Creative Accounting, EBITDA, and Core Earnings

Abstract

Many companies are prone to use financial levers, such as gains from their pension funds, to boost reported profits. Until recently, this was a legal accounting practice, but many investors say it gave an overly rosy view of company results. After the 1999–2002 problems, increased scrutiny of accounting practices means that companies have to be very careful about how they beautify their bottom line. They now have to:

• Release more data to regulators and shareholders in their Annual Reports

• Avoid practices which the market considers distortions of accounting procedures

• Stop leveraging their profits by mixing pension fund gains and other one-off or non-core items, and

• Distinguish intellectual property income as a separate line item, instead of combining it with general management to make overhead expenses look lower.

Proforma financial reporting, in which each company draws up the accounting presentation as it pleases, and accounting manipulations like earnings before interest, taxes, depreciation and amortization (EBITDA) have made investors very careful about the financial numbers they are getting. Increasingly, stakeholders have come to understand that in the corporate world it is not exactly black and white when it comes to accounting procedures.