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The AAO Weblog covers accounting issues and current events as they relate the practice of investment analysis.

Author: Jack Ciesielski Created: 10/13/2006 2:54 PM
The AAO Weblog is a weblog published by Jack Ciesielski , dealing with accounting issues and news topics related to investment and finance.

Make that "stock comp error correction treats shareholders well." Ah, no. More descriptive, but lacks punch.

WestAmerica Bancorporation filed its 10-K yesterday, and revealed a SAB 108 correction for the overaccrual of liabilities related to employee stock-based compensation.

It was a minor amount - $3 million pretax, $1.8 million aftertax - especially when compared to stockholders' equity of $424 million. The interesting thing is that it was a reduction of other liabilities for the compensation, and an increase to stockholders' equity.

When you think of error corrections involving stock compensation, you have a tendency to think in the reverse direction. Truly a case of "man bites dog."

And be done with it. This continuous deadline-pushing of Sarbanes-Oxley compliance deadlines is just a complete sham.

On second thought ... nahhh.

CFO.com reports that in a letter to SEC Chairman Christopher Cox and PCAOB Chairman Mark Olson, "Senators John Kerry and Olympia Snowe called for an extension in the deadline for companies of less than $75 million in market capitalization to comply with Sarbox 404 rules."

The Sarbanes-Oxley Act was passed in 2002. Big boys have been complying since 2004. And it looks like we've got a gigantic cadre of Peter Pan companies that refuse to grow up. Companies with market caps of less than $75 million have had their deadline for Section 404 management reports extended to 10-Ks for years ending on or after December 15, 2007; their auditors' attestation reports on the same don't show for another year after that.

The Senators want to give them another year. We've seen this movie before, and we'll probably see it again.

In its 10-K filed last Thursday, sneaker maker K-Swiss presented its clean-up adjustment of payroll withholding taxes:

"In 2006, we determined that there was an underpayment of payroll withholdings in a foreign jurisdiction from January 1, 1993 through December 31, 2006. With the assistance of our tax advisors, we estimated underpayment of withholdings of approximately $5,131,000 and related interest of approximately $5,974,000, totaling $11,105,000."

All told, the company adjusted its retained earnings balance for a net amount of $7.9 million - which would be a pretty sizable chunk of its $76.9 million in 2006 earnings. That is, a sizable chunk, if Staff Accounting 108 didn't give companies the chance to catch up adjustments through retained earnings. Instead of making such housecleanings visible through a charge on the income statement, SAB 108 forces investors to look through the notes or the equity section of the balance sheet to find them.

Yes, those amounts didn't all relate to 2006, as defenders of the approach might say. Then again, they didn't relate to activity for 2006 in retained earnings, either. When you've got charges relating to the wrong periods, it's best to restate in order to present the best picture of what really happened in the company. If the SEC isn't going to require firms to do that, at least they should have required them to make the cleanup visible in the income statement - something to point investors to the discussion of the cleanup.

It's an interesting little case. The errors were discovered in 2006, according to the disclosure - but they went all the way back to 1993. For the period 1993 to 2001, the cumulative errors amounted to 3.59% of the net income for the period - a pretty significant error, and you have to wonder how much any one year could have been affected in that nine-year stretch. Between 2002 and 2005, the errors never mattered to net income by more than 2.16%.

The errors weren't found until 2006, according to the filing. But the consequences live on. The total aftertax recognition of the payroll tax adjustments was $10.982 million; assuming a 35% tax rate, the gross under-withholding would be $16.985 million. According to the filing, the penalties in that particular jurisdiction can run from zero to 300% of the taxes owed - so there could still be a large tax bill down the road, maybe as much as $50 million. For perspective, that's about two-thirds of the company's net income for 2006. Little mistakes over time can really add up.

Just finished putting together a report on the new issues that will affect 2006 reporting: SAB 108, Statement 158, and to a lesser degree, FIN 48. (The "ending-in-8" series of simultaneous standards. Gee, I hope that doesn't mean something like "The Number 23." Ecchh.) Also, some information about the new proxies, and the stock option backdating corrections.

And a discussion of things to keep in mind as you do your annual report reading.

If you're interested in subscribing to The Analyst's Accounting Observer, maybe this is a good time to take a trial subscription. You'll receive the report (and maybe sign on for more.) Offer limited to corporate and institutional investors only, please. We'll check the BigDough database to see if you're an institutional investor, which is our litmus test.

Sounds like a rehash of stock compensation issues, but it's not.

The FASB issued Statement No. 159, "The Fair Value Option for Financial Assets and Financial Liabilities," last Thursday. The "option" aspect is that firms will now have a choice of whether or not to apply fair value accounting to some financial instruments that have always been accounted for at historical values.

[Subscribers to The Analyst's Accounting Observer: the exposure draft of this standard was covered in Volume 15, No. 5 "FASB's Fair Value Frenzy."

Companies that take the fair value option might find that hedging becomes easier than under Statement 133, with no need for "effectiveness testing" which seems to have been a hurdle in some restatements seen over the past year and a half. If firms are as good at hedging as they claim to be, the earnings volatility that results from having two offsetting instruments recorded at fair value should be relatively subdued. It might be a good chance for firms to control their financial exposures and reduce their compliance paperwork at the same time.

Only apparent downside at this time: comparability will suffer for investors. Remember - it's an option, not a mandate. And companies will also likely apply it only where fair value reporting will give them a better-looking balance sheet. So it's not without its drawbacks.

Kind of a rare daily double: two separate clips in the news about the Sarbanes-Oxley Act. And not one of them mentions how it's making the sky fall!

First up, reported by CFO.com, these comments from PCAOB member Charles Niemeier from a panel discussion titled "The Burdens of Regulation: Are the U.S. Capital Markets Less Competitive?" sponsored by the New York Society of Security Analysts.

"I don't believe that 'regulation light' is an answer. We're looking at an interesting time in where these markets are developing in other countries. It would put us in an extremely dangerous position to have lowered our standards in the United States..."If we start tweaking, are we putting at risk the one thing that gives us a true competitive advantage in the world?"

A question worth asking, I'd say. Then there's this interesting piece in yesterday's Wall Street Journal: a study by Thomson Financial that shows IPO activity hasn't diminished since the implementation. In fact, according to the article:

"... foreign IPOs, excluding investment funds and closed-end funds, accounted for 16% of the 208 IPOs in the U.S. last year, the highest proportion of foreign IPOs in Thomson Financial's 20-year review...foreign IPOs in the U.S. last year raised $10.6 billion of the $45.3 billion in IPO offerings priced in the U.S. It represents a 23% share of IPO volume sold last year, the highest level since 1994."

Maybe all that foreign money is being raised here because the companies like what Sarbanes-Oxley might be doing for stock prices: there's still a valuation premium for raising capital here - despite the higher banking fees.

This in from Sydney, Australia via WebCPA: actor Paul Hogan, a.k.a. “Crocodile Dundee,” has been linked to an Australian investigation of tax fraud.

"According to the newspaper The Australian, a string of nearly two dozen companies associated with Hogan, his financial adviser Anthony Stewart and his artistic collaborator John Cornell, have been cited in federal court relating to an alleged $300-million fraud.

Hogan has repeatedly denied any problems with the Australian Taxation Office, writing to the same paper last year and saying that he was not under investigation for failing to disclose $40 million in offshore trusts. "You got me. Almost,” the paper quoted Hogan as saying. “The last problem I had with the ATO was in 1972 when they claimed I had fudged the overheads on my earnings from my pub chook raffles.”

"Fudged the overheads?" "Pub chook raffles?" Had a hard time understanding him in the movies; I'm not doing much better in print.

* * * * * * * * * *

Light blog activity this week. Putting out a major Accounting Observer piece. Back soon, I hope, with better stuff than this. G'day, mate!

A more succinct reading than usual, I hope. Maybe I CAN get the hang of this thing...

Only regret: wish I had said MILLIONS, not THOUSANDS, on the bit about H.B. Fuller's SAB 108. Noticed it as I was going on and on, too late to re-record.

Thanks for not reminding me, eh? Podcast available here.

As blogged previously, the SEC's SAB 108 is two, two, two materiality tests in one. It requires firms to assess materiality of known but uncorrected errors on both a rollover basis and an iron curtain basis. (See linked post for discussion.) Applied correctly, it assures that known errors are isolated and removed from the balance sheet.

So, a new hobby might be developing here at the AAO Weblog: looking for interesting results from the application of SAB 108. It's bound to be some blog fodder over the next month or so as these items emerge in newly-filed 10-Ks.

One that caught my eye yesterday: H.B. Fuller's discussion in its 10-K. The net adjustment, a credit to retained earnings, was small - only $351 thousand - but there were a few moving parts:

* Investment-in-Affiliate Adjustment:
The company had recorded $309 thousand more expense than necessary when recording a subsidiary's earnings in a prior year, incorrectly reflected as an other long-term liability.

* Deferred Revenue on Shipments with Freight Claim Exposure:
Fuller had recognized $585 thousand of revenue on some pre-2004 shipments early, because they retained the risk of loss due to freight claim exposure.

* Consistent Application of Accounting for Sales Allowances:
Fuller had unrecorded reserves for sales allowances; putting them on the balance sheet required a net adjustment of $454 thousand.

* Tax Accounting Adjustments: The company had overstated income taxes payable by $1.081 million.

As we go through the discovery of what firms had previously chosen to ignore, it'll be interesting to see where errors occurred most often. Early bets (kind of like the sun coming up in the East): revenue issues and tax issues. Every company has both, there are plenty of moving parts to both, and especially in the case of taxes, a high concentration of technical issues. The opportunities to screw up are almost unlimited. It'll also be interesting to see what firms considered "immaterial" in the past.