NCPA - National Center for Policy Analysis

Accounting Irregularities Haven't Skewed Profitability Figures

February 22, 2002

Has fraudulent accounting drastically overstated the profitability of the U.S. corporate sector in recent years -- and thus the health of the economy?

Not in the judgment of Steven Wieting, a senior economist at Citigroup's Salomon Smith Barney unit.

  • He says analysts are on solid ground in using the operating income of the Standard & Poor's 500 companies as a measure of corporate profitability.
  • He notes the measure has risen and fallen in the same pattern as the overall economy going back at least as far as 1970.
  • For instance, manufacturing production fell a sharp 7 percent last year.
  • From past downturns, that should mean a 20 percent decrease in corporate profits -- and that's just how much S&P operating income did fall.

Wieting says the more conservative measure of profits -- net income under generally accepted accounting principles (GAAP) -- is actually a less accurate indicator because it is affected by one-time events such as write-offs. Looking again at manufacturing, for example, net income last year under GAAP fell 50 percent because of write-offs, exaggerating economic weakness.

As for the accuracy of debt measurements, the Federal Reserve bases its numbers on data from lenders rather than borrowers. So it is not misled by companies' attempts to hide debt off the balance sheet, as Enron did.

Source: Peter Coy, "Economic Trends: This Economy Is No Charade," Business Week, February 18, 2002.

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