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Financial Statement Analysis: A Practitioner's Guide, Fourth Edition by FERNANDO ALVAREZ, MARTIN FRIDSON

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Chapter 7

Expense Recognition

As Chapter 6 illustrated, companies can grossly distort their earnings through aggressive revenue recognition. Analysts who arm themselves with appropriate skepticism about financial statements are bound to wonder whether companies also pump up the bottom line by taking liberties in booking expenses. The answer is resoundingly affirmative. Corporate managers are just as creative in minimizing and slowing down the recognition of expenses as they are in maximizing and speeding up the recognition of revenues.

NORTEL'S DEFERRED PROFIT PLAN

Nortel Networks illustrated the distorting power of accruals, one of the most abused features of financial reporting. Founded in 1882 as the Bell Telephone Company of Canada's department for manufacturing telephones and telephone equipment, the unit was spun off as the Northern Electric and Manufacturing Company Limited in 1895. It went through various ownership and name changes, eventually becoming known as Nortel Networks to signify the company's quest to dominate the global market for public and private telecommunications networks.

Nortel grew into North America's largest telecommunications equipment manufacturer and rode the late-1990s boom in fiber optics equipment. From the mid-1990s until mid-2000, its market capitalization soared more than tenfold, and the company shelled out $30 billion for acquisitions. Nortel's showy advertisements featured celebrities such as Elton John.

The Tech Wreck brought those heady ...

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