Mulford, Charles W., and Eugene E. Cominsky, The Financial Numbers Game: Detecting Creative...

(New York, NY: John Wiley & Sons, Inc., 2002, 395 pp.)

In their new book, The Financial Numbers Game: Detecting Creative Accounting Practices, Charles Mulford and Eugene Cominsky have provided interested readers a great reference tool for examining the issues surrounding earnings

management. The authors examine the issue by defining earnings management, exploring the incentives for earnings management and then presenting illustrations and examples of how businesses manage earning. Within each chapter the authors examine the flexibility of GAAP and how some companies use this flexibility to their own ends.

While the entire book is very enjoyable, there are two features that the authors provided that I found to be very helpful. First, each chapter has a comprehensive glossary that will provide useful background for a reader who has no accounting experience. The second useful feature is the checklists provided in the later chapters to help readers apply the lessons of the chapter and detect instances of earnings management. The checklists provide a way to take the issues discussed in the chapter and apply them to a specific company.

The authors start by describing the issues surrounding earnings management in two introductory chapters. The first chapter introduces the idea of earnings management and describes why firms have an interest and an incentive to manage earnings. The second chapter provides a thorough examination of accounting policy choices and how these choices can be used or misused. In each case, the authors present numerous examples to reinforce the topics.

In the third chapter, the authors expand significantly on the introduction and examine the conditions and incentives for earnings management in greater depth by focusing on examples of abusive earnings management. SEC Enforcement Releases are used to provide illustrative cases of abusive earnings management and to help distinguish between aggressive and abusive earnings management. The authors also start a discussion of the notion of pro forma earnings in Chapter 3 that continues throughout the book.

The fourth chapter examines the SEC's response to earnings management that began with Chairman Levitt's 1998 speech at the NYU Center for Law and Business. The chapter starts with an examination of Chairman Levitt's plan to increase public confidence in financial reporting and moves on to analyze the SEC's response through issuance of Staff Accounting Bulletins and Enforcement Actions. The chapter continues with an interesting look at securities laws and how the SEC enforces the laws along with a multitude of examples of enforcement application. The chapter ends with a look at the penalties and consequences associated with violating SEC rules.

The fifth chapter provides the results of the authors' survey of financial professionals on the issue of earnings management. The first segment of the survey asked professionals if certain financial techniques are consistent or inconsistent with GAAP. The second portion asked professionals for their opinions about whether some commonly held beliefs about earnings management were consistent with their real-world experiences. The third section asked for the professionals to comment about earnings management they had observed personally, how it could have been detected, and what effect it has on investors.

The first five chapters would be an excellent addition to any accounting course. The authors explain earnings management and the complexities of the issue in an uncomplicated manner and use examples to bring home important points.

In Chapters 6 through 8, the authors provide an in-depth analysis of three common earnings management techniques: premature or fictitious revenue recognition, aggressive capitalization and extended amortization policies, and the misstatement of assets and liabilities. Each chapter begins with an examination of the accounting issue and provides examples of companies that have applied the accounting treatment in an aggressive manner. For example, the chapter on revenue recognition discusses the issue of identifying fictitious or premature revenue and then presents cases of different policies for recognition. The authors then go further in depth by examining the SEC's Staff Accounting Bulletins on revenue recognition and related SEC enforcement actions. The chapter ends with a discussion of how to detect premature or fictitious revenue and presentation of a checklist that readers can use to apply the concept to a specific company.

The book continues with two informative chapters examining disclosure issues associated with the income statement. The authors start with an instructive discussion of the components of the income statement and comprehensive income. Next is an interesting look at how a number of companies have creatively disclosed income statement components in order to change users' perceptions of the companies' operating strength. The tenth chapter focuses specifically on the use of pro forma measures of earnings and the confusion that the increasing use of these measures has introduced to the financial statements. It also illustrates how a lack of reporting standards can result in a simple issue, such as the definition of EBITDA, creating a lot of confusion. The examples in these two chapters alone will provide enough discussion points for an entire semester.

The authors finish with an examination of the cash flow statement. The initial explanation of how cash flow is reported, along with a short discussion of the indirect method of preparation, is another example of the authors' ability to explain difficult accounting subjects in a reasonable and parsimonious manner. The chapter continues with some of the accounting details that can make it difficult for novice users to understand accounting financial statements, such as how the tax benefits of stock options are treated and reported. The chapter ends with another useful checklist, in which readers can use operating cash flows to detect if their favorite firm is getting too creative with accounting practices.

The Financial Numbers Game was a very enjoyable and informative book. The authors cover all of the major issues concerning earnings management and back up each topic with a multitude of examples. The book would be appropriate for many levels of readers, from novice investors to audit committee members. This quality would make The Financial Numbers Game an excellent supplement to any financial or auditing course. In summary, I commend the authors for providing an excellent examination of an important current accounting issue.

DONALD P. PAGACH
North Carolina State University