Accounting Problems Reported in Major Companies Since Enron

CRS Report for Congress
Accounting Problems Reported in Major
Companies Since Enron
Mark Jickling
Specialist in Public Finance
Government and Finance Division
Since the sudden collapse of Enron Corp. in the fall of 2001, and the series of
accounting scandals that followed, the integrity of corporate financial accounting has
emerged as a public policy concern. Over 100 U.S. companies, including several of the
largest, restated (or corrected) their previously-announced financial results in the first
half of 2002. During the 1980s and early 1990s, by contrast, there were an average of
about 50 restatements per year. Does the increase represent a decline in the quality of
corporate accounting, the inevitable fallout from the end of an easy-money stock market
boom, or is it the result of more intense, post-Enron regulatory scrutiny? Do accounting
scandals reflect a few rotten apples in the corporate barrel, or has “gaming the numbers”th
become standard practice at many U.S. companies? The 107 Congress enacted
fundamental auditor and accounting reform legislation (the Sarbanes-Oxley Act, P.L.
107-204, summarized in CRS Report RL31483). This report presents brief summaries
of the accounting problems that have been reported at major corporations since Enron.
It will be updated as developments warrant.
This report provides a list of major companies where accounting problems have
surfaced since the collapse of Enron Corp. in late 2001. The companies are identified by
name and by their rank in the Fortune 500 (except for two – Tyco International and Global
Crossing – which are registered in Bermuda and not included in Fortune’s survey). Also
included is a brief summary of the substance of the accounting problem, derived primarily
from press reports. Because many of the firms listed are involved in ongoing
investigations and/or litigation, information available to date may be incomplete or

Congressional Research Service ˜ The Library of Congress

CompanyFortuneParticulars of Accounting Problem
500 Rank
Adelphia456Three members of the Rigas family, Adelphia’s founders, and
Communi-two others, face criminal charges of conspiracy, securities fraud,
cationswire fraud and bank fraud, in what the SEC describes as “one ofthe most extensive financial frauds ever to take place at a public
company.” The company has disclosed that it guaranteed loans
of $2.3 billion to off-the-books partnerships controlled by the
Rigas family. Much of this money was used to purchase
Adelphia stock. The share price has fallen sharply, and $1.6
billion of the $2.3 billion has been written off by the company.
Allegheny185In November 2002, Allegheny announced that it could not file
Energyits third quarter earnings report on time because of accounting
errors in previous statements. The firm has sued Merrill Lynch,
for allegedly inflating the revenues of an energy trading unit
purchased by Allegheny in 2001.
AOL Time37In July 2002, the SEC and Department of Justice launched
Warnerinvestigations of AOL’s accounting. No details of the probes
have been made public, but press reports have raised questions
about AOL’s accounting for advertising and Internet commerce
revenue. In October 2002, the firm announced that it would
restate earnings for the 2 years ended 6/30/02 by $190 million.
Bristol-Myers96In July 2002, Bristol-Myers Squibb announced that the SEC was
Squibbinvestigating sales tactics that may have boosted reported
revenues: drug wholesalers were offered discounts to purchase
excess inventory above and beyond market demand. In October

2002, the firm announced that it would restate 2000-2 results,

reducing revenues by about $1.5-$2 billion.
Cendant217In December 2002, Cendant officials were charged with
accounting fraud, related to accusations that the firm’s reported
operating income was improperly inflated for nearly a decade.
The charges supplemented indictments issued in February 2001.
Duke Energy14In October 2002, Duke Energy Corp.'s regulated electric utility,
Duke Power, agreed to pay $25 million to its customers to settle
allegations by regulators in North and South Carolina that it had
underreported net earnings by about $123 million between 1998
and 2002, in order to avoid having to cut its electricity rates.
Dynegy30In September 2002, Dynegy agreed to pay a fine of $3 million to
settle an SEC investigation of its accounting and trading
practices. Dynegy and several other energy firms have admitted
making “round-trip” transactions with no economic substance
intended to boost revenues or create the illusion of market
liquidity. Also under investigation was a complex series of
transactions called “Project Alpha,” which boosted reported
earnings via purchases and sales of natural gas between Dynegy
and its affiliates. The SEC described Project Alpha as “a loan
masquerading as operating cash flow.” In May 2002, Dynegy
restated 2001 earnings, reducing reported income by $79 mil. In
November 2002, the company restated 3 years of results.

CompanyFortuneParticulars of Accounting Problem
500 Rank
Enron15In September 2001, Enron restated its financial results from thendrd
2 quarter of 2000 through the 3 quarter of 2001. The major
issue behind the restatement was the use of unconsolidated
subsidiaries, or “special purpose entities,” to conceal major
losses in investments and assets related to Internet ventures and
fiber optic networks. Under the restated accounts, those losses
were attributed to Enron, rather than to essentially fictitious third
parties, and the company’s reported profits dropped
significantly. Numerous other accounting irregularities have
been disclosed or alleged. A criminal investigation is under way;
several indictments have been issued and guilty pleas received.
GlobalNAThe SEC is investigating accounting practices at Global
Crossing Crossing, now in Chapter 11 bankruptcy proceedings. Specific
issues include swaps of fiber optic telecommunication capacity
that may have artificially boosted revenues, and the accounting
treatment of long-term leases. In October 2002, the firm
announced a restatement of 2001 figures, reducing income by
about $19 million, and assets and liabilities by about $1.2 billion
Halliburton153The SEC is investigating Halliburton’s accounting practices.
Press reports suggest that the issue is an accounting policy –
adopted in 1998 – of reporting cost overruns on construction
projects as current revenue, even though those added costs might
be disputed by customers and never received by the company.
International9IBM has been criticized for reporting the sale of assets as
Businessoperating income, rather than as a one-time gain, or
Machinesextraordinary item. In 1999, the SEC questioned IBM’s
accounting treatment of the $4 billion sale of its Global Network
unit to AT&T – proceeds from the sale were used to offset
operating costs. IBM did not agree to the SEC’s request that it
amend its financial statements. Again, on the last day of 2001,
IBM sold a business unit for about $300 million, and booked the
proceeds as operating income rather than as an extraordinary
item. IBM continues to defend its accounting practice, but its
stock dropped by 5% following a New York Times story
discussing the 2001 transaction and its accounting treatment.
Kmart40Kmart’s accounting practices are under investigation by the SEC
and the FBI. Information about areas of investigation is limited
– they may include loans to executives, inventory valuation,
vendor allowances, lease obligations, and off-the-books
financing. In May 2002, Kmart (now in Chapter 11 bankruptcy)
restated 2001 results, increasing reported losses by about $500
million. In December 2002, the firm restated its earnings back
to 1999.

1 For more information, see CRS Report RS21135, The Enron Collapse: An Overview of
Financial Issues.

CompanyFortuneParticulars of Accounting Problem
500 Rank
Lucent76In October 2002, it was reported in the press that the SEC was
Technologiesinvestigating certain accounting practices at Lucent, including
the booking of fictitious sales and accounting for equipment sent
to distributors on consignment as final sales. The investigation
stems from a 2000 statement by the firm that it had overstated
earnings in fiscal 2000, but the SEC is reportedly looking at
earnings back to the mid-1990s.
Merck24In July 2002, Merck disclosed in an SEC filing that it had
overstated revenues for the last three years by $12.4 billion. The
amount was reported as revenues to the Merck-Medco
pharmaceutical benefits subsidiary even though it was never
collected. The West Virginia Public Employees Insurance
Agency has filed suit against Merck-Medco, alleging
overcharging for pharmacy benefits.
Microsoft72In June 2002, Microsoft settled an SEC complaint about its
“cookie jar” accounting practices between 1994 and 1998, and
agreed to restate its financial results for those years. The SEC
found that Microsoft established seven reserve accounts, without
providing an accounting justification for them. The reserve
accounts were used to manage reported earnings – in some
quarters, money would be added to the reserves to reduce
reported earnings, while in other quarters, money was
withdrawn to boost earnings. The accounts held between $200
and $900 million over the 1994-98 period.
Pacific Gas &87In February 2002, PG&E announced that it would delay
Electricreleasing its 2001 results because certain off-the-books
arrangements for financing several power plants, called
“synthetic leases,” may have been improperly reported. Had the
synthetic leases been reported as debt, PG&E’s balance sheet
liabilities would have been about $1 billion higher. The
synthetic leases were transactions between PG&E and an
unconsolidated subsidiary, National Energy Group, and part of
the accounting dispute is whether National was in fact
independently controlled. (If it was not, its liabilities should
have been consolidated with PG&E’s.)
PNC269The Federal Reserve and the SEC opened inquiries into PNC’s
Financialaccounting in January 2002. At issue was the sale of problem
Services loans and non-performing assets to three unconsolidated
subsidiaries. In 2001, PNC disposed of $550 million in loans
and $162 million in venture capital investments, removing these
assets and liabilities from its balance sheet. The regulators
insisted that the subsidiaries were part of PNC and the company
restated its 2001 results.

CompanyFortuneParticulars of Accounting Problem
500 Rank
Qwest102The SEC is investigating Qwest’s revenue recognition policies
Communi-in 2000 and 2001. A central issue is said to involve swaps of
cationsfiber optic capacity, which accounted for $664 million of
Qwest’s reported 2001 income. In a swap, telecommunications
companies exchange optical fiber networks or parts of networks
(or rights to use network capacity). A swap may be a legitimate
transaction to meet customer demand, or it may be a “wash
trade” without economic substance, designed to create artificial
revenues. For example, a company (or both parties to the trade)
may record one side of the swap as a sale of assets, and report it
as revenue, and treat the other side of the transaction as a capital
expenditure, which does not appear on the income statement.
Enron was the counterparty in several of Qwest’s capacity
swaps. In September 2002, Qwest restated its financial results
for 2000 and 2001, reducing reported revenues by $950 million.
In November 2002, further accounting mistakes were disclosed,
reducing earnings by a further $358 million.
Raytheon119In November 2002, the SEC sanctioned Raytheon for violations
of Regulation FD, which prohibits release of financial
information to Wall Street analysts before that information is
made available to the general public. In January 2003, the firm
announced that the SEC had begun an informal inquiry into its
accounting practices.
TycoNATyco, a conglomerate that has acquired over 700 businesses in
Internationalthe last three years, faces questions about its accounting for
mergers. Critics allege that the financial results of acquired
companies were manipulated before and after the takeovers to
produce a sharp increase in revenues and profits once the
acquisitions were completed. Driven partly by accounting
uncertainties, Tyco stock has fallen by about 80% since the end
of 2001. Tyco defends its accounting practices – the SEC ended
a probe in 2000 without action and in mid-2002 a judge
dismissed 38 investors’ lawsuits. In January 2002, the firm
proposed to split itself into four independent companies, in part
make its accounting results more transparent. Several Tyco
executives have been indicted for tax evasion, enterprise
corruption, and/or grand larceny.
WorldCom242In June 2002, WorldCom announced that it had overstated 2001st
and 1 quarter 2002 revenue by about $3.9 billion. Subsequent
announcements brought the total accounting errors to over $7.1
billion. The firm had classified routine operating expenses –
payments to other telecommunications carriers for use of their
equipment – as capital expenditures, boosting reported income
and assets. On July 31, 2002, WorldCom’s former CFO and
Controller were charged with securities fraud and conspiracy.
Also under investigation are various loans and payments to
senior management.

2 For more information, see CRS Report RS21253, WorldCom: The Accounting Scandal.

CompanyFortuneParticulars of Accounting Problem
500 Rank
Xerox120In April 2002, Xerox paid a $10 million fine (the largest ever
imposed in an accounting case) to settle an SEC complaint and
restated its reported income since 1997. The SEC found that
Xerox had improperly inflated its reported earnings by over $3
billion, primarily by recognizing future payments as current
income. For example, revenue from long-term leases of Xerox
equipment was reported immediately, rather than at the time
payments were received. The SEC’s complaint also noted that
Xerox’s management had not cooperated with its investigation,
which began in 2000.