For most corporate financial managers, the front line of the SEC's war on earnings management took shape with the three Staff Accounting Bulletins issued over the past year by the Commission's staff: SAB 99, 100 and 101. These pronouncements deal with some of the more commonly used accounting tactics designed to smooth out or inflate reported earnings.

 

At a conference, "Benchmarking the Quality of Earnings," co-sponsored by the American Institute of CPAs and Financial Executives International, analyst Pat McConnell of Bear Stearns said analysts favor financial transparency over deceptive accounting practices, but that in the case of the latter they are well-prepared to decipher financial reports and get to the truth.

 

According to McConnell, analysts define the highest quality earnings as "the earnings that can be taken right to the bank and deposited," and which are "replicated every quarter with 100 percent certainty." In contrast, they define the lowest quality earnings as "those earnings that may turn into cash in some distant day in the future, and yet are not too certain they'll ever see this transaction happen again in the future."

 

McConnell explained that "analysts are much better educated and much more sophisticated" than ever before. "Today, many financial analysts know more about the rules or at least as much about the rules as many accountants. ... We have new and sophisticated ways to deal with them, and we are getting closer and closer to this representational faithfulness." Hence, analysts are sifting through the information that they are being given and trying to discern how to use that information in the models they use.

 

In this tug-of-war between standard setters and financial reporting methods used by management and analysts, McConnell's recommendation to standard setters for improved financial reporting was simple: "Stick to the basics, report transactions in a representationally faithful way. Do not give into the urges of many to define terms being used by analysts in business, such as restructuring charges and non-recurring items, but do try to label things in the income statement in an informative and useful manner. Disaggregate numbers that are measured using different bases and come up with a better way to present the information useful to investors."

 

McConnell's full speech at the conference is available through the The CPA Report segment, Benchmarking the Quality of Earnings.