Financial Statement Analysis, 5th Edition

CHAPTER 7Expense 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.

DIAMOND FOODS'S MOVABLE EXPENSES

On February 8, 2012, Diamond Foods announced that it would restate its earnings for the previous two years. The snack food producer also found material weaknesses in its financial reporting controls. Chief executive officer Michael J. Mendes and chief financial officer Steven M. Neill were placed on administrative leave and fired the following day.

Diamond's shares fell as much as 44 percent in after‐hours trading. Jefferies stock analyst Thilo Wrede wrote in a research bulletin that the company would probably violate its debt covenants as a result of the coming reduction of reported earnings. In addition, Standard & Poor's reduced its outlook for the company's credit rating from Stable to Slightly Negative.

The company's planned earnings restatement involved payments to walnut growers of $20 million in August 2010 and $60 million in September 2011 that were booked in the wrong periods. Shareholders who were ...