Accounting Footnotes

Ellen Simon takes a closer look at accounting footnotes:

One-time charges
At some companies, one-time charges have become a way of life. Consider Eastman Kodak Co., which has taken one-time charges for each of the last 14 quarters. By treating the charges as extraordinary events, the company can say its earnings would be ever-so-much stronger without them. But, considering that the charges seem unrelenting, that argument looks wobbly.
Bianco crunches 10 years’ worth of one-time charges across the S&P 500 to “normalize” them. In 2006, one-time charges will cost the aggregate S&P 500 $5 a share in earnings per share, he estimates.
Pension accounting
Under current pension accounting rules, a company can legally book a pension credit, even if its pension fund is losing money. How does this accounting magic work?
Under a process called “smoothing,” the company can set an assumed return for its pension fund. Across the S&P 500, that assumed return is 8.22 percent, according to Howard Silverblatt, editor of quantitative services at S&P.
That would be a stellar return in today’s market, especially because pension funds are almost always diversified. With interest rates near historic lows and equity returns anemic at best, it’s the rare fund manager who is getting the assumed return.
But, thanks to smoothing, a company doesn’t actually have to see that return to act as if it did. It can add its expected return right into its net earnings, even if the actual return differs greatly.
“You’ll see amounts on the balance sheet for the pension plan,” said David Zion, accounting analyst at Credit Suisse First Boston. “What I would counsel is to completely ignore that amount. It’s meaningless. In many cases, it’s completely misleading.”
Instead, he said, look for pension information in the annual report. Read the footnotes, which will tell you what the fund’s actual return is. Then do the math yourself.
A tiny change in one assumption in a pension plan can mean big bucks. For instance, Lucent Technologies Inc. changed the mortality assumptions for its plan. The change is expected to reduce its 2006 pension credit by approximately $50 million, according to the company’s filings with the Securities and Exchange Commission.
How much do aggressive return-on-asset assumptions cost the stocks in the S&P 500? Bianco calculates the cost at $1 to $2 a share for 2006.
Stock Options
“Most companies will be required to expense employee stock options beginning in 2006, but earnings guidance and analyst estimates for many companies have yet to reflect this cost,” Zion said in an October research note. “In fact, there are only 96 companies in the S&P 500 where the analyst consensus earnings estimate includes the cost of stock options.”
How much will options really cost? About $2 to $3 a share across the S&P 500, Bianco estimates.

Posted by on December 18th, 2005 at 1:03 pm


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