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Daisytek, a distributor of office products and computer supplies, engaged in an elaborate manipulation of earnings from 2001 to 2003, according to the SEC.²⁶ The company regularly released earnings forecasts it could not meet and made the numbers by a practice euphemistically called “booking to budget.” This, stripped to its essence, meant recording fictitious “budgeted” revenues and expenses instead of the actual numbers. At the end of each quarter, the increasing gaps between real and booked (budgeted) amounts were bridged by income from vendors’ allowances and rebates granted on large inventory purchases Daisy had made.²⁷ The vendor allowances recorded as income were substantial, often exceeding reported earnings, such as in 2002, when Daisytek reported net income of $10.85 million, while vendor allowances were $22 million. Reported earnings were thus significantly inflated by rebates from the acquisition of unnecessary, often obsolete inventory.

Not surprisingly, inventory levels at Daisytek spiraled: $83.6 million, $115.4 million, and $190.7 million at the end of 2001, 2002, and the first nine months of 2003, respectively. Total revenues for the corresponding periods rose only slightly: $1.01 billion, $1.19 billion, and $1.33 billion. Throughout, Daisytek assured investors that “Our purchases of inventory generally are closely tied to sales.” As an aside, since both inventories and sales figures were publicly reported and prominently displayed, one wonders about the gullibility of investors and analysts who failed to realize the increasing misalignment between Daisytek’s inventories and sales. Ultimately, the large inventory purchases, often of hard-to-sell items, had a devastating effect on the company’s liquidity and operations, leading suppliers to place it on a credit hold, until it mercifully filed for Chapter 11 in May 2003.

Daisytek’s schemes, aimed at meeting its own performance forecasts, demonstrate the recklessness and shortsightedness of some managers, willing to mortally hurt the company—purchasing large quantities of unneeded, obsolete inventory—to temporarily mask a deteriorating business, and even paying taxes on fictitious income. Daisytek’s managers apparently believed that they were immune to detection because they manipulated earnings by real actions—excess inventory purchases—rather than by twisting accounting rules. Managing earnings by actions like R & D cuts or deeply discounted sales, some managers believe, is safer than by misapplying accounting techniques, because business decisions are rarely second guessed.²⁸ Earnings manipulation by actions, however, is often more costly than by accounting means, as clearly demonstrated by Daisytek’s bankruptcy.