Earnings Management - Accounting Red Flags
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Richard J. Wayman

Delaying Expenses
Under certain circumstances, companies are allowed to delay recognizing expenses on their income statements. For example, if a company makes a major investment in a plant or large machinery (a capital investment), the benefit of that investment will be returned over a number of years. In order to match the benefit with the expense, GAAP allows companies to depreciate the investment over the useful life of the asset.

In recent years, however, companies have gotten creative by delaying expenses by capitalizing them. For example, a few years ago AOL (before it purchased Time Warner) capitalized the costs of producing the millions of CDs it gave away to market its online service. As people started to sign up, profit and revenue grew rapidly, but the cost of making and distributing the CDs were being spread over a longer period of time. Eventually, the regulatory bodies required AOL to restate results and expense the cost of the CDs over a much shorter period of time.

Another example of delaying expenses was the way telecoms would buy the right to use the capacity of another carrier over a long period of time. The buyer of the capacity would classify the transaction as a capital expense, reducing the impact on earnings. Combining this with selling capacity to another carrier and booking the revenue up front (see: Accelerating Revenue) would result in astronomical earnings growth.