Barriers to Interpretation—A Case Study of Philips Electronics NV

Philips Electronics NV, a very large European company, went through considerable upheaval in the period 1980 to 1994. Accounting disclosures did not seem to be very helpful to statement readers who wanted to evaluate Philips' progress and position. The company's financial condition and income results deteriorated significantly during most of the period, and large losses were shown in 1990 and 1992. Prior to the huge loss recorded in 1990, there were few indications in the annual reports that troubles were mounting. In earlier periods a series of accounting changes were made, the effect of which typically was to increase income. The most significant change came in 1992, when Philips abandoned current cost accounting. We investigated financial analysts' reactions to company disclosures and found that they had problems interpreting the effects of Philips' accounting changes. In addition to accounting changes, Philips also used a somewhat arbitrary restructuring charge (or credit) to adjust income amounts. Finally, the absence of full explanations from the directors at some points could have resulted in users of the annual report being misled. Over the period studied, Philips lost a significant portion of its stockholders' equity. The effect of its reporting practices was to obscure the impact of the unfavorable economic events that affected the company. Financial reporting, at least for this company, fell short of providing disclosures that told a clear story of what was taking place. In the periods before large losses were recorded, few hints were provided of impending disasters. Overall, the results of this study are disturbing. Although the study is restricted to one company, the results deserve the thoughtful consideration of both academics and practising accountants.