Atari's Accounting: An Example of Cash Flow Arbitrage (ATAR)

| About: Atari Inc. (ATAR)

Tiny Atari, Inc. filed a non-reliance 8-K yesterday due to an incorrect presentation in its cash flow statements for the past couple of years - 2004 and 2005, and the nine months ended December 31, 2006. Details of the amounts affected weren’t disclosed; we’ll see what the effects were when the firm files an amended 10-K and amended 10-Q.

What’s being restated? The game company had taken promissory notes from a majority shareholder in satisfaction of a royalties due from the shareholder. According to the filing:

In our previously issued financial statements, the amounts associated with these transactions had been reported as cash provided by operating activities and cash used in investing activities.

The statement above makes it sound like the cash in from the notes appeared in the operating section of the cash flow statement, while the lending actions appeared in the investing section.

Think of it as a cash flow statement arbitrage: the good stuff appears in operating activities, the bad stuff appears in the investing activities. You’ve carved up a single kind of activity into two components and put the good stuff where investors will notice (or at least take it for granted) and the bad stuff will be in a section where they’ll ignore it (or at least expect it).

No picking on just Atari here: this cash flow arbitrage, whether intentional or just the result of sloppy thinking, has been at the heart of other restatements such as the floor plan financing issues mentioned a couple weeks ago. It’s also at the heart of restatements last year by auto manufacturers and others with captive finance companies.

Anyway, the restated figures will put all of the notes activity in one bucket: the investment classification.

There’s been increased SEC interest in the cash flow statement in the past few years, no doubt due to the fine work done by Professor Charles Mulford and his Financial Reporting & Analysis Lab. (Worth a visit, if you haven’t yet.) That’s not a bad thing, given that users pay attention to this statement more closely than ever.

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