Education, November 5, 2010 ---
http://chronicle.com/blogs/wiredcampus/new-web-site-offers-career-resilience-advice-for-women-academics/28044?sid=wc&utm_source=wc&utm_medium=en 

Questions
How can you tell that the market does not trust the audited accounting numbers in financial statements of listed corporations?
What happens when the market thinks the reported assets are overstated and/or liabilities are understated?

From The Wall Street Journal Accounting Weekly Review on August 12, 2011

BofA Pays the Price for Equity Stance
by: David Reilly
Aug 09, 2011
Click here to view the full article on WSJ.com
 

TOPICS: Banking, Contingent Liabilities, Financial Analysis, Financial Statement Analysis, Ratios

SUMMARY: "There is a difference between the amount of equity a bank needs to run its business and the amount it needs to maintain market confidence." This is the statement the author uses introduces issues stemming from a confluence of factors impacting BofA: first, lawsuits related to the $8.5 billion settlement that it reached in June regarding mortgage bonds based on mortgages originated by Countrywide Financial; second, the fact that BofA did not raise equity capital before markets fell around the time of S&P's downgrade of U.S. sovereign debt. "BofA is in a particularly precarious position. The stock is now trading at just 32% of book value and about 51% of tangible book. In other words, markets seem to believe BofA's assets are significantly overstated or liabilities understated."

CLASSROOM APPLICATION: The article is useful to introduce the importance of bank balance sheet amounts and to cover current events in U.S. markets.

QUESTIONS: 
1. (Introductory) Identify the three major components of any company's balance sheet. List items common for a bank in each of these three categories.

2. (Advanced) What does stockholders' equity represent?

3. (Advanced) Why do bank regulations require a certain amount of "equity capital" calculated on the basis of percentages of risky assets held by banks?

4. (Advanced) What do you think the author means when he writes, "There is a difference between the amount of equity a bank needs to run its business and the amount it needs to maintain market confidence" ? In your answer, define the term "run on the bank."

5. (Advanced) BofA's stock price values the overall company at just 32% of book value and 51% of tangible book. Define each of these two ratio measures.

6. (Advanced) Why does the author state that the values of the above two ratios indicate that either assets are overstated or liabilities are understated? Based on the discussion in the article, what assets do you think are possibly overstated? What liabilities are possibly understated?

7. (Introductory) BofA "points out the bank has created $18 billion in reserves to deal with repurchase claims" by AIG and others for BofA to repurchase mortgage-backed securities it or Countrywide financial sold prior to the financial crisis. What are these "reserves"? What is another preferred accounting term for these items?
 

Reviewed By: Judy Beckman, University of Rhode Island
 

---

"BofA Pays Price for Taking Equity Hard Line," by David Reilly, The Wall Stree Journal, August 9, 2011 ---
http://online.wsj.com/article/SB10001424053111904140604576496532016849182.html?mod=djem_jiewr_AC_domainid

Brian Moynihan is relearning a painful lesson: There is a difference between the amount of equity a bank needs to run its business and the amount it needs to maintain market confidence.

That's something Mr. Moynihan, chief executive of Bank of America, and every other bank chief should have remembered from the financial crisis. Yet, despite jitters over burgeoning legal threats associated with mortgage-repurchase demands at BofA, Mr. Moynihan has repeatedly said the bank doesn't need more equity.

Having failed to raise equity before the recent stock drop, he may have squandered an opportunity to bulk up the balance sheet. Now, BofA's shareholders are paying the price.

That could put Mr. Moynihan's job in jeopardy.‬

Stock in BofA fell as much as 22% at one point Monday, after dropping a total of 15% on Thursday and Friday last week. Meanwhile, the cost to insure BofA bonds against default leapt by 50%. That is a particularly scary tumble given BofA is the country's largest bank by assets.

To be sure, BofA is being hammered by a confluence of events. Besides its own legal issues, the bank was caught up in the broader market selloff on the back of the U.S. rating downgrade, a flight from financial stocks given debt concerns on both sides of the Atlantic and growing worries the U.S. economy could double dip.Citigroup, for example, also saw its shares fall 20% at one point Monday, even though it doesn't face the same kind of mortgage woe.

Still, BofA is in a particularly precarious position. The stock is now trading at just 32% of book value and about 51% of tangible book. In other words, markets seem to believe BofA's assets are significantly overstated or liabilities understated.

Much of the concern is because investors continue having difficulty gauging the ultimate cost of demands that BofA repurchase shoddy mortgages originated by Countrywide Financial, which it acquired in 2008. One big worry is whether an $8.5 billion settlement the bank reached in June regarding mortgage bonds is coming undone.

That deal was challenged last Thursday by New York State Attorney General Eric Schneiderman. American International Group also joined the fray Monday, filing to oppose the deal and, in a separate action, suing BofA over mortgage bonds it had bought.

BofA has rejected AIG's allegations and defended the settlement with the other mortgage-bond investors. It also points out the bank has created $18 billion in reserves to deal with repurchase claims.

Still, there appears to be little Mr. Moynihan can do to quickly clarify uncertainties about BofA's ultimate losses. Moreover, raising equity with the stock in free fall would prove tough, if not impossible. But the bank shouldn't rule out the possibility.

Continued in article

Why does the market in particular not trust the financial statements of banks?

Amazon Flies Through Clouds in Search of Books
"Amazon Sees a Good Read in the Cloud:  Users can now access all of their Amazon Kindle content on anything with a browser," by Erica Naone, MIT's Technology Review, August 10, 2011 ---
http://www.technologyreview.com/web/38298/?nlid=nldly&nld=2011-08-12

Bob Jensen's threads on electronic books are at
http://www.trinity.edu/rjensen/eBooks.htm

"Cheating: The Experts Weigh In," by: Louis Lavelle, Business Week, July 26, 2011 ---
http://www.businessweek.com/bschools/blogs/mba_admissions/archives/2011/07/cheating_the_experts_weigh_in.html
Thanks to David Albrecht for the heads up.

On July 18, the Bloomberg Businessweek Getting In blog publicized the story of NYU Stern Professor Panos Ipeirotis, who caught 20 percent of his class cheating and found the effort he put into rooting out the cheaters was not worth it. In the future, Ipeirotis said he would assign projects requiring more original thought to creatively channel the energies of his highly competitive students.

Some of those who commented on the blog faulted Ipeirotis, blamed the cheating on the Stern grading curve, or said that cheating was common at many schools. Bloomberg Businessweek asked two ethics experts about the views they expressed.

David Callahan is a senior fellow at Demos, a public policy organization in New York. He has a Ph.D. in politics and has written extensively about ethics on his blog for years and in his book, The Cheating Culture, published in 2004.

John Gallagher is an associate dean for the executive MBA program at Duke University’s Fuqua School of Business, where one of his responsibilities is to prosecute honor code violations. Duke dealt with its own cheating scandal in 2007. It’s use of the episode to reinforce the honor code was applauded by many.

Below is an edited transcript of their interview with reporter Kiah Lau Haslett.

What was your reaction to this story?

David Callahan: I’m not surprised at the high level of cheating among business students; research tells us that business students cheat at among the highest rates of students. I think that a lot of professors often get a lot of pushback for exposing cheating. A professor at the University of Central Florida reported a lot of cheating and he was subjected to a lot of attacks to him as a teacher, that it was somehow his fault. I think there’s a lot of rationalization of students about cheating: They don’t find it surprising and people are cynical. They assume there’s a lot of cheating and it’s not a big deal.

Why do students plagiarize?

David Callahan: I think you have to look at the real, underlying causes. Students are extremely anxious today, they’re incurring record levels of debt to go to college, and they’re relying on scholarships and grants dependent upon maintaining a certain GPA. College is no longer the last stop; now it’s a stepping-stone to a professional school and graduate school. College transcripts and GPA really matter. On the one hand, there’s more pressure than ever before to cheat, and on the other hand there’s a tremendous amount of cynicism. When a professor complains about cheating and points it out, students push back in a cynical way and say, “This is commonplace. What’s the big deal?” Or they push back in a defensive way and say, “The pressure’s on me to get good grades and cheating is one way to do it.”

What are some assignments that make it easy for students to cheat or plagiarize? What are some assignments where it's harder to cheat?

John Gallagher: If you are giving a proctored exam in a closed room, there's going to be far less opportunity than if you are giving an assignment that requires people to do analysis and make recommendations. Many institutions use case studies, so it's likely that somewhere you can find someone who has done an analysis of the case. I think that any time you ask students to personalize their work, talking about its applications and concept, it's very much more difficult. No one has written that material and it's unique.

What is the professor's role or responsibility to ensure students don't cheat?

David Callahan: The responsibility on professors in this day and age is to teach in such a way that makes it harder for students to cheat. They need to take seriously the responsibility to reduce the amount of cheating. It doesn't just fall on students to not cheat. Lots of professors feel overburdened as it is, in terms of their teaching obligations. Many don't want to make the extra effort in reducing cheating, and unfortunately they have to make that effort.

Is this the curve's fault?

David Callahan: A zero-sum game where students have to compete against other students exacerbates the situation. Nobody wants to be the chump who's honest when everyone else is cheating and you're in direct competition for grades.

John Gallagher: I don't think so. [At Fuqua] we have a recommended grade distribution that our professors follow, but they are never required to give a low pass or a failing grade. There's no need for students to cheat. There are all kinds of people who cheat for all kinds of reasons. I don't think that you would ever say that the primary factor or force that leads students to cheat is there's some kind of a curve.

What should the punishment be for students caught cheating? Maximum? Minimum?

David Callahan: For the most part there's typically very little punishment for cheaters, which is one reason why there's so much cheating. You typically get punished with a slap on the wrist: flunk a paper, flunk a class. Rarely are they suspended or expelled. Of course, there are different gradations of punishment. But I think there needs to be more. One incentive to cheat is that the punishment is lax or minimal. If there's no punishment there's no deterrent.

John Gallagher: For us, the maximum punishment is rescinding the degree. We've had five cases of alumni where it was later discovered they cheated in one of their courses and their degrees were revoked. The next is that people are simply expelled from the university and there is a notation on their official university transcript stating they were dismissed from the university because of a cheating conviction.

The least severe punishment I have ever seen is mandatory failing of the course, but in our particular world that has significant ramifications. Anyone who fails a course must take a mandatory one-year leave of absence before being allowed to return to retake the failed course and finish the program. Everyone who graduates must have a minimum 3.0 GPA. If you can imagine a five-semester program with a conviction of cheating the fourth semester and you were given a grade of F in a course, looking at the number of courses remaining, it might be mathematically impossible to maintain a GPA and you'd be academically dismissed.

What do you do when a cheating conviction happens? What happens to the student?

John Gallagher: I never speak to companies [who sponsor EMBA students] because of student privacy issues, but I have witnessed the impact of convictions on students. In my experience, companies treat this very severely. It's a severe violation of ethics and it is not something that I would ever expect a company would ignore or have a wink-wink-nudge-nudge attitude toward at all. In many cases, these companies are paying students' tuition and if they're not financially involved, then they've given them the time they need. They are stakeholders in the student's education, and now the student is caught in an extremely awkward situation having to explain the circumstances. It is very serious. It can destroy someone's career and professional reputation.

What should a school do when this happens?

Continued in article

Bob Jensen's threads on Professors Who Let Students Cheat ---
http://www.trinity.edu/rjensen/Plagiarism.htm#RebeccaHoward

Bob Jensen's threads on plagiarism are at
http://www.trinity.edu/rjensen/Plagiarism.htm

Some years back the Texas State Board of Public Accountancy (TSBPA) declared war on distance education by requiring a minimum of five semester courses (15 credits) of accounting onsite instead of online ---
http://www.cs.trinity.edu/~rjensen/temp/TexasBigBrother.htm

Large universities in Texas such as the University of Texas and Texas A&M have extensive online degree programs in such areas in science and engineering, but not in accountancy where very large and highly-rated onsite accounting degree programs have shown virtually no interest in reaching out to students who are unable to attend classes on campus. In fact, I've suspected for a long time that these major universities have pressured the TSBPA to discourage distance education.

Western Governors University --- http://en.wikipedia.org/wiki/Western_Governors_University

WGU is a competency-based online university where course instructors do not assign grades. Instead the grading is competency based much like professional certification examinations such as the CPA Examination and medical board examinations ---
http://www.trinity.edu/rjensen/assess.htm#ComputerBasedAssessment

"WGU Lassoes Texas," by Steve Kolowich, Inside Higher Ed, August 4, 2011 ---
http://www.insidehighered.com/news/2011/08/04/governor_perry_partners_with_western_governors_university

Western Governors University continued to live up to its name on Wednesday, as Texas Governor Rick Perry announced a partnership with the fast-growing online institution — and was promptly showered with praise from nearly everyone.

Western Governors, a regionally accredited, nonprofit university founded in 1997 by 18 politicians who held that office at that time, represents an alternative model of higher education that has garnered both praise and skepticism.

Aimed at working adults (the average student is 36), Western Governors confers bachelors and master’s degrees based on a student’s ability to demonstrate skills. There are no classrooms and no professors. Students learn online and mostly on their own, with light guidance from their advisers. They take proctored tests at local testing centers whenever they feel they are ready. Students pay tuition — between $2,890 and $4,250, depending on the program — every six months until they graduate, which 40 percent of them do within four years. (First-time, full-time students are considerably less successful, graduating at a 22 percent rate.)

The partnership with Texas will create a state-branded version of Western Governors called WGU-Texas. Texas is the third state to create a local version of Western Governors, which is based in Salt Lake City, Utah; Indiana Governor Mitch Daniels created WGU-Indiana last summer, and the Washington State legislature voted WGU-Washington into existence earlier this year.

Like Indiana and Washington, Texas will not allocate any money out of its state budget to Western Governors, which supports itself based on tuition. However, a Western Governors spokeswoman says the university is currently working with Texas officials to allow Texas residents to spend in-state financial aid grants on the Utah-based institution.

Amid deep cuts to public higher education budgets, Governor Perry earlier this year challenged state institutions to come up with some way to offer a four-year degree program for the total price of $10,000. Alas, WGU-Texas is not the answer to that challenge, said Catherine Frazier, a Perry spokeswoman. The average Western Governors graduate earns a degree in 30 months, or five pay periods; including fees, that means $14,735 for the least expensive degrees (information technology and business), and $21,890 for the most expensive (nursing pre-licensure).

“But, certainly, having this affordable option does prove that a degree can be offered by an institution at an affordable price,” Frazier said.

In its effort to expand into various states, Western Governors has faced criticism from some educators, particularly in Washington state. “[B]rain research demonstrates that real learning requires students to struggle with difficult material under the consistent guidance of good teachers,” wrote Johann Neem, an associate professor of history at Western Washington University, in an April op-ed for The Seattle Times. “WGU denies students these opportunities. In fact, its advertisements pander to prospective students by offering them credit for what they already know rather than promising to teach them something new.”

But advocates say the Western Governors model has its place in the constellation of state higher education systems. For adult students who possess the knowledge and skills to bypass a chunk of the curriculum — either because they have some prior college or because they have picked it up in their working lives — the competency-based model is a good way to avoid the tedium and expense of sitting through redundant classes, the Center for Adult and Experiential Learning has said.

“The idea is that these adult learners will bring certain skills and knowledge to the table and that they [will] be able to use them to accelerate progress toward an academic degree and advance in the workforce,” said Dominic Chavez, a spokesman for the Texas Higher Education Coordinating Board, in an e-mail. “While students will typically be able to gain course credit for having specific knowledge in certain areas, students reach a point at which they acquire new knowledge and skills beyond their existing levels,” Chavez said. “These are the skills that take them to the next level and that offer increased workforce opportunities.”

The WGU-Texas announcement met with glowing praise elsewhere. The partnership “will help address our state's key workforce needs while offering affordable career and continuing education opportunities to Texans over 30," said State Senator Judith Zaffirini, a Democrat who chairs the state senate’s higher education committee, in a statement.

“This low-cost alternative will expand access to more Texans, engaging our diverse student population and upholding our statewide commitment to help more students reach their academic and lifelong goals,” wrote the Texas Coalition for Excellence in Higher Education, a group of former administrative heavyweights from the Texas higher ed system who have challenged much of Governor Perry's higher education agenda.

Rey Garcia, president of the Texas Association of Community Colleges, said his organization was planning a statewide articulation agreement with WGU-Texas that would make it easy for students to finish their bachelor’s degrees at Western Governors after two years at community college. “The traditional universities don’t make it terribly easy for students with an applied science degree [at a community college] to transfer into a baccalaureate,” Garcia said in an interview. “WGU is a lot more flexible in that regard.”

Garcia added that he is not worried students will skip the community colleges altogether and opt for all four years at WGU-Texas because “they’re considerably more expensive than we are.”

But Mary Aldridge Dean, executive director of the Texas Faculty Association, said prospective students — especially younger ones — should consider more than just the price tag when considering enrolling at WGU-Texas.

Continued in article

Question
Why can't the highest scoring CPA Exam taker in the nation probably can't become a licensed CPA in Texas?

Answer
Because in Texas, unlike the other 49 states, nobody can become a CPA without having taken at least five accounting courses onsite. Distance education graduates need not apply for a CPA certificate if they have distance education degrees and/or did not take about half of the required accounting, auditing, and tax courses onsite instead of online.

In effect this means that Texas does not allow full distance education accounting degrees such that even flagship universities like Texas and Texas A&M like flagship universities in Connecticut, Wisconsin, and Maryland have distance education accounting degrees.

March 31, 2011 message from Barbara Scofield

In the state of Texas educators are struggling with ever more onerous rules for candidacy. The AICPA, however, seems to be ignoring issues that loom large for the TSBPA. One of their newly featured "new CPAs" at the link below is an award winner from Colorado (not a 150 hour state) who took her accounting courses online (Texas requires 15 credit hours face to face of upper division accounting courses) from DeVry.

http://www.thiswaytocpa.com/exam-licensure/exam-diary/leslie-rezgui/

Could this person work as a CPA in Texas?

Barbara W. Scofield, PhD, CPA
Chair of Graduate Business Studies
Professor of Accounting
The University of Texas of the Permian Basin
4901 E. University Dr. Odessa, TX 79762
432-552-2183 (Office)

November 5,. 2010 reply from Bruce Lubich <BLubich@umuc.edu>
Note that Bruce is the Director of an online accounting distance education program in the University of Maryland System

Hi Bob,  

When TX first went to the 15 credit requirement, we had a couple of  University of Maryland University College students apply for the exam there,  and be rejected. Our transcript doesn't show which courses were taken  online. Apparently it's on the TX paperwork. Lying on that is not  something to be encouraged for future CPAs. So, unless a student has no  desire to sit for the CPA exam or they just need to fill in a few holes to  qualify, the TX market has dried up for all online programs.

Evidently, the  TX board takes this requirement very seriously, so my guess is that your  Deloitte hire would be denied the ability to sit. Seems to me Deloitte  would need to send the student to a different office until they pass the  exam.   As for reciprocity, I haven't heard of any problems. That doesn't mean  they're not out there, but I haven't heard of them.   Bottom line is TX has protected their investment in their brick & mortar  schools.   At one time LA and New Mexico had similar, though weaker rules like this.  I believe both have woken up and done away with those rules.  

Bruce Lubich 
University of Maryland University College

November 6, 2010 reply from Bob Jensen

Hi Bruce,

Thanks for this.
What you are saying is that the Texas Board may be cooperating with Texas Universities to reserve all entry-level accounting jobs in Texas for only graduates of Texas universities. Graduates from your program in the University of Maryland system can, thereby, not compete for jobs in Texas CPA firms. .

Out-of-state graduates need not apply. Seems like a great idea for the other 49 states so that graduates of a given state have a monopoly on jobs within the state. Of course the national and international CPA firms might object to complications this creates in hiring. And students who want to leave a state might object to not having jobs available anywhere other than the state where they graduated.

Why didn't the European Union think of this as a clever way of restricting labor flows between borders?

Bob Jensen

My threads (rough draft notes) on this antiquated and absurd ruling by the TSBPA (read that Big Brother) can be found at
http://www.cs.trinity.edu/~rjensen/temp/TexasBigBrother.htm

If colleges want to make it more difficult to earn an A, they need to consider why faculty members feel pressure to award them.
Peter Eubanks

"Why We Inflate Grades," by Peter Eubanks, Inside Higher Ed, August 9, 2011 ---
http://www.insidehighered.com/views/2011/08/09/essay_on_why_faculty_members_participate_in_grade_inflation

The University of North Carolina at Chapel Hill made headlines recently by announcing a plan to fight grade inflation: all grades received will be contextualized on student transcripts, allowing graduate schools and potential employers to see grade distributions for each course and thus to determine just how much value to attach to those ever-prevalent As and Bs. This move is the latest in a series of attacks on what is perceived by many (rightly) to be an epidemic in higher education today, particularly among those institutions that seem to do well in the national rankings.

Student anxiety about such policies is understandable. Graduating seniors are naturally concerned about their competitiveness during difficult economic times, while juniors and seniors worry that they may be passed up for fellowships, summer programs, or other academic opportunities on account of a lowered grade-point average.

Professors, too, have their concerns about grade deflation; we not only care about our students’ successes but also about the implications of anti-inflation policies on our own careers. While institutions are increasingly taking measures to combat grade inflation, there are several key pressures faculty members face when assigning grades, and these may cause us to feel uneasy or hesitant about immediately subscribing to a strict regimen of grade deflation. These pressures in no way excuse or minimize the ethical implications of grade inflation, nor do I seek to undermine the efforts of those striving to curtail what is indeed a significant and widespread problem in higher education today. My purpose is only to suggest some of the underlying causes of this epidemic from a faculty perspective; to point out some of the pressures faculty face as they assign their students grades. These pressures, as I see it, come from three primary sources:

Pressure from students: Most professors are experienced in the familiar end-of-semester scene in which a student comes to office hours to argue for a higher grade. Such discussions often involve a student’s disputation of minutiae from past exams, papers, and assignments, all in the hope of gaining a point or two here and there and thus retroactively improving his or her grade. Such discussions can be quite time-consuming, and they often come at the busiest time of the semester, thus bringing with them the temptation to do whatever it takes to close the matter and move along. There may also be a nagging fear that minor grading errors have indeed been made and that the student should be given the benefit of the doubt. With ever-increasing college costs and the inevitable sense of student entitlement and consumerism that follow, such discussions are becoming all too common. and are not always limited to the end of the semester. Even more important, many faculty members dread and even fear the negative classroom atmosphere that often results from giving students "bad" grades (i.e.. C or below, though even a B fits this category for many), particularly in courses dependent on student discussion and participation, such as a seminar or a foreign language class.

Pressure from administrators: Success with student evaluations is a career necessity, whether one is a young scholar seeking the elusive Elysium of tenure or one belongs to that now-majority of faculty members who teach part-time or on an adjunct basis and are dependent on positive student evaluations for reappointment. At teaching-intensive colleges and universities, in particular, student evaluations are often of paramount importance, and faculty members must do what they can to keep their customers happy. Many faculty members feel, and numerous studies seem to suggest, that generous grade distributions correspond to positive teaching evaluations, so many faculty members, under pressure from administrators to produce good evaluations, feel a temptation to inflate grades to secure their own livelihoods. Since administrators usually have neither the time nor the expertise to make independent evaluations of a professor’s teaching ability (imagine a dean with both the leisure and the proficiency to sit in on and evaluate in the same semester both a Russian literature course and an advanced macroeconomics course, without having done any of the previous coursework...) they must rely heavily on student descriptions of what goes on in the classroom, descriptions that are often contradictory and that unfortunately do not always cohere.

Pressure from colleagues: Some faculty who wish to curb grade inflation may feel that they are the only ones fighting the problem. If everyone else is giving out inflated grades, why should they be the ones to stand alone, only to incur the displeasure of students who may be confused by inconsistent standards? As college freshmen arrive on campus increasingly unprepared for college work, faculty members, inheriting a problem passed on to them by their colleagues in secondary education, often have the difficult task of trying to determine reasonable standards of achievement. It takes effort and planning for faculty to balance their professional responsibilities to both their respective disciplines and to their students’ positive academic experience. In an era where budget cuts affect most severely those departments and programs with low enrollments, no one wants to lose the bidding war for students, and many professors, particularly those in vulnerable fields, fear that a "strict constructionist" approach to grade deflation may cost them student interest and consequently much-needed institutional support, both of which risk being redistributed to more favored colleagues. Furthermore, the seemingly ubiquitous nature of grade inflation may simplify the ethical quandaries involved: if everyone understands that grades are being unfairly inflated, then there may, in fact, be no unfairness involved at all, since the very transparency of grade inflation thus removes any sense of deception that may linger in our minds.

There is a final pressure to grade inflate, and it comes from ourselves. It may be the disquieting feeling that our own efforts in the classroom have sometimes been inadequate, that poor student performance reflects poor preparation or teaching on our part, and that grades must be inflated to compensate for our failings. It may come from the difficulties inherent in assigning grades to elusive and ultimately unquantifiable phenomena such as class participation, essays, student presentations, and the like. In such cases, grade inflation ceases to function as a lazy or disinterested tool for maintaining steady waters; it becomes, instead, a corrective measure seeking to make restitution for our own perceived shortcomings.

Continued in article

Bob Jensen's threads on the utter disgrace of grade inflation ---
http://www.trinity.edu/rjensen/HigherEdControversies.htm#GradeInflation

Competency-Based Grading
"Professors Cede Grading Power to Outsiders—Even Computers:  One college gives the job to software, while another employs independent 'evaluators," by Jeffrey R. Young, Chronicle of Higher Education, August 7, 2011 ---
http://chronicle.com/article/To-Justify-Every-A-Some/128528/?sid=wb&utm_source=wb&utm_medium=en

The best way to eliminate grade inflation is to take professors out of the grading process: Replace them with professional evaluators who never meet the students, and who don't worry that students will punish harsh grades with poor reviews. That's the argument made by leaders of Western Governors University, which has hired 300 adjunct professors who do nothing but grade student work.

"They think like assessors, not professors," says Diane Johnson, who is in charge of the university's cadre of graders. "The evaluators have no contact with the students at all. They don't know them. They don't know what color they are, what they look like, or where they live. Because of that, there is no temptation to skew results in any way other than to judge the students' work."

Western Governors is not the only institution reassessing grading. A few others, including the University of Central Florida, now outsource the scoring of some essay tests to computers. Their software can grade essays thanks to improvements in artificial-intelligence techniques. Software has no emotional biases, either, and one Florida instructor says machines have proved more fair and balanced in grading than humans have.

These efforts raise the question: What if professors aren't that good at grading? What if the model of giving instructors full control over grades is fundamentally flawed? As more observers call for evidence of college value in an era of ever-rising tuition costs, game-changing models like these are getting serious consideration.

Professors do score poorly when it comes to fair grading, according to a study published in July in the journal Teachers College Record. After crunching the numbers on decades' worth of grade reports from about 135 colleges, the researchers found that average grades have risen for 30 years, and that A is now the most common grade given at most colleges. The authors, Stuart Rojstaczer and Christopher Healy, argue that a "consumer-based approach" to higher education has created subtle incentives for professors to give higher marks than deserved. "The standard practice of allowing professors free rein in grading has resulted in grades that bear little relation to actual performance," the two professors concluded.

Naturally, the standard grading model has plenty of defenders, including some who argue that claims of grade inflation are exaggerated—students could, after all, really be earning those higher grades. The current system forges a nurturing relationship between instructor and student and gives individualized attention that no robot or stranger could give, this argument goes.

But the efforts at Western Governors and Central Florida could change that relationship, and point to ways to pop any grade-inflation bubble.

An Army of Graders

To understand Western Governors' approach, it's worth a reminder that the entire institution is an experiment that turns the typical university structure on its head. Western Governors is entirely online, for one thing. Technically it doesn't offer courses; instead it provides mentors who help students prepare for a series of high-stakes homework assignments. Those assignments are designed by a team of professional test-makers to prove competence in various subject areas.

The idea is that as long as students can leap all of those hurdles, they deserve degrees, whether or not they've ever entered a classroom, watched a lecture video, or participated in any other traditional teaching experience. The model is called "competency-based education."

Continued

Bob Jensen's threads on competency-based grading ---
http://www.trinity.edu/rjensen/Assess.htm#ECA

Question
How do GMAT scores in your MBA program stack up against the competition from the most prestigious MBA Programs?

"GMAT::  How Low is Too Low for Top B-Schools?" by: Louis Lavelle, Business Week, August 3, 2011 ---
http://www.businessweek.com/bschools/blogs/mba_admissions/archives/2011/08/gmat_how_low_is_too_low_for_top_b-schools.html

Below is a list of publicly available information (or information obtained by Bloomberg Businessweek) on the most recent lowest score or lowest range of scores for our top ten schools. All information is for the Class of 2012. Where available, we’ve provided links to current class profiles.
 

1. Booth School of Business
Median score: 720
Lowest 10 percent: 660 or below
Source: Booth spokesperson

2. Harvard Business School
Median score: 730
Lowest score: 550
Class Profile

3. Wharton School
Median score: 720
Lowest 10 percent: 540
Class Profile

4. Kellogg School of Management
Median score: 720
Lowest 10 percent: 670 or below
Source: Bloomberg Businessweek survey

5. Stanford Graduate School of Business
Median score: 730
Lowest score: 580
Source: Stanford GSB spokesperson

6. Fuqua School of Business
Median Score: 700
Lowest 10 percent: 640 or below
Class Profile

7. Ross School of Business
Average score: 704
Lowest 10 percent: 650 or below
Class Profile

8. Haas School of Business
Average score: 718
Lowest 10 percent: 680 or below
Class Profile

9. Columbia Business School
Median score: NA
Lowest 10 percent: 680 or below
Class Profile

10. Sloan School of Management
Average score: 717
Lowest 10 percent: 680 or below
Class Profile

 

"Enrollments Plunge at Many For-Profit Colleges," by Rachel Wiseman, Chronicle of Higher Education, August 16, 2011 ---
http://chronicle.com/article/Enrollments-Plunge-at-Many/128711/?sid=wc&utm_source=wc&utm_medium=en

. . .

Bucking the Trend

While some of the biggest for-profit colleges saw declines, a few showed enrollment increases. Total enrollment in the American Public University System, which charges $250 per undergraduate credit—less than many of its proprietary peers do—grew 28 percent in the quarter ending June 30. The system is operated by American Public Education Inc.

With a similarly low price point, Bridgepoint Education saw a slight uptick in new-student enrollment. But whether enrollment will continue to climb is open to question, given the company's revelation in May that New York's attorney general is investigating its business practices.

How for-profit enrollments will trend in the future is "difficult to call," said Robert L. Craig, a managing director of the investment bank Stifel Nicolaus. He says external factors such as the economy and federal student aid will affect how well those institutions fare. He expects the for-profit sector will continue to grow in the long term, as emphasis is placed on expanding higher education to a greater portion of Americans and as traditional options for acquiring a degree reach capacity in some states.

But some analysts are concerned that if institutions do not lower their prices, they risk losing applicants and profits. "A lot of these institutions have a cost system that is going to be untenable for the consumer," said Mr. Safalow, as more traditional universities enter into online education and the number of available applicants plateaus. "This is an industry that is closer to saturation than I think most people realize."

 

Jensen Comment
The big exception is American Public Education (University) Inc. that was bolstered when Wal-Mart elected to heavily subsidize employees who elect to further their educations from APE.

Bob Jensen's threads on For-Profit Universities Operating in the Gray Zone of Fraud ---
http://www.trinity.edu/rjensen/HigherEdControversies.htm#ForProfitFraud

Bob Jensen's threads on distance education alternatives (some for-profit universities have onsite as well as online programs) ---
http://www.trinity.edu/rjensen/Crossborder.htm

Teaching Case on How to Overstate Revenues
Auditor Ernst & Young is also named in the $7 billion lawsuit

Jensen Comment
I don't know what it is about The Wall Street Journal, but it is very common for me to be forced to go elsewhere to find the names of the audit firms included in client lawsuits. It's like the WSJ tries to protect audit firms.

From The Wall Street Journal Accounting Weekly Review on September 2, 2011

Sino-Forest CEO Gives Up Position
by: Isabella Steger
Aug 29, 2011
Click here to view the full article on WSJ.com
 

TOPICS: Audit Quality, Auditing, Ethics, Financial Accounting, Financial Statement Analysis, Financial Statement Fraud, Fraud, Fraudulent Financial Reporting

SUMMARY: Sino-Forest Corp. is traded on the Toronto Stock Exchange (TSX) with the symbol TRE. The exchange suspended trading in the company's shares for 15 days beginning Friday, August 26. TSX also ordered the chief executive and other key managing executives to resign on Friday, though that order was then delayed to allow for a hearing first. The current article indicates the executives "resigned voluntarily" over the weekend of August 27 to 28 after "Canadian regulators said the company may have committed fraud." These proceedings began based on "allegations...published by short seller Muddy Waters LLC" (see the related article). This short-selling analyst alleged the company may have overstated revenues and timber holdings; the Ontario Securities Commission also said that the company "'appears to have engaged in significant non-arm's length transactions which may have been contrary to Ontario securities laws and the public interest.'"

CLASSROOM APPLICATION: The article is second in this week's coverage of accounting and auditing issues at Chinese companies traded on North American exchanges. This case involves accounting for revenues and natural resources-timber reserves-and highlights potential issues from non-arm's-length transactions conducted through subsidiaries. Questions on accounting and auditing these areas are posed, but the auditing questions may be deleted for instructors wishing to focus on only the accounting-related issues.

QUESTIONS: 
1. (Introductory) What steps has Sino-Forest undertaken in response to allegations that the company may have committed fraud? List all that you find described in the main and related articles.

2. (Introductory) What areas of accounting are specifically of concern at Sino-Forest Corp.?

3. (Advanced) Name some audit steps that are designed to detect potential accounting problems in these areas of specific concern at Sino-Forest. In your answer, state the audit objectives you would try to achieve by conducting these tests and identify whether they are transaction-related audit objectives or balance-related audit objectives.

4. (Advanced) If Sino-Forest and its management have committed fraud as alleged by analysts and Canadian regulators, are these audit steps that you list above designed to detect this fraud with absolute certainty? Explain your answer.

5. (Advanced) What is a "non-arm's-length transaction"? What is a subsidiary? What potential accounting measurement concerns arise if Sino-Forest has undertaken this type of transaction? Why does conducting the actions through a subsidiary potentially exacerbate these accounting measurement concerns?

6. (Advanced) Name some audit steps that are designed to detect these potential accounting measurement problems stemming from non-arm's-length transactions. In your answer, state the audit objectives you would try to achieve by conducting these tests and identify whether they are transaction-related audit objectives or balance-related audit objectives.
 

Reviewed By: Judy Beckman, University of Rhode Island
 

RELATED ARTICLES: 
Regulator Challenges Sino-Forest Claims
by Caroline Van Hasselt
Aug 27, 2011
Online Exclusive

Special Report: The "Shorts" Who Popped a China Bubble
by Daniel Bases, Ryan Vlastelica, and Clare Bal of the International Business Times
Aug 05, 2011
Online Exclusive

"Sino-Forest CEO Gives Up Position," by: Isabella Steger, The Wall Street Journal, August 29, 2011 ---
http://professional.wsj.com/article/SB10001424053111904199404576536154293011240.html?mod=djem_jiewr_AC_domainid

HONG KONG—Sino-Forest Corp. said its chairman and chief executive resigned and three employees have been temporarily suspended, after Canadian regulators said the company may have committed fraud.

The forestry company said Sunday that Allen Chan voluntarily stepped down as chairman and CEO pending completion of the company's review of fraud allegations published two months ago by short seller Muddy Waters LLC.

Mr. Chan will assume the title of founding chairman emeritus of the Chinese-operated company, shares of which are listed in Toronto. He wasn't available for comment.

William Ardell, lead director and chairman of Sino-Forest's independent committee conducting the investigation, will succeed Mr. Chan as chairman. Sino-Forest Vice Chairman Judson Martin, an executive director, will become chief executive. Mr. Martin also is chief executive of Sino-Forest's Greenheart Group Ltd. unit, shares of which are listed in Hong Kong.

Sino-Forest said Mr. Chan would continue to assist the company's internal investigation and that he had planned to resign before the Ontario Securities Commission on Friday ordered a 15-day trading halt for the company's shares.

The commission issued the order after saying regulators had found that the company may have "misrepresented some of its revenue and/or exaggerated some of its timber holdings." The commission said the company, through its subsidiaries, also "appears to have engaged in significant non-arm's-length transactions which may have been contrary to Ontario securities laws and the public interest."

The commission on Friday ordered executives to resign but revoked the order the same day, saying it would require a hearing.

Sino-Forest's stock is down 72% for the year. The shares took a beating in June when Muddy Waters published its allegations of questionable accounting. The shares closed Thursday at 4.81 Canadian dollars (US$4.90), down 5.7%.

Continued in article

"Beleaguered Sino-Forest facing $7-billion lawsuit," Pulp & Paper Canada, September 1, 2011 ---
http://www.pulpandpapercanada.com/news/beleaguered-sino-forest-facing-7-billion-lawsuit/1000550204/

.. . .

The lawsuit seeks money for those who bought Sino-Forest shares on the stock market and through the company's public offering.

The claim names several Sino-Forest executives, including former CEO Allen Chan, auditor Ernst & Young, and financial institutions that acted as underwriters for the company's 2009 prospectus offering. They include TD Securities, Dundee Securities, RBC Securities, Scotia Capital, and CIBC World Markets.

The lead plaintiffs in the suit are the Labourers' Pension Fund of Central and Eastern Canada and the International Union of Operating Engineers Local 793 pension plan.

If the suit is granted class-action status, any judgements or settlements would be available to all members of the class.

The allegations against Sino-Forest have not been proven in court.

Continued in Article

Bob Jensen's threads on Ernst & Young are at
http://www.trinity.edu/rjensen/Fraud001.htm

Bank of America --- http://en.wikipedia.org/wiki/Bank_of_America
BofA was riding high after the 2009 financial crises until it acquired the disasters called Countrywide and Merrill Lynch!

Merrill Lynch had a friend in Hank Paulson, but he was no friend to Bank of America shareholders
The ex-US Treasury Secretary has admitted telling the Bank of America boss he might lose his job if he walked away from a merger from Merrill Lynch. The former US Treasury Secretary says the merger was necessary Hank Paulson warned the bank's chief executive Kenneth Lewis that the Federal Reserve could oust him and the board if the rescue did not proceed. But Mr. Paulson insisted that remarks he made were "appropriate." Bank of America bought Merrill during the height of the financial crisis and suffered severe losses.
"Paulson admits bank merger threat," BBC News, July 15, 2009 ---
http://news.bbc.co.uk/2/hi/business/8152858.stm
 

Jensen Comment
Paulson's claim that his threats were "appropriate" comes as little comfort to Bank of America shareholders who will be losing greatly because of the threats.

Bank of America is now paying a steep (fatal?) price for having purchased the fraudulent Countrywide and Merrill Lynch companies. The poison-laced Countrywide was a lousy investment decision. However, then CEO Kenneth D. Lewis contends that then Treasury Secretary Hank Paulson held a gun to his head and forced BofA to buy the deeply corrupt and poison-laced Merrill Lynch.

"BofA plunges as AIG sues for $10 billion "fraud," by Jonathan Stempel and Joe Rauch, Reuters, August 8, 2011 ---
http://www.reuters.com/article/2011/08/08/us-bankofamerica-aig-lawsuit-idUSTRE7772LN20110808

Bank of America Corp shares plunged more than 20 percent on Monday, capping a three-day rout in which the largest U.S. bank lost nearly one-third of its market value.

Monday's decline was triggered by a $10 billion lawsuit from American International Group Inc alleging a "massive" mortgage fraud.

The action raised new concerns about burgeoning losses related to the bank's $2.5 billion purchase of Countrywide Financial Corp in 2008 and prompted questions about the stability of the bank's management team.

"The bank just can't get its hands around the liabilities it's facing," said Paul Miller, an analyst at FBR Capital Markets.

He said investors fear the bank will have to raise equity to cover potential losses, diluting existing shareholdings.

Bank of America spokesman Jerry Dubrowski countered that the bank has adequate reserves to buy back mortgages if necessary and is comfortable with its strategic plans.

"We don't think we need to raise capital to run our businesses," he said. "We have the right strategy and management team in place."

In a separate court filing on Monday AIG, challenged an $8.5 billion agreement Bank of America reached in late June to end litigation by several large investors who bought securities backed by subprime Countrywide loans.

New York Attorney General Eric Schneiderman and other investors have previously tried to block that accord, saying the settlement amount is too small.

Bank of America shares closed down $1.66 at $6.51 after earlier plunging to $6.31, their lowest since March 2009. More than $30 billion of the company's market value has been wiped out since August 3.

Monday's drop came amid a broad market selloff, led by financial stocks, on the first trading day after Standard & Poor's downgraded its rating of U.S. government debt.

The shares of Citigroup Inc, another large bank, fell 16.4 percent to $27.95.

The cost of insuring Bank of America debt against default, an indicator of potential trouble at companies, rose roughly 50 percent on Monday to a level higher than several of the bank's main rivals, data provider Markit said.

It now costs $310,000 a year to insure the bank's bonds for five years, compared with $143,000 for the bonds of JP Morgan Chase & Co, the second largest U.S. bank.

CONFIDENCE AND TRUST

AIG's lawsuit also upped the ante for Bank of America Chief Executive Brian Moynihan, who is struggling to contain losses from the Countrywide deal engineered by his predecessor, Kenneth Lewis.

"Brian Moynihan and the management team have not gained the confidence and trust of investors," said Jonathan Finger, whose Finger Interests Number One Ltd in Houston owns BofA stock and was a vocal critic of Lewis.

Moynihan is scheduled to participate in a public conference call on Wednesday hosted by Fairholme Capital Management LLC, one of its largest shareholders.

"Brian will have to give the performance of his life," said Tony Plath, a professor at the University of North Carolina at Charlotte, where Bank of America is based.

Moynihan's saving grace might be that the bank's board has no obvious candidates to replace him, said Miller of FBR Capital Markets.

Some large investors appeared to have avoided some of the debacle.

Hedge fund manager David Tepper, who has made a fortune betting against financial company shares, sold nearly half of his stake in Bank of America during the second quarter, according to a regulatory filing from his company, Appaloosa Management.

"Bank of America's stock price will remain under duress," said Michael Mullaney, who helps invest $9.5 billion at Fiduciary Trust Co in Boston and who said his company has sold nearly all its BofA shares.

Continued in article

Bob Jensen's threads on the subprime mortgage scandals ---
http://www.trinity.edu/rjensen/2008Bailout.htm

From The Wall Street Journal Accounting Weekly Review on August 4, 2011

Ex-E&Y Auditors Barred by PCAOB
by: Michael Rapoport
Aug 02, 2011
Click here to view the full article on WSJ.com
 

TOPICS: Audit Firms, Audit Quality, Auditing, PCAOB, Public Accounting, Public Accounting Firms

SUMMARY: The Public Company Accounting Oversight Board (PCAOB) barred two former Ernst & Young LLP employees, Peter C. O'Toole and Darrin G. Estella, "...from auditing public companies, alleging they provided misleading documents to inspectors who were evaluating the accounting firm's work... [The men also have been barred] from associating with public accounting firms for at least three years and at least two years, respectively."

CLASSROOM APPLICATION: The article is useful to cover ethics, the function of the PCAOB, and the reputational foundation for the public accounting profession-typical topics in an opening chapter of an auditing text.

QUESTIONS: 
1. (Advanced) What is the Public Company Accounting Oversight Board (PCAOB)? What are the organization's responsibilities?

2. (Introductory) According to the PCAOB, what did Peter C. O'Toole and Darrin G. Estella do to some audit workpapers?

3. (Advanced) What options for action are available to the PCAOB when finding something such as Messrs. O'Toole and Estella did? What actions did the PCAOB take and what has been the result?

4. (Advanced) An attorney for Mr. O'Toole "...noted that the PCAOB didn't allege any deficiencies in the audit, nor...[that] the men were trying to hid any audit failure or lie about the work that was actually done...." Then how has the announcement of these men's actions by the PCAOB harmed the accounting and auditing profession?

5. (Advanced) Do you think what Messrs. O'Toole and Estella did was ethically acceptable? Support your answer.
 

SMALL GROUP ASSIGNMENT: 
Question for small group discussion: Suppose you are asked by a superior to introduce an audit workpaper or alter an audit workpaper after completing an audit engagement. What would you do? What impact will your decision have on your immediate future? On your potential long term future?

Reviewed By: Judy Beckman, University of Rhode Island

"Ex-E&Y Auditors Barred by PCAOB," by: Michael Rapoport, The Wall Street Journal, August 2, 25011 ---
http://professional.wsj.com/article/SB20001424053111904292504576482550957477580.html?mod=djem_jiewr_AC_domainid

The government's audit overseer barred two former Ernst & Young LLP employees from auditing public companies, alleging they provided misleading documents to inspectors who were evaluating the accounting firm's work.

The Public Company Accounting Oversight Board barred Peter C. O'Toole and Darrin G. Estella, a former partner and former senior manager in E&Y's Boston office, from associating with public accounting firms for at least three years and at least two years, respectively. Mr. O'Toole also was fined $50,000.

The PCAOB said Mr. O'Toole's three-year bar was the longest it had ever imposed on a partner of a Big Four accounting firm. The two men agreed to settlements with the PCAOB but didn't admit or deny the board's findings. Mr. O'Toole and Mr. Estella may apply to remove their bars after three and two years, respectively.

The PCAOB said that shortly before its inspectors were to scrutinize an E&Y audit of an unidentified company in 2010 as part of its regular inspections of the firm, Mr. O'Toole and Mr. Estella created, backdated and placed in the audit file a document concerning the valuation of one of the audit client's investments, the most important issue in the audit. Mr. O'Toole also allegedly authorized other members of the audit team to alter other working papers in advance of the inspection. The changes weren't disclosed to the PCAOB, the board said.

Ernst & Young said in a statement that it had "separated" both men from the firm after it determined that its policy prohibiting supplementing or changing audit documents had been violated. E&Y said it cooperated fully with the PCAOB's investigation, and that Mr. O'Toole's and Mr. Estella's conduct had no impact on the client's financial statements or on E&Y's audit conclusions.

Continued in article

Bob Jensen's threads on Ernst & Young are at
http://www.trinity.edu/rjensen/Fraud001.htm

China Yurun Foods has generated about 9% of its profit from goodwill....That should be a red flag for investors.

From The Wall Street Journal Accounting Weekly Review on September 2, 2011

China's Yurun Seeks Investor Goodwill
by: Duncan Mavin
Aug 13, 2011
Click here to view the full article on WSJ.com
 

TOPICS: Advanced Financial Accounting, Audit Quality, Auditing, Business Ethics, Goodwill

SUMMARY: "Since 2006, China Yurun Foods has generated about 9% of its profit from goodwill....That should be a red flag for investors....Several areas in the firms' accounts are under scrutiny from investors, including high levels of government subsidies, which are above industry norms, and margins that appear out of whack with those of its peers." The article notes that Yurun and its auditors KPMG declined to comment on the issues raised in this article.

CLASSROOM APPLICATION: The article is useful to discuss the topic of negative goodwill. It also may be used to generally cover financial statement analysis used for either investment decision-making or audit reasonableness testing. This article is the first of three this week discussing the current rash of concerns with financial reporting by Chinese companies traded on North American exchanges.

QUESTIONS: 
1. (Introductory) What business combination transactions did the Hong Kong- based company Yurun undertake in the last five years?

2. (Advanced) What is negative goodwill? How does this account balance arise from a business combination transaction?

3. (Advanced) What parts of the accounting for a business combination giving rise to negative goodwill-or positive goodwill-are subject to management judgment?

4. (Advanced) What are a company's auditors-in this case, KPMG LLP-responsible for doing to assess the reasonableness of asset values assigned by a company in business combination transactions? In this case, what issue raises questions about concerns in those valuations?

5. (Introductory) Refer to the related article as well as comments in the main article regarding "several areas in the firms accounts" that are "under scrutiny." What are investors analyzing in company's annual reports? What investment actions are they taking based on their assessments?
 

Reviewed By: Judy Beckman, University of Rhode Island
 

RELATED ARTICLES: 
Special report: The "Shorts" Who Popped a China Bubble
by Daniel Bases, Ryan Vlastelica, and Clare Bal of the International Business Times
Aug 05, 2011
Online Exclusive

"China's Yurun Seeks Investor Goodwill," by: Duncan Mavin, The Wall Street Journal, August 13, 2011 ---
http://professional.wsj.com/article/SB10001424053111904332804576540364006721704.html?mod=djem_jiewr_AC_domainid

Five years of "negative goodwill" sounds like a run of seriously bad luck. For China Yurun Foods Group, the opposite is true.

Since 2006, China Yurun Foods Group has generated about 9% of its profits from negative goodwill, an accounting quirk that allows the company to mark up the value of the pig slaughterhouses it buys. That should be a red flag for investors.

Yurun, a Hong Kong-listed pork processor with a market capitalization of about $4.2 billion, has bought eight slaughterhouses at knock-down prices over the past five years and booked 587 million Hong Kong dollars (US$75.3 million) in gains.

To generate profits this way from negative goodwill several years running and across multiple transactions is highly unusual, says Prof. Gary Biddle, chairman of accounting at the University of Hong Kong. [yurunherd0830] Bloomberg News

Yurunshares lost a third of their value since mid-June.

Negative goodwill is rare because sellers don't usually part with their assets at bargain prices. The other concern is it is the buyer who determines how much it underpaid for the assets and what they are worth now.

The company and its auditors KPMG declined to comment.

Yurun is one of a number of Chinese businesses under fire from short sellers targeting alleged accounting problems. The company's shares have already lost a third of their value since mid-June, and several areas in the firm's accounts that are under scrutiny from investors. Another area of concern: High levels of government subsidies, which are above industry norms, and margins that appear out of whack with those of its peers.

Continued in article

Jensen Comment
This reminds me of the KPMB twist

KPMG’s “Unusual Twist”
While KPMG's strategy isn't uncommon among corporations with lots of units in different states, the accounting firm offered an unusual twist: Under KPMG's direction, WorldCom treated "foresight of top management" as an intangible asset akin to patents or trademarks.  
See  http://www.trinity.edu/rjensen/FraudEnron.htm#WorldcomFraud

Punch Line
This "foresight of top management" led to a 25-year prison sentence for Worldcom's CEO, five years for the CFO (which in his case was much to lenient) and one year plus a day for the controller (who ended up having to be in prison for only ten months.) Yes all that reported goodwill in the balance sheet of Worldcom was an unusual twist.

Bob Jensen's threads on goodwill and other impairment issues ---
http://www.trinity.edu/rjensen/Theory02.htm#Impairment

Grumpy Old Accountants
"Paper Tigers: The U.S. Accounting Oversight Regime," by Anthony H. Catanach Jr. and J. Edward Ketz, Grumpy Old Accountants Blog, August 2011 ---
http://accounting.smartpros.com/x72497.xml

Jensen Comment
I really had more hope when the PCAOB took on many of the responsibilities of state CPA societies when it came to sanctioning audit firm bad behavior and negligence. And indeed the PCAOB's audit inspection reports are far more rigorous, and the largest auditing firms have been called on the carpet so many times that it's becoming clear that clients are not necessarily getting what they pay extra for to get a more expensive international auditing firms.

Francine, Tony, Ed, Jim, Tom, David, and other leading bloggers are disclosing more and more problems with the new sheriff in town. Penalties for fraud and negligence that are handed down by the PCAOB and the SEC are becoming so lenient that they hardly discourage repeat auditor fraud and negligence.

What's lacking is the rap sheet impact on punishment. I criminal courts, repeat offenders eventually find their punishments grow harsher and harsher with each new violation. Auditing firms, on the other hand, are merely brushing aside the latest marshmallows thrown at them by the oversight regimes.

It may be time for punishments that match the crime, especially for repeat offenders.

Meanwhile the PCAOB is contemplating a disastrous solution that will bring down the good guys along with the bad guys.  I'm talking here about the dangerous proposal being contemplated to require mandatory audit firm rotation. Go get the bad guys and make them pay even when they are among the good guys in a given firm. But don't make the good guys and clients pay for bad things they did not do.

Teaching Case on PCAOB Proposal to Rotate Auditing Firms

From The Wall Street Journal Accounting Weekly Review on August 19, 2011

Curbs on Auditor Terms Explored
by: Michael Rapoport
Aug 17, 2011
Click here to view the full article on WSJ.com
 

TOPICS: Audit Committee, Audit Firms, Audit Quality, Auditing, Auditing Services, Auditor Changes, Auditor Independence, Public Accounting, Public Accounting Firms

SUMMARY: "The [Public Company Accounting Oversight Board (PCAOB)] voted Tuesday to explore whether companies should have to change their outside auditors every several years, with the aim of improving audit quality and auditors' independence from their clients."

CLASSROOM APPLICATION: The article is useful in an auditing class to introduce the process of engaging auditors, auditor rotation, professional skepticism, and the PCAOB.

QUESTIONS: 
1. (Introductory) What is the Public Company Accounting Oversight Board (PCAOB)? What is this entity proposing with regard to the engagement of CPAs performing audits of financial statements?

2. (Advanced) Who engages a certified public accountant to provide an audit opinion on annual financial statements?

3. (Advanced) Define the term "professional skepticism" in performing an audit. According to the article, what evidence exists that auditors may have difficulty maintaining professional skepticism on audit engagements?

4. (Advanced) What are the negative points related to the PCAOB proposal? How could those problems lead to difficulty in accomplishing the goals of an audit just as a lack of professional skepticism might do?
 

Reviewed By: Judy Beckman, University of Rhode Island
 

"Curbs on Auditor Terms Explored," by: Michael Rapoport, The Wall Street Journal, August 17, 2011 ---
http://professional.wsj.com/article/SB10001424053111903480904576512351445912480.html?mod=djem_jiewr_AC_domainid

The U.S. government's auditing regulator voted Tuesday to explore whether companies should have to change their outside auditors every several years, with the aim of improving audit quality and auditors' independence from their clients.

The move by the Public Company Accounting Oversight Board is the first step toward requiring auditor "term limits" that could break up client-auditor relationships that have lasted decades or even more than a century in some cases.

Supporters say the move would help alleviate coziness between audit firms and clients that could lead an auditor to be not as skeptical as it should be in questioning a company's books. Critics say it would increase costs to companies as a new auditor gets up to speed and would deprive companies of a longstanding auditor's institutional knowledge.

Investors "would be better positioned and the capital markets would be better served if we could increase the skepticism of auditors," said Joseph Carcello, a University of Tennessee professor who serves on two advisory boards that counsel the auditing watchdog. "This is one proposal that may get us there."

The consideration of mandatory audit-firm rotation is still in its early stages. The board is accepting public comments on rotation, and soliciting input on other audit-independence ideas, until Dec. 14. It plans to hold a public discussion next March on the possibility of rotation. Any move to require rotation would be subject to approval by the Securities and Exchange Commission.

Board Chairman James Doty said it is important to explore audit-firm rotation as a move that might help counter the pressures, incentives and mindset that might lead a longstanding auditor to go easy on a client.

"For example, when we see auditors marketing themselves to potential clients as 'a partner in supporting and helping' the client 'achieve its goals,' it's hard not to question whether their mindset might have contributed to some of these audit failures," Mr. Doty said at the board's meeting Tuesday.

Michael Gallagher, a managing partner at PricewaterhouseCoopers LLP, said in a statement that PwC wants to discuss how to improve audit quality, but "we are not supportive of mandatory audit-firm rotation." The firm believes the move could have "negative consequences"—for example, he said, it limits the discretion of a company's audit committee in choosing the auditor it believes is best suited to that company's needs.

Mandatory rotation or any other new requirements should "meet the objective of improving audit quality," and making sure any benefits of new rules are worth the costs "should be central to the project," said Cindy Fornelli, executive director of the Center for Audit Quality, an accounting-industry group.

Audit-firm rotation has been proposed before, notably in the discussions after the Enron Corp. and WorldCom Inc. accounting scandals that led to passage of the Sarbanes-Oxley corporate-overhaul law in 2002. In that case, Congress ultimately said the General Accounting Office—as the Government Accountability Office was known at the time—should study the issue, and the GAO, amid opposition from accounting firms and their clients, said rotation "may not be the most efficient way" to improve audit quality and auditor independence.

But the GAO also said regulators could consider further auditor-independence steps after they had had time to evaluate the effectiveness of Sarbanes-Oxley's overhauls. Members of the auditing oversight board said the timing is appropriate now, since the board has inspected accounting firms for several years and uncovered hundreds of audit failures, indicating auditor independence may still be a problem.

Continued in article

Jensen Comment
How some AECM actives vote, to date, on proposals to have mandatory rotation of audit firms of public company clients as long as the rotations are not too often (nothing less than 5-7 years between required rotations). Note that this is rotation between firms and not just the present rules for rotating auditors within one auditing firm assigned to a particular client.

Tom Selling (Yes)


Bob Jensen (No)

Doty's initiative probably has epsilon chance of eventually happening in the near future. It ain't going to happen until more Andersen type audits happen that once again threaten the very foundation of securities markets --- when investors commence abandoning the securities markets in droves because of distrust of audited financial statements.


Personally, I think there are better ways around the auditor independence issue than rotating audits between Big Four firms. Firstly, there are many huge international clients such that fixed costs of taking on a new huge client are enormous. Deloitte found this out when it had to bring over 600 new auditors to Washington DC when KPMG was fired from the audit of Fannie Mae and Deloitte took on the responsibility.


Secondly the cost of dismantling after the loss of a huge client are enormous, especially in a local office that's responsible for most of the audit of a large client. Did KPMG have to ship over 600 auditors out of Washington DC when it was fired from the Fannie Mae audit?


Thirdly, if there are only four firms that can really take on the largest clients in the world, the advantages of rotation are minimal, and "random rotation" is a bad joke. In this case I like Jim's carousel metaphor.
 

Jim Peterson (No) ---
http://www.jamesrpeterson.com/home/2011/08/mandatory-auditor-rotation-the-pcaob-sails-off-th-charts.html


Francine Mckenna (No) ---
http://retheauditors.com/2011/08/15/dear-pcaob-my-response-to-your-request-for-comments/

Bob,
You make excellent points about firm specialization (Jim P. did too from a country perspective) and the lack of true geographic mobility of staff even within the United States. There's the licensing issues and local taxes to deal with too. If an auditor works in another state they have to be licensed and pay local income taxes and head taxes like in NYC, Ohio, some cities, etc. It's a nightmare. They'd rather layoff staff if they lose a big client in NYC as Deloitte did during crisis (lost Bear Stearns and Merrill Lynch) and hire new cheaper grads in midwest or west for those new clients. Practices are run locally, rewards are dished out on local office results primarily, and partners protect their teams and won't pay another partner for their staff especially if they are higher paid and require travel.

Francine

Francine has a recent summary of her reactions to various PCAOB proposals and to some recent court decisions involving audit firms as defendants ---
http://retheauditors.com/2011/08/15/dear-pcaob-my-response-to-your-request-for-comments/

As I recall virtually all commentators on the AECM have been opposed to having the public sector (read that government) takeover private sector auditing. One exception has been David Albrecht who said that he favors government auditing but he did not elaborate on why the government would do a better job in the best interests of investors.
 

The Saga of Auditor Professionalism and Independence ---
http://www.trinity.edu/rjensen/Fraud001c.htm

"The Berkshire Hathaway Corporate Governance Performance," by Francine McKenna, re:TheAuditors, September 2, 2011 ---
http://retheauditors.com/2011/09/02/the-berkshire-hathaway-corporate-governance-performance/

. . .

Buffett’s reluctance to sell loser portfolio operating companies or fire under performing managers means he has to make repetitive $5 billion Bank of America and Goldman Sachs preferred stock plays to compensate for tragic flaws like misplaced loyalty and day-to-day conflict avoidance.

And then there’s the numbers.

Berkshire Hathaway is a publicly traded company, listed on the New York Stock Exchange and regulated by the Securities and Exchange Commission. The integrity of Berkshire Hathaway’s external financial reporting should be ensured by the strictures of the Sarbanes-Oxley Act of 2002. Berkshire Hathaway and Warren Buffett, however, pay no more than lip service to the requirements and reject many other recommended corporate governance practices.

What’s left – of the financial reporting process, the internal audit organization, and the external audit relationship – is not enough, in my opinion, to prevent someone from spinning straw into gold.

Questionable corporate political campaign finance practices and foreign corrupt practices in the mid -1970s prompted the U.S. Securities and Exchange Commission and the U.S. Congress to enact campaign finance law reforms and the 1977 Foreign Corrupt Practices Act (FCPA) which criminalized transnational bribery and required companies to implement internal control programs. The Treadway Commission, a private-sector initiative, was formed in 1985 to inspect, analyze, and make recommendations on fraudulent corporate financial reporting. The original chairman of the Treadway Commission was James C. Treadway, Jr., Executive Vice President and General Counsel, Paine Webber and a former Commissioner of the U.S. Securities and Exchange Commission.

The accounting industry regulator, the PCAOB, tells us that existing auditing standards are neutral regarding the internal control framework that auditors use for obtaining an understanding of internal controls over financial reporting (ICFR), testing and evaluating controls, and, in integrated audits, reporting on ICFR. For integrated audits, PCAOB standards state that auditors should use the same internal control framework that management uses.

Since the Committee Of Sponsoring Organizations of the Treadway Commission’s (COSO) Internal Control-Integrated Framework (IC-IF) was published in 1992, many companies and auditors have used IC-IF as their framework in considering internal control over financial reporting. Also, since companies and auditors began reporting on the effectiveness of ICFR pursuant to §404 of Sarbanes-Oxley Act of 2002, many of those companies and auditors have used IC-IF as the framework for evaluating and reporting on ICFR.

Before leading the Treadway Commission, before the savings and loan scandals of the 1980’s, before Enron and the rest of the scandals of the 90’s such as WorldCom, Tyco, Adelphia, HealthSouth, and many others, James Treadway, SEC Commissioner, made a speech about financial fraud.  His remarks specifically mentioned corporate structure, in particular a decentralized organizational structure, as a common characteristic of companies involved in financial fraud.

An excerpt of remarks by James Treadway to the Third Annual Southern Securities Institute, Miami Beach, Florida, April 8,1983

I refer to a decentralized corporate structure, with autonomous divisional management. Such a structure is intended to encourage responsibility, productivity, and therefore profits—all entirely laudable objectives. But the unfortunate corollary has been a lack of accountability.

The situation has been exacerbated when central headquarters has unilaterally set profit goals for a division or, without expressly stating goals, applied steady pressure for increased profits. Either way, the pressure has created an atmosphere in which falsification of books and records at middle and lower levels became possible, even predictable. This atmosphere has caused middle and lower level management and entire divisions to adopt the attitude that the outright falsification of book and records on a regular, on going, pervasive basis is an entirely appropriate way to achieve unrealistic profit objectives, as long as the falsifications get by the independent auditors, who are viewed as fair game to be deceived.

Treadway goes on to describe a company that’s almost an exact replica of Berkshire Hathaway.  What’s most troubling is that nearly thirty years later there’s no excuse – lack of technology, real time communications, or specific regulatory requirements -  for these conditions to still exist in a company of the size and systemic importance of Berkshire Hathaway. The weaknesses remain by design, not by default, which begs the question of whether they could serve an illegal or unethical purpose at any time.

Continued in article

"Bringing banks to book Financial institutions are not going to voluntarily embrace honesty and social responsibility - there is little evidence they do so now," by Prem Sikka, The Guardian, February 27, 2008 --- http://commentisfree.guardian.co.uk/prem_sikka_/2008/02/bringing_banks_to_book.html

Bob Jensen's threads on corporate social responsibility accounting are at
http://www.trinity.edu/rjensen/Theory02.htm#TripleBottom

Bob Jensen's threads on corporate governance ---
http://www.trinity.edu/rjensen/Fraud001.htm#Governance

"METHODOLOGY IN ACCOUNTING RESEARCH: A critique of taxonomy," by Taiwo Olalere, SSRN, September 2, 2011 ---
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1921192

September 6, 2011 reply from Bob Jensen

Hi Taiwo,

I thank you for this summary paper that contains a great summary of references.

My suggestions for improvements include the following:

Where you discuss empirical methods, please stress the importance of timely and extensive validation and replication. The virtual lack of these in accountics research seems to say a lot about the lack of importance in the findings of accountics science relative to real science.

When you discuss analytical accounting research please stress the Achilles heel of virtually all of those studies --- the realism of the untested underlying assumptions. This overlaps with the questions about empirical research when the underlying assumptions are not validated.

Do more to stress the limitations as well as the advantages of each method. For example, former AAA President Gary Sundem wrote the following as quoted at
http://www.trinity.edu/rjensen/395wpTAR/Web/TAR395wp.htm

 

The following is a quote from the President’s Message of Sundem [1993, p. 3]:

Although empirical scientific method has made many positive contributions to accounting research, it is not the method that is likely to generate new theories, though it will be useful in testing them. For example, Einstein’s theories were not developed empirically, but they relied on understanding the empirical evidence and they were tested empirically. Both the development and testing of theories should be recognized as acceptable accounting research.

It would be really helpful if you provided frequency distributions of appearance of each of your methodologies in leading accounting research journals ---
Updated BYU Study (especially David Woods):  Universities Ranked According to Accounting Research ---
Issues in Accounting Education, November 2010, Volume 25, Issue 4, pp. 613-xv
http://www.byuaccounting.net/rankings/univrank/rankings.php
 

It would also be interesting to discuss the history of these methods in accounting research. When did some methods replace other methods in leading accounting research journals and what were the advantages and limitations of these takeovers. For example see Appendix 1 at
http://www.trinity.edu/rjensen/TheoryTAR.htm

What went wrong in accounting/accountics research? 
How did academic accounting research become a pseudo science?
http://www.trinity.edu/rjensen/theory01.htm#WhatWentWrong

"Ernst & Young Lehman Litigation: It’s No Victory If You’re Going To Trial," by Francine McKenna, re:TheAuditors, July 29, 2011 ---
http://retheauditors.com/2011/07/29/ernst-young-lehman-litigation-its-no-victory-if-youre-going-to-trial/

It wasn’t even a verdict. Just a decision by New York Federal Court Judge Lewis Kaplan in one Lehman failure case Ernst & Young is fighting. A decision to allow substantially all of the allegations against Lehman executives and at least one of the allegations against Ernst & Young to move forward to discovery and trial.

That is, if there’s not a settlement first.

Yesterday I wrote up my analysis of the decision by Judge Kaplan for my column, “Accounting Watchdog”, at Forbes. In the interest of time and space, I stuck to commenting on the Ernst & Young portion of the decision.

Judge Kaplan dismissed the majority of the allegations against Ernst & Young. The same things auditors are always dismissed for. The only thing that’s new about the judge’s opinion is an indictment of the accounting standards themselves.

The Third Amended Complaint points to several General Standards (“GS”), interpretive Statements on Auditing Standards (“AU”), and Statements of Fieldwork that allegedly are part of GAAS and that E&Y allegedly violated. Many 288 of those standards are couched in rather general and in some cases inherently subjective terms. They require, for example, that the auditor plan the audit engagement properly, use “due professional care,” exercise “professional skepticism,” and “assess the risk of material misstatement due to fraud” – all matters as to which reasonable professionals planning or conducting an audit reasonably and frequently could disagree.

Bearing in mind that E&Y’s GAAS opinion, just like those rendered by all or substantially all accounting firms, is explicitly labeled as just that – an opinion that the audit complied with these broadly stated standards – more is necessary to make out a claim that the statement of opinion was false than a quarrel with whether these standards have been satisfied.

Or is this really news?

Judge Richard Posner during oral arguments in Fehribach v. Ernst & Young LLP, 2007 WL 2033734 (7th Cir. 7/17/07) (pdf),

“Posner: The auditor’s responsibility … so far as the company is concerned … is to make sure the [numbers] are accurate….  You don’t need an auditor to tell you your market is collapsing….  The auditors are not supposed to have business insight.  They’re counters.  They’re not supposed to make predictions about how your markets are doing.  They’re supposed to reconcile your books and indicate you’re not a going concern because your debt is too high and so on….

Do you think the auditor is supposed to know about market power?…  An auditor is not an economic consultant who goes out and figures out what the market trends in an industry are!…Your trends? That’s what the company knows. [Plantiff’s Attorney: You’re right. Here’s what the auditor’s responsibility under SAS 59...]

 

Posner: That is too vague for me…”

To his credit, Judge Kaplan does leave one important one allegation for Ernst & Young to defend:

Ernst & Young had reason to know that Lehman’s 2Q 2008 financial statements could be materially misstated because of the extensive use of Repo 105 transactions.

John McDermott of FT Alphaville does a good job explaining why:

Kaplan dismisses the majority of the specific allegations against the auditors but writes that one particular incident means that the case against them cannot be thrown out [when] he stops to ask another question on Repo 105:

 

In other words, have plaintiffs sufficiently alleged that E&Y knew enough about Lehman’s use of Repo 105s to “window-dress” its period-end balance sheets to permit a finding that E&Y had no reasonable basis for believing that those balance sheets fairly presented the financial condition of Lehman?

The answer: yes, in one case.

Plaintiffs rely for this purpose on precisely the same alleged red flags discussed previously in connection with E&Y’s GAAS opinion – the “true sale” opinion, the netting grid, and the Lee interview. The first two are no stronger in this context than in that. The Lee interview, however, is a different matter.

The “Lee interview” pertains to warnings allegedly made by Matthew Lee, Lehman’s SVP for Global Balance Sheet and Legal Entity Accounting, that Ernst & Young were told of a $50bn repo 105 move in June 2008 but did not pass on the full information to Lehman’s board. Thus, it failed to fulfill GAAP requirements as part of its Q2 2008 auditing.

I’ve been saying for a while that there’s too much deflective focus on the accounting for Repo 105 and not enough on the disclosure. And I took particular exception early on to Ernst & Young’s handling of the Matthew Lee “whistleblower” situation:

Ernst & Young failed to follow professional standards of care with respect to communications with Lehman’s Audit Committee.

Ernst & Young failed to follow professional standards of care with respect to an investigation of a whistleblower claim

Lehman’s own Corporate Audit group led by Beth Rudofker, together with Ernst & Young, investigated allegations about balance sheet substantiation problems made in a May 16, 2008 “whistleblower” letter sent to senior management by Matthew Lee. On June 12, 2008, during the investigation, Lee informed Ernst & Young about Lehman’s use of $50 billion of Repo 105 transactions in the second quarter of 2008. At a June 13, 2008 meeting, Ernst & Young failed to disclose that allegation to the Board’s Audit Committee. (Bankruptcy Examiner’s Report V3 page 945)

As the lawyers would say, the optics are bad here. The Audit Committee asks EY to support Lehman’s internal auditor in investigating a “whistleblower’s” allegations of balance sheet improprieties.  The auditors interview the “whistleblower” and then don’t say anything at any of the Audit Committee meetings. Turns out what Mr. Lee, the “whistleblower”, was alleging is what the examiner believes is the fundamental problem and grounds for “colorable claims” against top officers and EY.

The word “whistleblower” is tainted with tons of emotion post-Enron. We now look at those called “whistleblowers” and see heroes. But let’s look at what I think may have actually happened. Lehman’s Internal Audit department “naturally” asked their trusted, all-things-to-all-people advisor, EY, to help with the investigation of the “whistleblower’s” claims. The Internal Audit Department, not EY, was in charge of the investigation.

That was their first mistake. If I’ve said it once, I’ve said it a thousand times: The external auditor should not be conducting or assisting with internal investigations of potential fraud or illegal acts by top executives. I wrote about it atSiemens, subject of the largest ever FCPA settlement in history. KPMG, their auditor, got sued.

The external auditor should stay the hell away from internal investigations because they may get caught up in something they would rather not know. They may want to claim plausible deniability. And a company should not engage the external auditor to support internal investigations especially involving fraud or illegal acts by top management. Do they do it to be cheap or to keep dirty laundry inside? The external auditor is too often part of the problem, an enabler, instead of part of the solution.

If Lehman had hired another firm – a law firm or anyone except their external auditor – to perform the investigation, the investigation would have been covered end to end in privilege, the external auditor may or may not (in this case EY would have been better not to) have been included in the “circle of privilege,”  and the investigation would have been completed professionally.

However, by supporting this investigation, EY was essentially doing internal audit work, a prohibited service under Sarbanes-Oxley for independence reasons. It’s shocking to me that the EY audit partners did not at least turn over the investigation to EY’s Forensic Accounting and Investigations Practice in order to provide some semblance of independence and professionalism.

Even though EY may have been an unwilling party to knowledge of an ugly situation right before an audit committee meeting, they got stuck. They had an obligation under AU 380, as the external auditor  - not as an investigator – to inform the Audit Committee. They could have been on the other side being informed – or not – instead of being the one supposed to be doing the informing.

AU 380, the  rules for auditor communication with the Audit Committee, are very clear. But they relate to the auditors’ role as an auditor not the role  of an auditor who is lent as muscle to an internal investigation. By playing the “trusted advisor” they screwed themselves.

Stoplight?  Yellow. Looks bad, but EY may be able to talk their way out of this one once it gets to court. They need to explain how they were still looking into the issue, doing their “auditor” work and make sure their full but limited role and responsibilities for the process are explained. If they lose on this chalk it up to another case of audit partners wanting to be supermen to their clients, the corporation’s executives, rather than looking out for their own best interests. Unfortunately in this situation, the shareholders were probably going to lose either way.

For a few dollars more…  Or, more likely, no additional fee for helping with the internal investigation, Ernst & Young got stuck. Unfortunately, Berkshire Hathaway ignored this lesson in the Sokol case. They used a non-independent attorney and his law firm to investigate Sokol’s suspicious Lubrizol trades. And News Corp. is ignoring it, too. They also are using insiders to investigate the phone hacking allegations.

Despite what some columnists are saying…

Floyd Norris, The New York Times, July 28, 2011:

The company misled investors and its officers and directors may be held liable. But the company’s auditor seems likely to escape any responsibility for an audit that wrongly concluded the company’s financial statements were completely proper. That, anyway, is the conclusion a federal judge has reached regarding Lehman Brothers. The judge said this week that it appeared Lehman had violated Generally Accepted Accounting Principles, or GAAP, even if it was in technical compliance with accounting rules. But he threw out a claim against Ernst & Young, whose 2007 audit certified that Lehman had followed GAAP.

…I believe Ernst & Young has not escaped anything. Here’s what I emailed Lynn Turner, former Chief Accountant at the SEC, after he circulated Norris’ column to his newsletter subscribers:

They are on the hook for something, it allows discovery, and this is not the only case against them.

This Lehman suit over a securities offering is not Ernst & Young’s biggest worry. They are a bit player. The New York Attorney General’s case against them, the one about fraud, is where they star.

Continued in article

Bob Jensen's threads on Lehman and Ernst are at
http://www.trinity.edu/rjensen/Fraud001.htm#Ernst

Good News
"Grant Thornton Dodges the Koss Bullet, Is Dismissed From Shareholder Lawsuit," by Adrienne Gonzalez, Going Concern, August, August 3, 2011 ---
http://goingconcern.com/2011/08/grant-thornton-dodges-the-koss-bullet-is-dismissed-from-shareholder-lawsuit/

U.S. District Judge Lynn Adelman has dismissed Grant Thornton as a defendant in a class-action shareholder lawsuit against GT, Koss Corp. and CEO Michael J. Koss, filed in January 2010 on behalf of plaintiff David Puskala and other Koss shareholders.

In his ruling, Adelman stated that the plaintiffs failed to make a case for GT’s epic failure to detect former Koss executive Sue Sachdeva’s $34 million embezzlement/hoarding scheme. Reasonable, considering GT auditors scared the crap out of old Sue, even though they were sticking newbies on the gig.  “Fear was one thing. I thought it was imminent,” she said in a court deposition last year. “Their auditors, every time they walked in, I’d say, ‘This is it. They’re going to catch me.’” Shareholders’ issue – we assume – is that they didn’t. Year after year after year after year until 2009 rolled around and the whole house of cards came tumbling down.

The judge also dismissed claims of willful or reckless behavior against Michael Koss, saying “I conclude that the innocent explanations are more compelling than the inference of recklessness.” Meaning Mike couldn’t possibly have known Sue had been siphoning off millions in company money over a six year period, absent hanging out at her house and noticing all the fancy new shit she had strewn everywhere. And stashed in closets. And bursting out of her garage.

As for Grant Thornton, the judge wrote that the occurrence of fraud and failure to detect it doesn’t imply recklessness on the part of the accounting firm, but rather that the firm was negligent. While it is clear that Sachdeva used her position with Koss to bypass the company’s not-rock-solid internal controls, it is also believed that the controls were sufficient so as not to be obviously unreliable to a reasonable person (or auditor fresh out of accounting school). We’re looking forward to hearing how audit professors use this decision to emphasize the cavernous depth between “negligence” and “recklessness” on the part of auditors.

Continued in article

Also see
http://www.jsonline.com/business/126590353.html

This outcome contradicts Francine's indictment of "Grant Thornton’s self-serving defense to the Koss fraud."
I must admit I tended to agree with Francine on this one in terms of the audit firm's gross negligence, although I see nothing wrong is principle with a "self-serving defense."

"Defending Koss And Their Auditors: Just Loopy Distorted Feedback," by Francine McKenna, re: TheAuditors, January 16, 2010 ---
http://retheauditors.com/2010/01/16/defending-koss-and-their-auditors-just-loopy-distorted-feedback/

My objective in writing this story was to handily contradict Grant Thornton’s self-serving defense to the Koss fraud.

The defense supported by some commentators:

Audits are not designed to uncover fraud and Koss did not pay for a separate opinion on internal controls because they are exempt from that Sarbanes-Oxley requirement.

But punching holes in that Swiss-cheese defense is like shooting fish in a barrel.  Leading that horse to water is like feeding him candy taken from a baby. The reasons why someone other than American Express should have caught this sooner are as numerous as the acorns you can steal from a blind pig…

Ok, you get the gist.

Listing standards for the NYSE require an internal audit function.  NASDAQ, where Koss was listed, does not.  Back in 2003, the Institute of Internal Auditors (IIA) made recommendations post- Sarbanes-Oxley that were adopted for the most part by NYSE, but not completely by NASDAQ. And both the NYSE and NASD left a few key recommendations hanging.

In addition, the IIA has never mandated, under its own standards for the internal audit profession, a direct reporting of the internal audit function to the independent Audit Committee. The SEC did not adopt this requirement in their final rules, either.

However, Generally Accepted Auditing Standards (GAAS), the standards an external auditor such as Grant Thornton operates under when preparing an opinion on a company’s financial statements – whether a public company or not, listed on NYSE or NASDAQ, whether exempt or not from Sarbanes-Oxley – do require the assessment of the internal audit function when planning an audit.

Grant Thornton was required to adjust their substantive testing given the number of risk factors presented by Koss, based on SAS 109 (AU 314), Understanding the Entity and Its Environment and Assessing the Risks of Material Misstatement.  If they had understood the entity and assessed the risk of material misstatement fully, they would have been all over those transactions like _______. (Fill in the blank)

If they had performed a proper SAS 99 review (AU 316), Consideration of Fraud in a Financial Statement Audit, it would have hit’em smack in the face like a _______ . (Fill in the blank.) Management oversight of the financial reporting process is severely limited by Mr. Koss Jr.’s lack of interest, aptitude, and appreciation for accounting and finance. Koss Jr., the CEO and son of the founder, held the titles of COO and CFO, also.  Ms. Sachdeva, the Vice President of Finance and Corporate Secretary who is accused of the fraud, has been in the same job since 1992 and during one ten year period worked remotely from Houston!

When they finished their review according to SAS 65 (AU 322), The Auditor’s Consideration of the Internal Audit Function in an Audit of Financial Statements, it should have dawned on them: There is no internal audit function and the flunky-filled Audit Committee is a sham.  I can see it now. The Grant Thornton Milwaukee OMP smacks head with open palm in a “I could have had a V-8,” moment but more like, “Holy cheesehead, we’re indigestible gristle-laden, greasy bratwurst here! We’ll never be able issue an opinion on these financial statements unless we take these journal entries apart, one-by-one, and re-verify every stinkin’ last number.”

But I dug in and did some additional research – at first I was just working the “no internal auditors” line – and I found a few more interesting things.  And now I have no sympathy for Koss management and, therefore, its largest shareholder, the Koss family.  Granted there is plenty of basis, in my opinion, for any and all enforcement actions against Grant Thornton and its audit partners.  And depending on how far back the acts of deliciously deceptive defalcation go, PricewaterhouseCoopers may also be dragged through the mud.

Yes.

I can not make this stuff up and have it come out more music to my ears. PricewaterhouseCoopers was Koss’s auditor prior to Grant Thornton. In March of 2004, the Milwaukee Business Journal reported, “Koss Corp. has fired the certified public accounting firm of PricewaterhouseCoopers L.L.P. as its independent auditors March 15 and retained Grant Thornton L.L.P. in its place.” The article was short with the standard disclaimer of no disputes about accounting policies and practices.  But it pointedly pointed out that PwC’s fees for the audit had increased by almost 50% from 2001 to 2003, to $90,000 and the selection of the new auditor was made after a competitive bidding process.  PwC had been Koss’s auditor since 1992!

The focus on audit fees by Koss’s CEO should have been no surprise to PwC.  Post-Sarbanes-Oxley, Michael J. Koss the son of the founder, was quoted extensively as part of the very vocal cadre of CEOs who complained vociferously about paying their auditors one more red cent. Koss Jr. minced no words regarding PwC in the Wall Street Journal in August 2002, a month after the law was passed:

“…Sure, analysts had predicted a modest fee increase from the smaller pool of accounting firms left after Arthur Andersen LLP’s collapse following its June conviction on a criminal-obstruction charge. But a range of other factors are helping to drive auditing fees higher — to as much as 25% — with smaller companies bearing the brunt of the rise.

“The auditors are making money hand over fist,” says Koss Corp. Chief Executive Officer Michael Koss. “It’s going to cost shareholders in the long run.”

He should know. Auditing fees are up nearly 10% in the past two years at his Milwaukee-based maker of headphones. The increase has come primarily from auditors spending more time combing over financial statements as part of compliance with new disclosure requirements by the Securities and Exchange Commission. Koss’s accounting firm, PricewaterhouseCoopers LLP, now shows up at corporate offices for “mini audits” every quarter, rather than just once at year-end.”

A year later, still irate, Mr. Koss Jr. was quoted in USA Today:

“Jeffrey Sonnenfeld, associate dean of the Yale School of Management, said he recently spoke to six CEO conferences over 10 days. When he asked for a show of hands, 80% said they thought the law was bad for the U.S. economy.

When pressed individually, CEOs don’t object to the law or its intentions, such as forcing executives to refund ill-gotten gains. But confusion over what the law requires has left companies vulnerable to experts and consultants, who “frighten boards and managers” into spending unnecessarily, Sonnenfeld says.

Michael Koss, CEO of stereo headphones maker Koss, says it’s all but impossible to know what the law requires, so it has become a black hole where frightened companies throw endless amounts of money.

Companies are spending way too much to comply, but the cost is due to “bad advice, not a bad law,” Sonnenfeld says.”

It’s interesting that Koss Jr. has such minimal appreciation for the work of the external auditor or an internal audit function. By virtue, I suppose, of his esteemed status as CEO, COO and CFO of Koss and notwithstanding an undergraduate degree in anthropology, according to Business Week, Mr. Koss Jr. has twice served other Boards as their “financial expert” and Chairman of their Audit Committees.  At Genius Products, founded by the Baby Genius DVDs creator, Mr. Koss served in this capacity from 2004 to 2005. Mr. Koss Jr. has also been a Director, Chairman of Audit Committee, Member of Compensation Committee and Member of Nominating & Corporate Governance Committee at Strattec Security Corp. since 1995.

If I were the SEC, I might take a look at those two companies…Because I warned you about the CEOs and CFOs who are pushing back on Sarbanes-Oxley and every other regulation intended to shine a light on them as public company executives.

No good will come of this.

I don’t want you to shed crocodile tears or pity poor PwC for their long-term, close relationship with another blockbuster Indian fraudster. Nor should you pat them on the back for not being the auditor now. PwC never really left Koss after they were “fired” as auditor in 2004.  They continued until today to be the trusted “Tax and All Other” advisor, making good money filing Koss’s now totally bogus tax returns.

Continued in article

Bob Jensen's threads on Grant Thornton litigation ---
http://www.trinity.edu/rjensen/fraud001.htm#GrantThornton

Bob Jensen's threads on PwC and other large auditing firms
http://www.trinity.edu/rjensen/fraud001.htm

Jensen Comment
You may want to compare Francine's above discussion of audit fees with the following analytical research study:

In most instances the defense of underlying assumptions is based upon assumptions passed down from previous analytical studies rather than empirical or even case study evidence. An example is the following conclusion:

We find that audit quality and audit fees both increase with the auditor’s expected litigation losses from audit failures. However, when considering the auditor’s acceptance decision, we show that it is important to carefully identify the component of the litigation environment that is being investigated. We decompose the liability environment into three components: (1) the strictness of the legal regime, defined as the probability that the auditor is sued and found liable in case of an audit failure, (2) potential damage payments from the auditor to investors and (3) other litigation costs incurred by the auditor, labeled litigation frictions, such as attorneys’ fees or loss of reputation. We show that, in equilibrium, an increase in the potential damage payment actually leads to a reduction in the client rejection rate. This effect arises because the resulting higher audit quality increases the value of the entrepreneur’s investment opportunity, which makes it optimal for the entrepreneur to increase the audit fee by an amount that is larger than the increase in the auditor’s expected damage payment. However, for this result to hold, it is crucial that damage payments be fully recovered by the investors. We show that an increase in litigation frictions leads to the opposite result—client rejection rates increase. Finally, since a shift in the strength of the legal regime affects both the expected damage payments to investors as well as litigation frictions, the relationship between the legal regime and rejection rates is nonmonotonic. Specifically, we show that the relationship is U-shaped, which implies that for both weak and strong legal liability regimes, rejection rates are higher than those characterizing more moderate legal liability regimes.
Volker Laux  and D. Paul Newman, "Auditor Liability and Client Acceptance Decisions," The Accounting Review, Vol. 85, No. 1, 2010 pp. 261–285
http://www.trinity.edu/rjensen/TheoryTAR.htm#Analytics

Bob Jensen's threads on Grant Thornton are at
http://www.trinity.edu/rjensen/Fraud001.htm

We have never before seen a firm issue a 10-K one day and rescind it the next business day. Perhaps there was a miscommunication between managers and KPMG, though that’s one humongous miscue.
See below.

"MILLER ENERGY RESOURCES: NOW YOU SEE THE 10-K, NOW YOU DON’T," by Anthony H. Catanach, Jr. and J. Edward Ketz, Grumpy Old Accountants Blog, August 1, 2011 ---
http://blogs.smeal.psu.edu/grumpyoldaccountants/archives/255

Bob Jensen's threads on KPMG are at
http://www.trinity.edu/rjensen/Fraud001.htm

Methodology to Identify Small Businesses and Their Owners
Department of the U.S. Treasury
Technical Paper 4
August 2011 --- Click Here
http://www.treasury.gov/resource-center/tax-policy/tax-analysis/Documents/OTA-T2011-04-Small-Business-Methodology-Aug-8-2011.pdf

Comments from Paul Caron on August 9, 2011 ---
http://taxprof.typepad.com/

The Treasury Department's Office of Tax Analysis has released Methodology to Identify Small Businesses and Their Owners:

Due to data constraints and the lack of clear definitions, prior analyses of the tax code’s impact on small business owners were flawed. In this paper, we develop a methodology to define and identify small businesses. We then apply that methodology to a new data source to identify the individual owners of those small businesses. Having matched owners to their small business entities, we present tabulations that detail various tax characteristics of small businesses and their owners for tax year 2007. ...

For tax year 2007, our previous methodology counted 34.7 million filers reporting $662 billion of net flow-through business income as small business owners. Using our revised methodology, we count 20.0 million filers reporting $376 billion of net business income as small business owners under a broad measure of small business owner. Under our narrow definition, we count 9.4 million filers reporting $335 billion of net business income as small business owners.

• The Hill, Treasury Looks to Redefine Small-Business Label
• Wall Street Journal, Using New Definition, US Treasury Report Finds Fewer Small Businesses

"A Much Needed Accounting Lesson for Two Senators," by Tom Selling, The Accounting Onion, August 8, 2011 --- Click Here
http://accountingonion.typepad.com/theaccountingonion/2011/08/a-free-accounting-lesson-for-two-us-senators.html?utm_source=feedburner&utm_medium=email&utm_campaign=Feed%3A+typepad%2Ftheaccountingonion+%28The+Accounting+Onion%29

August 8, 2011 reply from Bob Jensen

Hi Tom,

I was not aware of this pending legislation appreciate your calling our attention to more ignorance of our senators in Washington DC.

What would help your article is to introduce a better distinction between intrinsic value versus time value in the valuation of options and opportunity value/risk over time --- http://www.trinity.edu/rjensen/acct5341/speakers/133glosf.htm#IntrinsicValue 

In your illustration, the option is granted "at-the-money" such that there is zero intrinsic value to the company or the employee receives the contractual right (which may be in advance of both the vesting and exercise dates). The entire $2 total value is all time value on the grant date. Something of value (i.e., all time value and no intrinsic value) has been granted to the employee in lieu of higher wages even if the option's resale is restricted. This is the entire basis for the FAS 123R requirement that the option be booked as an expense on the date of granting the contractual right. Something of value was transferred from the corporation to the employee on the grant date. Of course there's an enormous problem of estimating time value on the grant date since the Black-Scholes model is known to be lousy when applied to employee stock options (since employees tend to be more risk averse regarding the tanking of time value).

William Brighernti has a practical solution for valuation of stock options using the Black-Scholes model ---
http://www.cpa-connecticut.com/sfas123r.html 
http://www.cpa-connecticut.com/IPIC.html 

I'm not at all clear why you, Tom, are arguing that FAS 123R makes an error (sausage) for not requiring a deduction for intrinsic value present value at the grant date. Firstly, the future intrinsic value is a great unknown and is generally, in my viewpoint, too uncertain to book at the date options are granted. Secondly, it's the employee who is bearing the financial risk of that intrinsic value which starts at zero when the option is granted.

The corporation (actually shareholders) will lose opportunity value if the granted option eventually gains in intrinsic value. But at the same time, the corporation (and its shareholders not receiving stock options) gain opportunity value if the gain in intrinsic value arises from the added efficiency, creativity, and motivation of employee to create this intrinsic value for his or her options. In other words, shareholders did not really lose the entire entire intrinsic value of the option on the exercise date. They in fact gained because shareholders can sell their own shares for higher values if they owned the shares on the date the employee options were first granted in lieu of wages.

My point is that the intrinsic value of an employee option that arises between the option's grant and exercise dates is not entirely an opportunity loss to shareholders equal to the intrinsic value on the exercise date. Shareholders who held shares between the grant and exercise dates gained to the extent that the intrinsic value arising from the marginal efforts of employees to increase the intrinsic value of their options.

What's not clear to me is why the corporation gets any tax break for dealing in its own stock or stock options. Employees, on the other hand, should have to pay a compensation tax, and it seems to me that they owe this tax on the date that they are entitled to sell the option (which may in fact be the exercise date but may also be in advance of the exercise date). Some might argue that an employee using a cash basis for tax accounting purposes does not owe the tax until cash is received, but the tax code requires that employees owe taxes on the date value is received irrespective of cash timing such as if employees are given inventory in lieu of wages.

There are of course fine points that must be worked out in the tax code. If each Apple employee receives a free iPad for personal use but is not allowed to resell that iPad for ten years when it is worth virtually zero, the employee should probably be taxed on the date the iPad is received rather than ten years from the grant date. That's because the employee is receiving the benefits of use before the iPad can be sold for cash. There is no benefit of use in a stock option, however, before the option can be turned into cash (ignoring its possible and questionable use as loan collateral).

Hence, I think an employee stock option is fundamentally different from inventory grants in terms of tax obligations. Employers should get tax deductions for inventory grants, and employees should be taxed for value received on the grant dates. Corporations should not get tax losses/gains for and dealings in their own shares or share options, but employees should be taxed for value received on the date they have the right to convert their stock option contracts into cash. If they do not sell on that date, the contracts become investments taxable on the basis of the difference between ultimate sales value and the value on the date for which they paid an initial compensation tax.

Bob Jensen

Bob Jensen's threads on FAS 123R ---
http:/www.trinity.edu/rjensen/theory/sfas123/jensen01.htm

This report looks at the federal government as if it were a business, with the goal of informing the debate about our nation’s financial situation and outlook.
"About USA Inc.," by Mary Meeker, Scribd, February 2011 ---
http://www.scribd.com/doc/49434520/USA-Inc-A-Basic-Summary-of-America-s-Financial-Statements

This report looks at the federal government as if it were a business, with the goal of informing the debate about our nation’s financial situation and outlook. In it, we examine USA Inc.’s income statement and balance sheet. We aim to interpret the underlying data and facts and illustrate patterns and trends in easy-to-understand ways. We analyze the drivers of federal revenue and the history of expense growth, and we examine basic scenarios for how America might move toward positive cash flow.

Thanks go out to Liang Wu and Fred Miller and former Morgan Stanley colleagues whose contributions to this report were invaluable. In addition, Richard Ravitch, Emil Henry, Laura Tyson, Al Gore, Meg Whitman, John Cogan, Peter Orszag and Chris Liddell provided inspiration and insights as the report developed. It includes a 2-page foreword; a 12-page text summary; and 460 PowerPoint slides containing data-rich observations. There’s a lot of material – think of it as a book that happens to be a slide presentation.

We hope the slides in particular provide relevant context for the debate about America’s financials. To kick-start the dialogue, we are making the entire slide portion of the report available as a single work for non-commercial distribution (but not for excerpting, or modifying orcreating derivatives) under the Creative Commons license. The spirit of connectivity and sharing has become the essence of the Internet, and we encourage interested parties to use the slides to advance the discussion of America’s financial present and future. If you would like to add yourown data-driven observations, contribute your insights, improve or clarify ours, please contact usto request permission and provide your suggestions. This document is only a starting point for discussion; the information in it will benefit greatly from your thoughtful input

Jensen Comment
The high quality graphs are especially frightening.

Bob Jensen's threads on entitlements ---
http://www.trinity.edu/rjensen/Entitlements.htm

Getting Away With Fraud
"Spitzer's Latest Loss An appeals court tosses convictions in the Gen Re-AIG case," The Wall Street Journal, August 2, 2011 ---
http://online.wsj.com/article/SB10001424053111903341404576482441499454516.html#mod=djemEditorialPage_t

Federal and state prosecutors have built a sorry record since the fall of Enron created a political incentive to pursue white-collar defendants, whether or not they've committed crimes. In the latest embarrassing episode, the abuses include prejudicial evidence, botched jury instructions and "compelling inconsistencies" suggesting that the government's star witness "may well have testified falsely."

Those were among the problems cited Monday by a three-judge panel of the Second Circuit Court of Appeals when it tossed out the convictions of four former executives of General Reinsurance and one former executive from AIG. The collapse of this case renders even more appalling the way that prosecutors used it to force both companies to fire their CEOs—Joseph Brandon at Gen Re and Hank Greenberg at AIG. In the latter case, the resulting loss of shareholder wealth—and creation of taxpayer risk—has been staggering.

The federal case was built on an obscure reinsurance transaction between the two companies in late 2000. The feds convinced a jury in 2008 to convict the executives of fraud and conspiracy on grounds that they had engineered the transaction as a sham simply to improve AIG's reported loss reserves and therefore juice its stock price.

Yesterday a unanimous three-judge panel vacated all of the convictions. Among other problems, the judges found that trial judge Christopher Droney had improperly defined for the jury what it means to "willfully cause" a crime. As a result, according to the appellate judges, "the court ended up with a charge that allowed the jury to convict without finding causation." Then there is the government's key witness, Richard Napier, whose story kept changing about who cooked up the allegedly fraudulent scheme.

The appeals court also found that Judge Droney allowed federal prosecutors a stolen legal base: displaying charts to the jury showing AIG's plunging stock price after details of the investigation appeared in the press in early 2005.

Oddly, the judge had realized that a chart with a continuous line moving downward would be prejudicial and disallowed it. But he nonetheless allowed similar charts with bar graphs and a series of dots. The appellate judges found "it is inevitable that jurors would connect them" and that "the charts suggested that this transaction caused AIG's shares to plummet 12% during the relevant time period, which is without foundation."

If news of an investigation and the resulting stock decline can be used as evidence of fraud, then prosecutors can simply manufacture damning evidence at will.

Along the way, prosecutors also used the investigation to force the two companies to fire their CEOs. Neither federal nor state prosecutors brought criminal cases against either man. But AIG's stock was losing altitude in early 2005 in part because New York Attorney General Eliot Spitzer was piggybacking on the federal case and demanding that AIG's board fire Mr. Greenberg. AIG's directors complied in March of that year. After Mr. Greenberg's firing, the company dramatically increased its mortgage exposure, and the rest is financial crisis history.

Continued in article

"Eliot Spitzer's Case Book," by Elizabeth Weinstein, The Wall Street Journal, April 28, 2005

In 2003, the Securities and Exchange Commission and Mr. Spitzer's office looked into insurance transactions that American International Group Inc. conducted with two firms, cellphone distributor Brightpoint Inc. and PNC Financial Services Group Inc. AIG paid $126 million in a settlement without admitting or denying guilt. Later, both the SEC and Mr. Spitzer's office scrutinized a deal struck between AIG and Berkshire Hathaway's General Reinsurance unit in 2000 to determine if the deal was aimed at making the giant insurer's reserves look healthier than they were. Longtime Chairman Maurice R. "Hank" Greenberg retired from the company, and in late March, AIG admitted to a broad range of improper accounting. Other AIG executives were forced out, including chief financial officer Howard Smith. Meanwhile, Berkshire chief Warren Buffett this week told investigators that he didn't know details about the contentious transaction. Mr. Greenberg also was deposed and repeatedly invoked his constitutional right against self incrimination.
 

"Jury Finds Former Insurance Executives Guilty," The New York Times, February 25, 2008 ---
http://www.nytimes.com/aponline/us/AP-CT-GenRe-AIGTrial.html

A Connecticut jury found five former insurance company executives guilty Monday of a scheme to manipulate the financial statements of the world's largest insurance company.

The verdict came in the seventh day of jury deliberations following a month long trial in federal court.

The defendants, four former executives of General Re Corp. and a former executive of American International Group Inc., sat stone-faced as the verdict was read. They were accused of inflating AIG's (NYSE:AIG) reserves through reinsurance deals by $500 million in 2000 and 2001 to artificially boost its stock price.

The defendants were former General Re CEO Ronald Ferguson; former General Re Senior Vice President Christopher P. Garand; former General Re Chief Financial Officer Elizabeth Monrad; and Robert Graham, a General Re senior vice president and assistant general counsel from about 1986 through October 2005.

Also charged was Christian Milton, AIG's vice president of reinsurance from about April 1982 until March 2005.

Ferguson, Monrad, Milton and Graham each face up to 230 years in prison and a fine of up to $46 million. Garand faces up to 160 years in prison and a fine of up to $29.5 million.

"This is a very sad day, not only for Ron Ferguson, but for our criminal justice system," Clifford Schoenberg, Ferguson's personal attorney, said in a statement distributed at U.S. District Court in Hartford. "I and the rest of Ron's legal team will not rest until we see him -- and justice -- vindicated."

Reinsurance policies are backups purchased by insurance companies to completely or partly insure the risk they have assumed for their customers.

Prosecutors said AIG Chief Executive Maurice "Hank" Greenberg was an unindicted coconspirator in the case. Greenberg has not been charged and has denied any wrongdoing, but allegations of accounting irregularities, including the General Re transactions, led to his resignation in 2005.

Continued in article

Over the last two weeks we have been flooded with revelations of problems with AIG accounting, in particular, some "round trip like" transactions between AIG and Berkshire's General Re: that will reduce AIG's net worth by 2% max according to AIG. However, a much deeper issue came to light that has widely been ignored by the press and maybe by the regulators and the FASB. AIG had extensive dealings with offshore companies which were also owned or controlled by AIG or its executives. These companies paid compensation to the executives that was not included in AIG's 10Ks. As IAG and / or its executives including Mr. Grenberg controlled for example Richmond and Union Reinsurance a Barbados based company the relationship was not arms-length... consequently it is possible that the deals included substantial "extra fat" for rich payments for these same executives in the privately held companies... This arrangement makes it feel very much like Mr. Fastow's Enron SPEs. As I have argued many times, any privately held company or partnership that does extensive business with publicly held companies should be subject to the same onus of disclosure of public companies... consequently the distinction is very murky and like some European countries most companies publicly or privately held including partnerships, LLPs and LLCs should have SEC-like disclosure requirements.
April 3, 2005 message from Miklos Vasarhelyi [miklosv@andromeda.rutgers.edu]

"Accounting for the Abuses at AIG," Insurance and Pensions at the Wharton School of Business," --- http://knowledge.wharton.upenn.edu/index.cfm?fa=viewfeature&id=1180

Improper Use of Finite Policies But in practice, finite policies have sometimes been used improperly. In 2000 and 2001, AIG's Greenberg asked General Re to do an unusual deal involving a bundle of finite contracts General Re had written for clients. AIG took over the obligation to pay up to $500 million in claims on the contracts. At the same time, General Re passed to AIG $500 million in premiums the clients had paid. AIG paid General Re a $5 million fee for moving these contracts to AIG's books.   Last year, General Re reported the deal to investigators who were questioning a number of reinsurers about finite policies. This deal carried a red flag because it was backwards: Typically, it would be AIG seeking a finite policy to shift risk to General Re. Because the $500 million in premiums had to be paid back to General Re, AIG seemed to be losing money on the deal, not making it. So why had Greenberg asked to take over those contracts?   In accounting for the deal, AIG tallied the premiums as $500 million in revenue and applied that amount to its reserve funds used to pay potential claims. This helped satisfy shareholders who had been concerned AIG did not have enough in reserve.   The issue in this deal, as in many finite insurance contracts, is whether AIG was providing insurance coverage or receiving a loan. To be insurance, AIG would have to assume a risk of loss. An industry rule of thumb known as "10/10" says the insurer should face, at a minimum, a 10% chance of losing 10% of the policy amount for the contract to be considered insurance.   In the absence of that degree of risk, the premiums transferred from General Re to AIG, and repayable later, would be a loan. AIG would then not be able to count the $500 million in premiums as additional reserves, as it had.   On March 30, AIG directors announced that: "Based on its review to date, AIG has concluded that the General Re transaction documentation was improper and, in light of the lack of evidence of risk transfer, these transactions should not have been recorded as insurance."   As a result, the company said it would reduce its reserve figure by $250 million and show that liabilities had increased by $245 million. However, it added, these changes would have "virtually no impact" on the company's financial condition. Bottom line: The AIG-General Re deal was an accounting gimmick to make AIG's reserves look healthier than they were -- an apparent effort to deceive regulators, analysts and shareholders.   More Cases of Questionable Accounting The directors then surprised observers by announcing they had uncovered a number of additional cases of questionable accounting.   The most serious involved reinsurance contracts AIG had taken with a Barbados reinsurer, Union Excess, allowing AIG's risk to pass to the other company and off AIG's books. AIG found that Union did business exclusively with AIG subsidiaries, and that Union was partially owned by Starr International Company Inc. (SICO), a large AIG shareholder controlled by a board made up of current and former AIG managers. Hence, the AIG statement said, SICO could be viewed as an AIG unit, or "consolidated entity," and SICO's risks were therefore actually AIG's. As a result, AIG had to reduce its shareholders' equity by $1.1 billion.   Another case involved a Bermuda insurer, Richmond Insurance Company, that the directors found to be secretly controlled by AIG. A third concerned Capco Reinsurance Company, another Barbados insurer, and "involved an improper structure created to recharacterize underwriting losses as capital losses," the directors said. Fixing this meant listing Capco as a consolidated entity and converting $200 million in capital losses to underwriting losses.   Yet another case involved $300 million in income AIG improperly claimed for selling outside investors covered calls on bonds in AIG's portfolio. Covered calls are supposed to give their owners the option to buy bonds at a set price for a given period, but AIG used other derivatives transactions to assure it could retain the bonds.   The directors also stated that certain debts owed to AIG might be unrecoverable, resulting in after-tax charges of $300 million. And they noted that the company was revising accounting for deferred acquisition costs and other expenses involving some AIG subsidiaries, resulting in as much as $370 million in corrections.   Some of the revelations seemed eerily similar to ones raised in the Enron case, which included use of little known offshore subsidiaries to hide liabilities, although the scale of the abuse so far appears to be far smaller at AIG.   The scandal highlights one of the dilemmas of American accounting, says Catherine M. Schrand, professor of accounting at Wharton. "We have one-size-fits-all accounting for firms in this country. If the standard-setters try to make it too specific and take out all the gray areas, then they would have a problem creating financial statements that are relevant."   The degree of risk assumed by a company that takes out a finite insurance policy is difficult to measure, so it may not be absolutely clear, even to the most well intentioned accountant, whether the policy should be counted as insurance or a loan. Companies like AIG are so big, and their accounting so complex, that it's impossible to write regulations to prevent all abuse, Strand suggests. "They will just find another way to do it.... Flexibility gives companies the opportunity to make their financial statements better. But it also gives them the opportunity to abuse the rules." his article is continued at   http://knowledge.wharton.upenn.edu/index.cfm?fa=viewfeature&id=1180

From The Wall Street Journal's Accounting Weekly Review on April 8, 2005

TITLE: SEC Brings New Federal Oversight to Insurance Industry with Probes
REPORTER: Deborah Solomon
DATE: Apr 01, 2005
PAGE: A1
LINK: http://online.wsj.com/article/0,,SB111230901945894804,00.html 
TOPICS: Insurance Industry, Regulation, Securities and Exchange Commission, Accounting

SUMMARY: "The Securities and Exchange Commission [SEC], using its power as an enforcer of accounting rules, is asserting for the first time in 60 years a key role for federal oversight of the insurance industry."

QUESTIONS:
1.) Why is the insurance industry regulated? Why is it regulated primarily by the states as opposed to the federal government?

2.) What accounting measures are used to regulate the insurance industry? List those that are mentioned in the article and any that you know of from experience or reading.

3.) How might improper transactions be undertaken to "dress up" the accounting information that is used in the regulatory process over the insurance industry? As one example, specifically comment on the product referred to in the article as "thinly disguised loans". (Hint: you may refer to the related article to help with this answer.)

4.) How has the SEC used its regulatory control over accounting issues to effect change in industries over which it has little jurisdiction, such as the insurance industry?

Reviewed By: Judy Beckman, University of Rhode Island

--- RELATED ARTICLES ---
TITLE: AIG Admits 'Improper' Accounting
REPORTER: Ian McDonald, Deborah Solomon, and Theo Francis
PAGE: A1
ISSUE: Mar 31, 2005
LINK: http://online.wsj.com/article/0,,SB111218569681893050,00.html 

Bob Jensen's Rotten to the Core Threads ---
http://www.trinity.edu/rjensen/FraudRotten.htm

Bob Jensen's fraud updates are at http://www.trinity.edu/rjensen/FraudUpdates.htm

Humor Between August 1 and August 31, 2011

Forwarded by Paula

Sharing in Marriage...

The old man placed an order for one hamburger, French fries and a drink.

He unwrapped the plain hamburger and carefully cut it in half, placing one half in front of his wife.

He then carefully counted out the French fries, dividing them into two piles and neatly placed one pile in front of his wife.

He took a sip of the drink, his wife took a sip and then set the cup down between them . As he began to eat his few bites of hamburger, the people around them were looking over and whispering.

Obviously they were thinking, 'That poor old couple - all they can afford is one meal for the two of them.'

As the man began to eat his fries a young man came to the table and politely offered to buy another meal for the old couple. The old man said, they were just fine - they were used to sharing everything

People closer to the table noticed the little old lady hadn't eaten a bite. She sat there watching her husband eat and occasionally taking turns sipping the drink.

Again, the young man came over and begged them to let him buy another meal for them. This time the old woman said 'No, thank you, we are used to sharing everything.'

Finally, as the old man finished and was wiping his face neatly with the napkin, the young man again came over to the little old lady who had yet to eat a single bite of food and asked 'What is it you are waiting for?'

She answered --

(Continue below)

'THE TEETH.'

Forwarded by Maureen

How to Give a Cat a Pill
 
 1.  Pick up cat and cradle it in the crook of your left arm as if holding a baby.
 
 
 Position right forefinger and thumb on either side of cat’s mouth and gently apply pressure to cheeks while holding pill in right hand.  As cat opens mouth, pop pill into mouth.
 
 Allow cat to close mouth and swallow.
 

 2.  Retrieve pill from floor and cat from behind sofa.
 
 
 Cradle cat in left arm and repeat process.
 
 
 3.  Retrieve cat from bedroom, and throw soggy pill away.
 
 
 4.  Take new pill from foil wrap, cradle cat in left arm, holding rear paws tightly with left hand.
 
 
 Force jaws open and push pill to back of mouth with right forefinger. Hold mouth shut for a count of ten.
 
 
 5.  Retrieve pill from goldfish bowl and cat from top of wardrobe.
 
 
 
 
 
 Call spouse in from the garden.
 
 
 6.  Kneel on floor with cat wedged firmly between knees, hold front and rear paws.
 
 
 Ignore low growls emitted by cat.  Get spouse to hold head firmly with one hand while forcing wooden ruler into mouth.  Drop pill down ruler and rub cat's throat vigorously.
 
 
 7.  Retrieve cat from curtain rail.
 
 
 Get another pill from foil wrap.  Make note to buy new ruler and repair curtains.  Carefully sweep shattered figurines and vases from hearth and set to one side for gluing later.
 
 
 8.  Wrap cat in large towel and get spouse to lie on cat with head just visible from below armpit.
 
 
 Put pill in end of drinking straw, force mouth open with pencil and blow down drinking straw
 
 
 9.  Check label to make sure pill not harmful to humans and drink one beer to take taste away.  Apply band-aid to spouse's forearm and remove blood from carpet with cold water and soap.
 
 
 
 10.  Retrieve cat from neighbor's shed.
 
 
 
 Get another pill.  Open another beer.  Place cat in cupboard, and close door onto neck, to leave head showing.  Force mouth open with dessert spoon.  Flick pill down throat with elastic band.
 
 
 11.  Fetch screwdriver from garage and put cupboard door back on hinges. Drink beer.  Fetch bottle of scotch.  Pour shot, drink.
 
 
 Apply cold compress to cheek and check records for date of last tetanus shot.  Apply whiskey compress to cheek to disinfect.  Toss back another shot.  Throw tee-shirt away and fetch new one from bedroom.
 
 
 12.  Call fire department to retrieve the damn cat from the top of the tree across the road.  Apologize to neighbor who crashed into fence while swerving to avoid cat.
 
 
 
 Take last pill from foil wrap.
 
 
 13.  Using heavy-duty pruning gloves from shed, tie the little *&#%^'s front paws to rear paws with garden twine and bind tightly to leg of dining table.  Push pill into mouth followed by large piece of filet steak.  Be rough about it.  Hold head vertically and pour two pints of water down throat to wash pill down.
 

Case Illustration of How to Compound a Felony

Forwarded by Paula

Two best friends graduated from medical school at the same time and decided that, in spite of two different specialties, they would open a practice together to share office space and personnel.

Dr. Smith was the psychiatrist and Dr. Jones was the proctologist; they put up a sign reading: "Dr. Smith and Dr. Jones: Hysteria's and Posteriors". The town council was livid and insisted they change it.

So, the docs changed it to read: "Schizoids and Hemorrhoids" This was also not acceptable, so they again changed the sign.

"Catatonics and High Colonics"......No go.

Next, they tried "Manic Depressives and Anal Retentives"....thumbs down again.

Then came "Minds and Behinds"...still no good.

Another attempt resulted in "Lost Souls and Butt Holes".......unacceptable again !

So they tried "Analysis and Anal Cysts".....not a chance.

"Nuts and Butts".....no way.

"Freaks and Cheeks".....still no good.

"Loons and Moons".....forget it.

Almost at their wit's end, the docs finally came up with: "Dr. Smith and Dr. Jones--Odds and Ends" Everyone loved it.

Forwarded by Paua (some old, some new)

"Time wounds all heels."

Yesterday's Meals on Wheels

"To expedite your visit, please back in. "

"We repair what your husband fixed."

"Don't sleep with a drip. Call your plumber."

"Invite us to your next blowout."

"We don't charge an arm and a leg.

We want tows.."

"Let us remove your shorts."

"If we see smoke, we will assume you are on fire and take appropriate action."

"Push. Push. Push.."

"If you don't see what you're looking for, you've come to the right place."

"We really know our stuff."

"Salesmen welcome! Dog food is expensive!"

"The best way to get back on your feet - miss a car payment."

"No appointment necessary. We hear you coming."

"Be back in 5 minutes. Sit! Stay!"

"We would be delighted if you send in your payment.

"Don't stand there and be hungry; come on in and get fed up."

"Drive carefully. We'll wait."

CHICAGO RADIATOR SHOP:

"Best place in town to take a leak."

**********************

"Caution - This Truck is full of Political Promises"

Forwarded by Paula

Catholic Heart Attack

You don't have to be Catholic to appreciate this one!!!

A man suffered a serious heart attack while shopping in a store. The store clerks called 911 when they saw him collapse to the floor. The paramedics rushed the man to the nearest hospital where he had emergency open heart bypass surgery.

He awakened from the surgery to find himself in the care of nuns at the Catholic Hospital he was taken to. A nun was seated next to his bed holding a clip board loaded with several forms, and a pen. She asked him how he was going to pay for his treatment.

"Do you have health insurance?" she asked.

He replied in a raspy voice, "No health insurance."

The nun asked, "Do you have money in the bank?"

He replied, "No money in the bank."

"Do you have a relative who could help you with the payments?" asked the irritated nun.

He said, "I only have a spinster sister, and she is a nun."

The nun became agitated and announced loudly, "Nuns are not spinsters! Nuns are married to God."

The patient replied, "Perfect. Send the bill to my brother-in-law."

Forwarded by Gene and Joan

Laws of Life

1. Law of Mechanical Repair - After your hands become coated with grease, your nose will begin to itch & you'll have to go to the bathroom.

2. Law of Gravity - Any tool, nut, bolt, screw, when dropped, will roll to the least accessible corner.

3. Law of Probability - The probability of being watched is directly proportional to the stupidity of your act.

4. Law of Random Numbers - If you dial a wrong number, you never get a busy signal & someone always answers.

6. Variation Law - If you change lines (or traffic lanes), the one you were in will always move faster than the one you are in now (also called the Kris Gatzemeyer Syndrome) 7. Law of the Bath - When the body is fully immersed in water, the telephone rings.

8. Law of Close Encounters - The probability of meeting someone you know increases dramatically when you are with someone you don't want to be seen with.

9. Law of the Result - When you try to prove to someone that a machine won't work, it will.

10. Law of Biomechanics - The severity of the itch is inversely proportional to the reach.

11.. Law of the Theater & Hockey Arena - At any event, the people whose seats are furthest from the aisle, always arrive last. They are the ones who will leave their seats several times to go for food, beer, or the toilet & who leave early before the end of the performance or the game is over. The folks in the aisle seats come early, never move once, have long gangly legs or big bellies & stay to the bitter end of the performance. The aisle people also are very surly folk.

12. The Coffee Law - As soon as you sit down to a cup of hot coffee, your boss will ask you to do something which will last until the coffee is cold.

13. Murphy's Law of Lockers - If there are only 2 people in a locker room, they will have adjacent lockers.

14. Law of PhysicalSurfaces - The chances of an open-faced jelly sandwich landing face down on a floor, are directly correlated to the newness & cost of the carpet or rug.

15. Law of Logical Argument - Anything is possible if you don't know what you are talking about.

16. Brown's Law of Physical Appearance - If the clothes fit, they're ugly.

17. Oliver's Law of Public Speaking - A closed mouth gathers no foot.

18. Wilson's Law of Commercial Marketing Strategy - As soon as you find a product that you really like, they will stop making it.

19. Doctors' Law - If you don't feel well, make an appointment to go to the doctor, by the time you get there you'll feel better.. But don't make an appointment, and you'll stay sick.

Forwarded by Paula

SCOTCH?

On the first day of school, the children brought gifts for their teacher.

The supermarket manager's daughter brought the teacher a basket of assorted fruit.

The florist's son brought the teacher a bouquet of flowers.

The candy-store owner's daughter gave the teacher a pretty box of candy.

Then the liquor-store owner's son brought up a big, heavy box. The teacher lifted it up and noticed that it was leaking a little bit. She touched a drop of the liquid with her finger and tasted it.

"Is it gin?" she guessed.

"No," the boy replied.

She tasted another drop and asked, "vodka?"

"No," said the little boy............."It's a puppy!"

This is attributed to Bill Cosby, but I did not verify this attribution

I HAVE DECIDED TO BECOME A WRITE-IN CANDIDATE FOR PRESIDENT IN THE YEAR 2012.

HERE IS MY PLATFORM:

(1). Any use of the phrase: 'Press 1 for English' is immediately BANNED!!! English is the official language; speak it or wait outside of our borders until you can.

(2). We will immediately go into a two year isolationist attitude in order to straighten out the greedy big business posture in this country. America will allow NO imports, and we'll do no exports. We will use the 'Wal-Mart 's policy, 'If we ain't got it, you don't need it.' We 'll make it here and sell it here!

(3). When imports are allowed, there will be a 100% import tax on it coming in here.

(4). All retired military personnel will be required to man one of the many observation towers located on the southern border of the United States (six month tour). They will be under strict orders not to fire on SOUTH BOUND aliens.

(5). Social Security will immediately return to its original state. If you didn't put nuttin in, you AIN'T getting nuttin out. Neither the President nor any other politician will be able to touch it.

(6). Welfare. -- Checks will be handed out on Fridays, at the end of the 40 hour school week, the successful completion of a urinalysis test for drugs, and passing grades.

(7). Professional Athletes -- Steroids? The FIRST time you check positive you're banned from sports ... for life.

(8). Crime -- We will adopt the Turkish method, i.e., the first time you steal, you lose your right hand. There is no more 'life sentences'. If convicted of murder, you will be put to death by the same method you chose for the victim you killed: gun, knife, strangulation, etc.

(9). One export of ours will be allowed: wheat; because the world needs to eat. However, a bushel of wheat will be the EXACT price of a barrel of oil.

(10). All foreign aid, using American taxpayer money, will immediately cease and the saved money will help to pay off the national debt and, ultimately, lower taxes. When disasters occur around the world, we'll ask The American People if they want to donate to a disaster fund, and each citizen can make the decision as to whether, or not, it's a worthy cause.

(11). The Pledge of Allegiance will be said EVERY day at school and every day in CONGRESS.

(12). The National Anthem will be played at all appropriate ceremonies, sporting events, outings, etc.

Medication Recommendations from Bob Overn