Our latest forensic accounting red flag is from an investment management firm with reported profit growth that comes entirely from unusual tax gains.
We pulled this highlight from yesterday’s research of 51 10-K filings, from which our robo-analyst technology collected 6,534 data points. Our analyst team used this data to make 1,064 forensic accounting adjustments with a dollar value of $37 billion. The adjustments were applied as follows:
- 449 income statement adjustments with a total value of $2 billion
- 436 balance sheet adjustments with a total value of $16 billion
- 179 valuation adjustments with a total value of $18 billion
Figure 1: Filing Season Diligence
Sources: New Constructs, LLC and company filings.
We believe this research is necessary to close the gap between the suitability and fiduciary standard of investment advice services.
Today’s Forensic Accounting Needle In A Haystack Is For Financial Investors
Analyst Lindsay Bohannon found an unusual item yesterday in Pzena Investment Management’s (PZN) 10-K.
On page 37, PZN disclosed a $62 million income tax benefit due to a change in their valuation allowance. Previously, PZN did not believe it would earn enough profit to recognize the benefits from much of its deferred tax assets, so it was forced to recognize a valuation allowance that decreased the value of those assets on its balance sheet.
In 2016, PZN increased its assets under management to the point where it now believes it will be able to realize the entirety of its deferred tax assets, so it decreased the valuation allowance and recognized that decrease as an income tax benefit.
This income tax benefit allowed PZN to more than double its reported GAAP net income. When we remove that benefit and give PZN a more normal tax rate, we see that net operating profit after tax (NOPAT) actually declined by 44%, from $50 million to $28 million. Investors who rely only on the financial statements get a misleading view of PZN’s profitability.
This article originally published here on March 15, 2017.
Disclosure: David Trainer, Lindsay Bohannon, and Sam McBride receive no compensation to write about any specific stock, sector, style, or theme.
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