Saturday, September 1, 2007

Lies everywhere

I ran across two completely unrelated, yet seemingly identical instances of data manipulation recently that I thought I would call out.

The first, from the NYT, suggests that the Pentagon and Bush Administration revised upwards the casualty totals from last winter, to retrospectively show a decline in violence during the much ballyhooed Surge-that-will-win-the-war (who the f calls a military strategy a surge? Eisenhower or Roosevelt would've laughed in his face).
"There were significant revisions to the way the Pentagon’s reports measure sectarian violence between its March 2007 report and its June 2007 report. The original data for the five months before the surge began (September 2006 through January 2007) indicated approximately 5,500 sectarian killings. In the revised data in the June 2007 report, those numbers had been adjusted to roughly 7,400 killings – a 25% increase. These discrepancies have the impact of making the sectarian violence appear significantly worse during the fall and winter of 2006 before the President’s “surge” began."
Another example comes from the publicly reported filings of Overstock.com, which have been analyzed by Sam Antar, reformed white-collar criminal. Overstock has been engaging in similarly sketchy machinations, this time with its inventory. In accounting, you track the value of your inventory-on-hand by estimating the lower of two numbers: either its cost, or its current market value. IF you don't sell your inventory, and it sits around and becomes unfashionable etc., then your inventory reduces in value. Typically companies will institute 'inventory reserves'. I'm going to use Sam's example:

In the first quarter, a company buys merchandise for $120, its books and records will reflect $120 of inventory.

In the second quarter, the company, under GAAP, reduces the value of its merchandise by increasing inventory reserves by $50 to reflect diminished future demand and market conditions. Therefore, in the second quarter, the company reduces its gross margins by $50. The net inventory book value on its balance sheet is reduced to $70 (original cost $120 less $50 inventory reserves).

In the third quarter, the company sells the merchandise for $90. Since the net value book value of the merchandise was previously reduced to $70, (as a result of taking a $50 reserve against its original purchase price of $120 in a previous quarter), the company recognizes gross margins of $20 (Sales $90 minus net book value $70).

The company, under GAAP, had gross margins of $20 in third quarter after selling the previously written down inventory. It would seem on its face to be an improvement over the reduction of gross margins by $50 in the second quarter resulting from the inventory write down. However, in reality the company lost $30 on its merchandise. The original cost of the merchandise was $120 and they sold it for $90.

Therefore, taking inventory reserves increases future gross margins.
Sam has put together a 3-part post (warning, pretty technical part 1, part 2, part 3) on the sleight-of-hand being done by the company behinds the scenes. In recent conference calls, the Overstock.com company executives have been touting their recently high margins. Well, as is convincingly demonstrated by Sam, overstock.com cooked the books by taking too many inventory reserves in previous quarters, which reflects positively on margins when they actually sell the inventory in later quarters, but is still a net loss for the company. Sound familiar? Like...maybe what the Bush Administration just did?

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