Dogbert Knows Earnings Management.

The second one is pretty timely - particularly since pension assumptions are covered in Level 2 of the CFA curriculum.

"Assisted Accounting Manipulation" and the AIG Probe

This from the Wall Street Journal on the ongoing investigation of AIG's accounting of a transaction with General Reinsurance:

Federal and state investigators are looking at whether a transaction between Berkshire Hathaway's General Reinsurance Corp. and American International Group Inc. four years ago transferred sufficient risk to AIG to allow the company to account for it as an insurance policy, people familiar with the matter said.

New York-based AIG booked the transaction at issue as insurance, the people said, a move that boosted its premium revenue by $500 million while also adding $500 million to its property-casualty claims reserves. Generally accepted accounting principles require insurance and reinsurance transactions to transfer "significant" risk from one party to another if either intends to account for the transaction as insurance; without significant risk transfer, such transactions must be accounted for as financing, under rules that are often less favorable.

Click here for the whole article.

I'm reminded of how much accounting chicanery requires the assistance of another party (in this case, General Re). Another example of "assisted maniputlation" ( requiring the assistance of a third party) is "channel stuffing", where a customer agrees to a sale far in advance of the normal period when it would take place, with delivery at a much later time. This allows the vendor to book the revenue in an earlier period. A classic example of channel stuffing would be the booking of sales of barbecue grills to stores in December, rather than in the spring when they normally would be sold.

Earnings Management By Banks

Business Week Online has this on earnings management by banks (compliments of The FInancial Accounting Blog):

Last year the banks had an easy way to juice their profits. All they had to do was allocate a little less money to loan-loss reserves -- the money they set aside to cover bad debt. As the economy has improved and defaults have slowed, many decided they didn't need as much in reserve as they did in 2003, and presto, their earnings per share would rise a few cents.

But investors who assume the profits are humming and decide to buy bank stocks could be in for a shock. In 2005 many banks won't have this profit source. Some have already pared loan-loss reserves as much as they reasonably can, analysts say. "A lot of banks may do this from time to time to meet estimates," says Brian Shullaw, senior research analyst at SNL Financial in Charlottesville, Va.

Academics have done dozens of studies on earnings management by non-financial firms over the years. There's been relatively little done, however on earnings management by banks (a few have been done on insurance companies, which also have to set aside loss reserves). This is surprising, since researchers often use the different regulatory environments faced by financial institutions as an interesting spin for examining issues faced on non-financial firms. However, since I don't do research in the area of financial institutions, there could be good reasons why the issue hasn't been done that I'm simply not aware of.