“Restating Revenues and Earnings at INVESTools, Inc.”
Question 1
In alignment with SAB 104, INVESTools may recognize 40 percent of deferred
revenue as cost of sales, and 85 percent of these costs may be capitalized. With this
policy, the pre-tax operating earnings for the year 2002 would be about
-$.9 million. In the 2003 the pre-tax operating earnings would be $1.3 million, and
in 2004 the earnings would be -$2.7 million. This shows that under this policy net
loss is significantly reduced, especially in the latter years as deferred revenue
increases. Management should capitalize these expenses since it has a significant
impact on reported earnings. Capitalizing these expenses seems to be more in line
with what is actually happening within the business and seems to reflect a little
more accurately how well the company is performing in this new structure of sales.
2004 2003 2002
Deferred Revenue $32.2 million $8.6 million $4.8 million
Required Balance in
Prepaid Costs
(Capitaliza!on Policy) $10.9 million $2.9 million $1.6 million
Adjustment to
Opera!ng Earnings
(change in Deferred
Exp.)
$8.0 million $1.3 million $0.4 million
Historic Pre-tax
Opera!ng Expenses $(8.2) million $(1.5) million $(1.5) million
Adjusted Pre-tax
Opera!ng Income $(0.2) million $(0.2) million $(1.1) million
Question 2
The historical data shows that restatements of revenue many times have a
negative effect on stock prices. So persistent is the restatement announcement that
stock prices for a company may continue to fall for “even a month after the
announcement.” While this affects the company on many levels, the board of
directors for INVESTools may be concerned about other issues that may arise due to
the restatement of revenues and earnings. A restatement of prior revenues may lead
to a more extensive investigation by auditors in the future. If the restatement is
perceived as being indicative of the company having something to hide, auditors
could rake through INVESTools’ numbers much closer than would be considered
normal. If the auditors feel they find something of any significance, which could
possibly lead to a federal investigation, especially with such a high jump in revenues
