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The AAO Weblog covers accounting issues and current events as they relate the practice of investment analysis. All posts prior to September, 2007 are in the public domain, but after September 4, 2007, only subscribers to The Analyst's Accounting Observer will see all posts going forward. Only selected, occasional posts will be released to the public domain from September 4 forward.

Mail Call, 12/16/05

Location: Blogs AAO Weblog (Public)
Posted by: Jack Ciesielski	12/16/2005 5:42 AM
Yesterday's post on the SEC's roll-back of filing deadlines for some companies prompted this note from Mark M., a former audit partner: "Jack, I will once again look at a topic from the standpoint of the auditors. It may not be a big deal to a company to accelerate its filings by 15 or 30 days, but this is a huge deal to the auditors. Let's not forget the logistics of doing so much work in such a short period of time for so many companies. While an effort is made to do as much work as possible pre-yearend, there are limits to that approach. Concern was expressed by many that prohibiting companies from suing their auditors pursuant to engagement letter provisions would impact the quality of audits (as per your earlier blog and comments related thereto). I don't think auditors want to admit it, but condensing the period in which to perform the yearend work cannot be a positive development for improving the quality of audits and potentially has a far bigger impact then that arising from engagement letter provisions." I think you're missing the point I made, Mark. My complaint is not necessarily that companies take too long in publishing financial information. (Although I'd prefer faster to slower, as would any user; back when the rules were first being proposed, I thought it was fairer to just require 10-Q filing when earnings are released. That way, companies who thought it was important to rush the job to release earnings would have to be certain they had the job done right - or maybe just release earnings later. Didn't come to pass, anyway.) My gripe was that by listening to everyone who's lodging a complaint about the fairness of a rule, the SEC is bringing complexity to a process that used to be pretty straightforward. And reducing complexity is their new initiative. Of course I realize this is a huge deal for auditors - one could only expect audit quality to be sturdier with a longer deadline. There's no way to minimize that this will affect auditors, and many more of them if the original timetable had stuck. As for whether or not longer deadlines would improve audit quality more than engagement contract provisions, there isn't even the possibility of such a trade-off. And I prefer not to speculate about what goes on in the mind of an auditor. * * * * * * * * * * * * * * From Bo A. , a few thoughts on stock comp, pro forma earnings, and the earnings clearinghouses: "I finally got around to reading your stock comp fever survey results (by the way, I guess I was one of the unvalidated participants). I'm not surprised to see that 80% of the estimates on First Call, Zacks, et al. do not include options expense. There is no way that the sell-side will switch to including these costs without being forced to do so. Nearly every buy recommendation (still far out numbering sell ratings, I believe) will look less attractive when published earnings estimate reflect options expenses. I don't know what the public justification is for not including these expenses, but the private one has to be that valuations are going to look richer (and for some companies a lot richer) with these costs in the numbers. First Call and Zacks will work to keep everyone "in line" which will further delay the process of getting these expenses into the estimates. In fact, I know from personal experience that you do the numbers their way or they will drop your estimates from their database. I see the situation changing when companies can use the lower earnings base from years past to their benefit i.e. they lower this year's earnings base by including options expenses which makes it easier to achieve a higher growth rate next year (all else being equal). I mean that companies will start using the reported figures rather than pro forma ex. options expenses in their "spin" of results when it works to their advantage. To illustrate, options expense is $0.05 this year and EPS ex. options are supposed to be $0.35. Next year EPS are supposed to be $0.40 ex. options expense of $0.05. The growth rate would be 14.3%. If you include options expense in both years, the EPS growth rate goes to 16.7%. The company might not care as long as growth was this high, but if growth is slowing..." I think Bo's got a good point here - I think that the firms would naturally come around to reporting all earnings with all costs when those costs aren't terribly material any more. Conventional wisdom has it that stock option usage is declining. But Bo has a better point I think, and that's that it might be advantageous to include the costs when the growth rate can be spun in the company's favor. We'll keep watching.

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