Overstating Sales Continued from page 33
Table 3: Descriptive Statistics (in Millions)
Consolidated sales Non-controlling income % of net income before non-controlling income Estimated overstated sales with non-controlling interest and therefore, it is necessary to calculate an estimate of non-controlling sales by grossing up the non-controlling income by the conglomerate’s percentage of net income before non-controlling income. In the example provided in Table 1, net income before non-controlling income is $30 million or 10 percent of the total consolidated sales of $300 million. The non-controlling income of $2 million is divided by 10 percent to arrive at $20 million, which represents the estimated amount of overstated sales reported by the conglomerate. This procedure was followed for all 694 consolidated companies examined in this study. LARGE RETAIL EXAMPLE Table 2 provides an example from the study of a large retail company that has consolidated sales of approximately $445 billion and non-controlling income of $688 million. Since the parent company’s percentage of net income before noncontrolling income is 3.68 percent, the overstated sales attributed to the
Mean
Max
Min
$21,173 147 9.3%
$470,171 7,794 10.4%
$37 2 8.8%
$1,580
$75,000
$23
parent can be estimated at $18.7 billion by dividing $688 million by 0.0368. Although $18.7 billion represents only a rounded 4 percent of the $445 billion in total sales generated by this consolidated company, $18.7 billion is still a material amount.
earnings quality, and the relationship between earnings quality and investment decisions.3 However, there is little written about sales quality and the likelihood that large conglomerates are actually creating revenue through the consolidation process.
RESULTS Table 3 summarizes the results of performing a similar analysis on each of the 694 consolidated companies included in the sample. The results indicate that average consolidated revenue for these 694 consolidated companies was $21.2 billion, and the average estimate of overstated sales was $1.58 billion or 7.5 percent of total sales. There is an abundance of literature written about the quality of financial statements. The majority of this literature is concerned with earnings quality and the cost of capital.1 It addresses the impact of earnings quality and income smoothing,2 the influence of the Internal Revenue Service (IRS) and taxes on
INDICATED RESULTS The results indicate that the average consolidated company included in this sample of 694 companies is overstating its sales revenue by $1.58 billion per year. The analysis provides evidence that large consolidated companies that have grown through mergers and acquisitions are actually creating revenue through the consolidation process. The results also suggest that this additional consolidated revenue may positively influence the market’s assessment of the company. ■
REFERENCES Apergis, N., Artikis, G., Eleftheriou, S., & Sorros, J. (2012). “Accounting information, the cost of capital and excess stock returns: The role of earnings quality-evidence from panel data.” International Business Research, 5(2), 123-136. doi:10.5539/ibr.v5n2p123 Chandra, U., Ro, B. (2008). “The Role of Revenue in Firm Valuation.” Accounting Horizons, 22(2), 199-222.
1. Apergis, N., Artikis, G., Eleftheriou, S., & Sorros, J., 2012 2. Hejazi, R., Ansari, Z., Sarikhani, M., & Ebrahimi, F., 2011 3. LI, F., 2011
Hejazi, R., Ansari, Z., Sarikhani, M., & Ebrahimi, F. (2011). “The impact of earnings quality and income smoothing on the performance of companies listed in Tehran stock exchange.” International Journal of Business & Social Science, 2(17), 193198. LI, F. (2011). “Earnings quality based on corporate investment decisions.” Journal of Accounting Research, 49(3), 721-752. doi:10.1111/j.1475-679X.2010.00397.x
Mark Crowley, DBA, CPA, is an Assistant Professor, Accounting and Finance department, Bridgewater State University, Bridgewater, MA. He may be contacted at mark.crowley@bridgew.edu. MaryBeth Tobin, MSF, MST, CPA is an Assistant
Professor, Accounting and Finance department, Bridgewater State University, Bridgewater, MA. She may be contacted at mtobin@bridgew.edu.
34
Today’sCPA
| MARCH/APRIL 2014