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3.

What is Disney trying to accomplish by assigning a higher value to the liabilities


and how did they do it?

According to the article Disney, by assigning a higher value to the liabilities, the
increased value of liabilities ($2.9 billion) were included into tax-deductible business
expenses, giving the company the tax benefit of around $1 billion. The $2.9 billion of
additional liabilities was poured into the “accounts payable and accrued liabilities line”
on Disney’s balance sheet in connection with the merger and represents loss reserves
and other liabilities added in the name of purchase accounting. Therefore it helped
disney’s undisclosed reserve more flexibility giving them a tool to manipulate their stock
price.

Agree why or why not?

We don’t necessary agree with Disney because Disney’s booking of these additional
liabilities related to the network’s future programming commitments as part of
accounting for the merger as a purchase was simply not permissible under GAAP.
“Commitments” is a generic term; all undertakings are commitments. Most are so
ordinary, ongoing and of relatively modest proportions that no special attention is given
to them by accountants. Where, however, they are long-term and substantial, some
notice may be given to them, generally in the footnotes to the financial statements.

In our opinion Disney’s reserve for the discounted value of the network’s programming
commitments wouldn’t qualify as a contingent liability under FASB statement 5. FASB 5
provides guidance in assessing the probability of an event’s occurence. Events are
classified into one of three groups: probable, reasonably possible, and remotely
possible. If the amount cannot be reasonably estimated, then note disclosure should be
provided.

How did it help the income statement?

Disney made a couple of unheralded adjustments to its books, including DIsney dipping
into it’s $2.5 billion reserve to cushion earnings. Without explanation the year end value
for the asset dubbed “TV and Film costs” that had been retroactively decreased by $653
million form the amounts listed in Disney’s fiscal ’96 annual report. Even though this
didn’t involve any changes to the income statement Disney laid the groundwork for
enhancing earnings in the future. The $653 million of costs should have been written off
against its $2.5 billion reserve. That way the operating income in future periods wouldn’t
be burdened with the amortization of the networks costs.
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Disney engaged Price Waterhouse to carry out those evaluations, Giesecke said, and
when the work was completed, “We determined that the fair value of a certain number of
these commitments was negative and we recorded a corresponding liability.

4.

Since market price is the composite of forecasts and guesses, and analyses of
individuals, and corporations that deal in the market each day, we can interpret the
dropping of the price the market reaction shows the pessimism about the effect of the
Briloff’s article in Barron’s.
Because Disney’s high stock price was based on manipulation of earnings by creating
contingent liabilities. The market reacted immediately after the article have pointed out
this manipulation.

Therefore, the drop of stock price reflects the market efficiency fairly, evidencing the
decrease of Disney’s stock price after the published article. The market followed semi-
strong market efficiency hypothesis; public information is impounded to the stock price.

In conclusion, Disney, through the agency of accounting, has adeptly masked the
negative impact of its CAP Cities/ABC acquisition on it’s earnings over the past two
years. But even accounting magic has its limits: From here on, the true picture will
become very much clearer.