Question Today the Ongoing Value of Capitalized Items

Part 2 of 5 by Gary Patterson - The Fiscal Doctor

 
Gary W. Patterson - http://www.fiscaldoctor.com

This article is the second of five by Firestorm Expert Council member Gary W. Patterson exploring the Five Key Areas where Risk may be lurking in your company, an excerpt from his book Stick Out Your Balance Sheet and Cough

Review Part 1 and take the Internal Exam Survey:

The Internal Exam – Five Areas Where Risk Can Lurk

Would you feel better about the issue of capitalization if you saw examples of how large companies with access to award-winning systems still make monumental mistakes when they http://news.cnet.com/2100-1033-257278.html misread the market? For example, Cisco had world-class information systems and processes for financial reporting and operational controls in place when it wrote off $3 billion of inventory in 2001.

In a series of widely discussed articles about how a write-off of such magnitude could occur with a company that has such sophisticated systems, Cisco’s executives admitted they misread the market downturn. At least Cisco made an honest, but embarrassing, mistake, but I wonder how many other companies would openly acknowledge such an error.

Another example is Fannie Mae. In business parlance, what Fannie Mae did is sometimes called “cooking the books”—not a good thing to do. Fannie Mae made highly questionable valuation decisions, not just once but twice. But the clean up team who was brought in to right the wrong appears to have made even more expensive and questionable actions than the “bad” people they had replaced.
 
Possibly, the motives of the second team were less questionable than the motives of the first team and were closer to reckless risk taking than unethical behavior.

Nonetheless, the net result was that in November 2008, Fannie Mae indicated that it would write off $20 billion in tax-related
assets.

While it may be several years before we have better indications of the total costs to shareholders and taxpayers of today’s financial institutions’ failures to make tough decisions, we never will know the real total cost of these wrongdoings. Companies of all sizes have legitimately capitalized some item in the past that should be regularly questioned. All of us have read the horror stories of write-offs that in hindsight raise questions that often were not valid or even a factor when they originated.

If you have reserves, allowances or estimates for loss, it is a worthwhile hedge against downside risk to take a more critical look at them now and at least once a year going forward. When bad things happen to good companies, some of the reasons those things were not corrected earlier can be tremendously embarrassing later, when the bad things are on the front page of the Wall Street Journal.

Why do you think incoming presidents of turnaround situations scrutinize everything and clean house–sometimes referred to as writing off everything including the kitchen sink? They would rather embarrass the outgoing leader than be the subject of embarrassment in the future.

Next Week, Part 3: Analyze Your Top Ten Customers’ Profits