The E-Numbers Game

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Accountants like to call it "earnings management." Regular folks prefer terms like "cooking the books." Whatever the term of art, there's been an increasing tendency by corporations, particularly dotcoms, to bend the rules of accounting to make their numbers look good.

Last week the rules snapped back with a vengeance when MicroStrategy, a supercharged Vienna, Va., software and Internet company, was forced to restate drastically results it reported in 1998 and 1999. MicroStrategy's stock, which had risen like Icarus--from $7.34 to $333 over the past 12 months--suddenly fell from the sky, losing more than 60% of its value in a single day. More than $11 billion in market value was erased, and the company's brash chairman, Michael Saylor, 35, personally lost $6 billion in paper wealth in less time than it takes to say overvalued dotcom. "There's no doubt this is a bump in the road," Saylor said bravely, "but we signed up to change the world and never believed it was going to be easy."

The accounting fiasco broke a long winning streak. His company, founded more than 10 years ago, sells software that allows firms such as American Express and K Mart to mine the masses of sales and other data they collect to better target customers. MicroStrategy went public in 1998, and the stock took off after the creation of Strategy.com a unit that beams custom-tailored information to subscribers of clients like Ameritrade, the Washington Post and the Wall Street Journal. This month, Saylor announced a $100 million charitable scheme to launch an "Internet university." He says these plans haven't been changed by the news.

MicroStrategy's reversal stems from a practice endemic in dotcom-land--overstating revenues. In the Internet twilight zone, where profits rarely exist, evaluating complex revenue streams can turn more on esoteric judgments than on accounting canon. The right outcome can add billions to a company's stock-market value. "It's a dangerous and uncertain game," says Howard Schilit, president of the Center for Financial Research and Analysis, a forensic accounting firm that issued two early warnings on MicroStrategy. "You know your stock could be dead meat if results are a couple of cents short, so you may sit down with your accountant and see if certain assumptions can be changed."

It's not just the hot start-ups that have had accounting issues. According to a recent study by Bear, Stearns, mainstays like Wal-Mart and Continental Airlines are among 32 companies that have restated their financial results since the Securities and Exchange Commission issued a clarification in December of the rules on recognizing revenues. For accounting firms, the choices are difficult. Challenge the client's bookkeeping, which Saylor insists was conservative, and you may end up without a client; fail to do so, and you face angry shareholders and their lawyers after the books are put right. PricewaterhouseCoopers, MicroStrategy's auditor, did not advise the firm that it had failed to comply with strict revenue accounting rules until the restatement.