Another interesting way to boost earnings by massaging accounts, courtesy Valeant.
Suppose you have Company A that has to incur heavy R&D expenses for drug discovery purposes. GAAP requires these to be expensed in earnings. But suppose the same company does not do any R&D and acquires another company that does exactly the R&D it wants and pays up for it by exactly the amount spent. In such a case the amount will be shown as an intangible assets and amortised over a long period of time which period would be far longer than the expense period. This is allowed as per GAAP.
The net effect is that you take a far lower amortisation every year and thus smoothen earnings.
This tactic was learnt in a fantastic article in WSJ link behind a pay wall – Valeant an accounting pioneer too.
It says ” Valeant’s approach to research and development also leads to favorable accounting treatment.
When drug companies spend on research in-house, they record quarterly expenses that eat into profits. But research gained through acquisitions is treated as an intangible asset that can sit on companies’ balance sheets indefinitely at full value.
That means that by buying, rather than creating, most of its drugs, Valeant can avoid recording big quarterly R&D expenses, thus lifting its earnings.”
Thanks,
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