****A special investigative report****
On December 13, 2017, Royals Review Manager, Max Rieper and Royals Review Staff Writer, Shaun Newkirk jointly published an article titled "You should be very skeptical of claims the Royals lost over $60 million the last two years," a sentiment to be sure, the author of this article shares. Indeed, it is this author's opinion that when it comes to the reporting of media, a healthy dose skepticism should always be employed by the consumers of that medium--for the power which the media wields can be used as a means to further the manipulative goals of those who have the desire and means to influence it, while those who consume it have little to no recourse to combat that manipulation. This opinion was one of the contributing factors that set this author into finding this very website, having grown tired of ramshackle coach speak proffered by Royals brass and the flimsy narratives of sports radio hosts on crackling AM radio stations, this author revolted against the status quo and reached out blindly into the wild expanse of the internet eventually finding a home here, where similarly skeptical individuals set out to discuss the team in a depth beyond the familiar talking points regurgitated by the mainstream media. That is why when this author encountered misleading or misinformed ideas regarding accounting fundamentals and accounting methods in the article under examination, the author felt the need to address this problem head on. It is this fanpost's intention to inform you, the skeptical reader, of the basic principles underlying accounting, thereby equipping you with sufficient knowledge and understanding to determine whether or not the underlying ideas of the article in question violates those very same accounting principles, warranting a high level of skepticism in regards to the Royal Review's article and--as well as, we will soon find out--generally, any article regarding accounting in the sports industry, especially when those articles tend to be written by non-accountants.
Generally Accepted Accounting Principles
For all organizations, GAAP [Generally Accepted Accounting Principles] is based on established concepts, objectives, standards and conventions that have evolved over time to guide how financial statements are prepared and presented. For companies or not-for-profits, GAAP is set with the objective of providing information that is useful to investors, lenders, or others that provide or may potentially provide resources.
Basically, in order to ensure that the users of financial statements can understand and compare financial statements among different enterprises, there needs to be a set of standards that everyone agrees to. The standards the FAF has established is an attempt to present financial statements in a fair and accurate way. Generally, GAAP refers to these standards, but sometimes it is used as shorthand to denote financial statement accounting methods, because as we will see, the IRS may require that an enterprises' financials be presented using different standards in certain instances.
Debits and Credits
A fundamental principle of accounting methodology is the concept of double-entry accounting. That is the idea that for every transaction in accounting there is both a debit (signified as a positive number) and a credit (signified as a negative number.) By entering both a debit and a corresponding credit in the exact opposite amount for each and every transaction, it keeps the books of the enterprise at zero, and therefore in balance. There is no such thing as a one-sided entry.
Financial Statement Basics
The basic financial statements of an enterprise are made up of the balance sheet and the income statement. The balance sheet is comprised of assets, which are generally things that are worth money and/or will be used to generate future income; liabilities, which is generally money owed to creditors or a future reduction in assets; and owners' equity which is sometimes called capital. Owners' equity or capital, represents the net worth of the enterprise as it consists of the amount invested by the owners plus the accumulated net income and losses of the enterprise minus distributions to the owners. Assets are normally debits while liabilities and owners' equity are normally credits. All of that is admittedly a lot to remember, so here are a few simple points that are important to remember: assets minus liabilities equals owners' equity, assets are generally debits (positive) and everything must remain in balance at all times, a debit to one account must be offset by a corresponding credit somewhere else.
The income statement is comprised of revenues and expenses. Revenues are credits (negative), the corresponding debit to which generally increase assets, usually cash. Expenses are debits and the offsetting credits generally decreases assets, also usually cash. Sometimes a reduction in liabilities can increase revenues, like if the bank forgives a loan, and sometimes a reduction in assets can increase expenses like depreciation, or if your uninsured assets are destroyed or lost. But at no time is it possible for one reduction in assets to spawn two increases in expenses that are each equal to the one asset reduction. Remember, dear reader, that debits and credits must always balance out to zero.
While the balance sheet is a snapshot of an entity's financial position at a fixed point in time, often December 31; the income statement is more like a map that details the activity of the entity during a specified time frame, usually one year. The balance sheet shows what an entity owns and what they owe, while an income statement shows how much money they received and how much they spent during a specified time frame. At the end of the accounting year, the net results of the income statement are transferred to the owners' equity section of the balance sheet and the income statement is wiped clean, ready to start anew.
Tax Accounting Method
Generally speaking, the overall framework and concepts of tax accounting methods are basically the same as those in GAAP. However, the the two methods use different methods to execute those broad concepts, and when one is discussing specific details from one method, the reader should realize that it is not necessarily applicable to the other. For instance, the purchase price of the intangible asset "Goodwill" is amortizable over a period of fifteen years for the tax method of accounting, however for GAAP purposes, it cannot be amortized at all. Indeed, one could write a book comparing the various differences between GAAP and tax methods, especially in light of the ever-shifting landscape of tax legislation and court cases, not to mention the periodic tweaking of FASB pronouncements regarding GAAP, but suffice it to say, dear reader, that when an author is discussing accounting methods and terminology, it would be easy to get embarrassingly tangled up--misleading the reader, and possibly even the author themself--by referencing some haphazard combination of the two without any regard as to those differences.
MEAT OF THE MATTER
Now having whet our appetites by sampling from the tasty hor d'oeuvres of relevant basic working knowledge of accounting, we turn to the Meat of the Matter, that is, this author's beef with the article under examination. Let's begin with the section of that article which is at issue:
As Max pointed out, the Royals didn't actually lose money. Yes, they can claim they did, but those numbers exist solely on paper.
A bold claim to be sure, but what does the author really mean by saying the losses claimed exist solely on paper? Has the author seen a copy of the financial statements showing this loss that they doubt actually exists? Certainly it would help bolster this claim if the article were to include a copy of the Kansas City Royals Baseball Corporation's financial statements here. But sadly, dear reader, it does not, as apparently the author of the article in question does not assume that the Royals are simply misleading the public with claims that they have lost money when they have not by referencing the myriad of ways language could be used to do so (for example, claiming that a decrease in gross receipts in a non playoff year as compared to a year in which the team reached the playoffs results, in a manner of speaking, in a "loss"), but rather decides to attack the very core of financial accounting principles in a misguided head-on assault.
Next, Royals Review includes a quote from the Toronto Blue Jays CEO:
Former MLB President and also former CEO of the Toronto Blue Jays Paul Beeston put it best:
"Anyone who quotes profits of a baseball club is missing the point. Under generally accepted accounting principles, I can turn a $4 million profit into a $2 million loss, and I can get every national accounting firm to agree with me."
Now, dear reader, as freshly minted accountants still brimming with the idealized notions of the accounting framework and principles within your heads, surely your first thoughts upon seeing such a brazen attack upon all the things which you now hold dear probably has you reaching for your pitchforks, ready to kick down the door to Mr. Beeston's house. I can assure you there is no need for violence. Let us instead examine the statement in a little more depth. First of all, skeptical reader, it appears to be in relation to a larger idea. "Anyone who quotes profits of a baseball club is missing the point." Fair enough, I suppose, but what pray tell is the point? "Under generally accepted accounting principles, I can turn a $4 million profit into a $2 million loss, and I can get every national accounting firm to agree with me." Was that it? Now, dear reader, after having become formally trained and educated in the theory behind GAAP, I ask you, doesn't this statement appear to be hyperbole? That any literal interpretation of the quote would be inherently flawed? For we now know that the whole point of GAAP is not to misrepresent the financial picture of an enterprise, but rather an attempt to standardize accounting over individual companies and industries in order to gain a better understanding of how an enterprise's financial picture relates to others. And would every national accounting firm really agree with this statement, invalidating their very purpose for existing? So you see, dear reader, unless Mr. Beeston is a raving lunatic, this quote must be simply a hyperbolic statement used in relation to an even larger point, and to find out what that was, we will now turn to the source of the quote, for without the entire quote, it would appear that this quote is being used out of context.
The underlying quote from Royals Review's article is actually pulled from a book titled, The Business of Sports by Scott Rosner and Kenneth Shropshire. Those of you intrepid enough to click the link will no doubt find that it is not the primary source itself, rather it was also pulled from an article at USAToday.com, an article that this author has tried in vain to find. No matter, let us instead scour the internet in hopes of finding it. Perhaps there, we will be able to find the primary material from which it was gleaned. Interesting, it appears that the quote itself has made the rounds, appearing in nearly every article and book on the broad subject of sports business. And no surprise! It's a juicy quote! But beware, dear reader, for as we have discussed before, without the full statement surrounding the quote, it appears that it may have been taken out of context, put to the manipulative use of the writers of these dusty tomes and articles to serve their own self-serving ends. For all we know, the original quote may actually have came from a bathroom stall in which a raving Mr. Beeston vandalized with indelible ink.
*[Update: As pointed out in the comments below, this quote probably originally appeared in a book by Andrew Zimbalists 1992 called "Baseball and Billions."]*
Continuing on with the Royals Review article:
What Beeston is referring to is the little known Roster Depreciation Allowance (RDA).
Well, dear reader, apparently the author of the article under examination believes they know precisely what the quote attributed to Mr. Beeston via several different layers of underlying media meant. The original context of which being difficult to discern. I put it to you, dear reader, do you think that the author of the Royals Review article has a clearer understanding of the context surrounding Mr. Beeston's quote than the poor janitor tasked with removing it from the allegedly vandalized bathroom stall?
Let us now briefly turn our attention to the article linked within that quote. As you will no doubt notice upon opening that link, right at the top of that article is the hyperbolic section of Mr. Beeston's quote which we have previously discussed. Just as previously mentioned, that juicy quote certainly does get used a lot. Now, before we dig too deep into this article, let us now briefly consider the possible reasoning behind the author of the SABR article's decision to include the quote in such a prominent position of their article. Could it be, dear reader, an attempt to sway you, the newly-minted accountant, into believing that the intentions of GAAP are to shield or misstate financial income on the financial statements in opposition of its defining purpose for even existing? Thankfully, after having endured the rigorous training in the previous section, you are now immune to the SABR article's machinations. Also, you will no doubt notice that this article, despite the opening quote blurb, is not about GAAP accounting at all, but rather tax accounting. Further calling into question the underlying intentions of the SABR article's authors by including that quote in reference to GAAP accounting at the top.
A little further down in the SABR article we see this:
The issues and regulations regarding valuation of franchises are so complex that sports analysts often fail to fully understand them.5
Indeed. Continuing on:
This article discusses one such tax issue: the Roster Depreciation Allowance. The topic has been discussed in simple terms in the popular press, as in this quotation from Time: "owners get to deduct player salaries twice over, as an actual expense (since they're actually paying them) and as a depreciating asset (like GM would for a factory or FedEx a jet)."
Hmm. Now let's not be too hasty, dear reader, who must no doubt feel very angry and confused by this claim that an expense can be deducted twice, perhaps they included Time in the population of sports analysts who fail to fully understand this issue.
Sports teams could then "double dip" by taking the RDA depreciation for the purchase price of the contracts, how much the new owners paid to old owners for the ability to enforce the contracts, and then deducting the salaries actually paid each year to players as labor costs. Moreover, unlike most assets which can only be depreciated once, the RDA applies anew each time a franchise is purchased.
Goddamn it. This quote, dear reader is sourced to a book called Sports Finance and Management: Real Estate, Entertainment, and the Remaking of the Business, also a book I have not read. You know what would be nice, is a citation to the actual tax law this describes. This entire boring article is about tax law and honestly, it is more boring than reading the results of a tax court case, so I am just going cut short my investigation into the flaws in this article, and instead display a more salient quote from it:
The RDA is one of several "gymnastic bookkeeping techniques" businesses and sports franchises use to minimize tax liabilities.10 The RDA is a depreciation of almost the entire purchase price of a sports franchise over 15 years. This means that each year for 15 years, the purchaser (or purchasers) of a professional sports franchise can take a tax deduction based on the purchase price of the franchise. The current RDA allows sports franchise purchasers to depreciate almost 100 percent of the purchase price over the first 15 years after the purchase; a tax deduction of about 6.67 percent of the purchase price per year
This is actually sourced to another book: No Money Down: How to Buy a Sports Franchise, A Journey Through an American Dream. Well, dear reader, after firmly establishing this article, which does not even appear to be entirely reliable, but does definitely succeed at being boring as hell, let's just end the analysis of this underlying article here. As you can see, the RDA only applies (according to the very article cited by the Royal Review's article) to contracts of salaries purchased by an owner. Obviously not something that would apply to Royals owner, David Glass, who has owned the team since 2000. Any intangible assets which may have been subject to this law would have been fully depreciated for tax purposes two years ago, if any even still remained.
We turn, once again to the article of concern, and Royals Review says:
Let me be clear: this idea doesn't exist anywhere else in business. No other enterprise can depreciate the cost of their employees. It's worth noting that the RDA only applies for players, not administrative staff. For Janet in accounting, her salary is an operating expense, not a depreciable asset.
Are you sure about that? Let's check with the actual United States Tax Code, Section 197(d)(1)(C)(i), which says:
(d)Section 197 intangible For purposes of this section—
(1)In general Except as otherwise provided in this section, the term "section 197 intangible" means—
(i)workforce in place including its composition and terms and conditions (contractual or otherwise) of its employment"
Well, dear reader, it appears that the USTC does not agree with this bold assertion at all. Very well, let us not belabor the point. Returning to the Royals Review article:
Depreciating is a "non-cash expense" (this will make more sense in a bit) and is part of Generally Accepted Accounting Principles (GAAP).
True, but let's not forget that even "non-cash expenses" were at one time actually paid in cash. Also note, it appears that now we have switched our accounting basis to GAAP rather than tax.
Every business has some sort of depreciating asset, whether it be a copier, a tractor, a piece of machinery, or an office building. Depreciating those assets is commonplace, and GAAP likes companies to typically be conservative, which means depreciating them over a shorter time period, while aggressive depreciation would be over a long period.
Apparently, what is meant here is that GAAP prefers that entities be conservative in estimating the expected longevity and usefulness of their assets. This is not how I have typically seen the term "aggressive depreciation" used, but I'm not going to nitpick, GAAP basis isn't really my forte.
Without getting too deep here, straight line depreciation is the default method. You estimate how long you think the life of the asset is - say, ten years - and then depreciate the cost evenly over the life of it.
Still talking about GAAP, again, not my area of expertise.
With RDA, teams can actually take an aggressive method and depreciate their contracts over long periods of time. This means they can manipulate profits/losses easier (this is also a standard protocol for publicly traded companies), as the more you spread out the depreciation, the more profit you make on paper.
Wait, what? The RDA was specifically mentioned in the articles cited as being tax legislation. Why even bring this up when discussing GAAP financials? And also, how is depreciating a smaller percentage of the total cost of an asset over a longer time frame manipulating their profit and loss? Wouldn't making more profit on paper be the opposite of what you're accusing David Glass of doing in the first place? Wait a second, the RDA? The tax law we established up above from which your very source explains that it only has to deal with the contacts on the books at the time of the purchase back in 2000? Which, even if Carlos Beltran was still a Royal, the part of his contract that this would apply to would have been fully amortized two years ago? How many of any contracts from then are still around? I've got a headache. Moving on...
Say I run a mowing service, and I buy a nice tractor for $5,000. I estimate that I'll get five years of life out of the tractor, so I'll depreciate it over five years ($1,000 a year). I charge $10 a lawn and I mow 50 lawns one summer. I of course have to pay for gas, and at the end of the summer I paid $100 for gas. My income statement would look like this:
Revenue: +$500 (50 lawns for $10 each)
Operating expense: -$100 (gas)
Operating income: +$400
Net income: -$600
Wow, you mean I lost money this year? Well, no I didn't,...
Actually, yes you did. You spent $5,000 on your company but now you only have $400 in your checking account.
...because as I mentioned, depreciation is a non-cash expense. I didn't actually pay $600 for it,...
Exactly, you paid $5,000 for it.
...but the IRS thinks I lost money this year, and I can tell reporters I did.
Well, you did actually lose money, but nothing was keeping you from telling the reporters that you lost money even if you hadn't. It's a free country.
Not only do I not owe any taxes, but I can recognize a loss and potentially carry it forward next year to offset taxes.
And thank God for that, you spent $5,000, and now all you have left is a lawnmower and $400 in your checking account. Can you, dear reader, imagine the injustice the hypothetical entrepreneur in this example would feel if they spent all of that money and were left with nothing but $400 in cash and a used lawn mower and yet they still owed taxes? Or if they had lost money for years, and then, in the first year they actually turned a net profit, the IRS ignored all of the previous years of losses and made the entrepreneur pay taxes as if hypothetical individual had not suffered actual financial harm during all of those previous years?
This example ignores the fact that I paid $5,000 for the tractor in the first year (a capital expenditure), but you can just move the example to the second year, and it would work just the same.
Seems like a pretty big item to ignore to this author. And yes, the hypothetical landscaper will still have a loss in the second year, but they still haven't gotten to fully deduct the entire cost of the lawnmower yet, either. In fact, in this example, the hypothetical landscaper wouldn't turn a net profit until year thirteen!
What's even more interesting is that teams can claim a contract twice. Once for the player's annual salary (operating expense), and then a second time as RDA (loss). This reduces taxes owed even further for a team.
Dear reader, I ask you, does this make sense to you? I mean, not the part about taxes being reduced if you are allowed to deduct the same expense twice (because let's be honest, it's fun to fantasize about doing this), the part where the author of that article says that you can deduct a single expense twice? I feel, dear reader, that if you agree that that is indeed an acceptable accounting position, that I have failed you in my quest of teaching you the basics of accounting, and must sincerely apologize for my failure in this regard.
So let's try an example with a baseball team,...
In leaked documents to Deadspin in 2010, we got a glimpse as to how teams were using depreciation of player contracts. For the Angels, you can see they list player contracts as assets, right alongside naming rights, sponsorships, and television rights.
Dear reader, I would ask here that you please click on this link that is embedded within the article linked in the Royals Review article. Perhaps in a second monitor, if you have one? Notice anything about these financial statements? Yes, very good! They do not include the Accountant's Letter to the Financial Statements. If they did, you would see a section of the letter that says something along the lines of "the notes are an integral part of the financial statements." Now dear reader, I ask you to scroll with me now to the notes, specifically, Note 2. "Summary of Significant Accounting Policies." Good, now onto page seven, "Player Contracts:"
Player contracts represent amounts paid to major and minor league players for signing bonuses, and are capitalized and amortized as player salaries and player development costs, respectively, over the the contract period or length of time until the individual is eligible for free agency, whichever is longer. In the event a player is prematurely released or traded, the remaining unamortized balance is charged to operations at the time the player is released or when PBP determines the player contract no longer has any value, whichever is earlier.
This doesn't really seem so shocking does it? I mean, if you are going to offer a signing bonus to a player to get them to sign with you, shouldn't you expense it over the life of their contract and not all at once in the year it is actually paid? I mean, without doing this, wouldn't you actually be misrepresenting the true cost of the player per year? For example, couldn't you sign a player to an MLB minimum contract for a period of years, by offering a huge signing bonus that is paid up front, and then claim to be only paying the player the minimum amount in following years? Dare I even say, dear reader, that by not engaging in this practice of capitalizing the signing bonus and then deducting the cost of it over the subsequent years the contract is in force that one would be guilty of distorting income? That the true cost of the hypothetical player is not the minimum salary, but that plus a portion of the bonus paid up front?
The Texas Rangers even went so far as to count managers and bench coaches as depreciating assets.
OK? What's the problem here? Why should the signing bonuses of certain employees be treated any differently that those of another employee?
This suggests that the Rangers are treating not only players but managers, bench coaches, etc., as depreciating assets, further stretching the already-thin logic of the tax allowance. "If it extends to manager contracts, I wouldn't be surprised," Fort says. "Maybe owners' dogs can be thrown into this, too. It's a very, very strange allowance in the first place." It's smart accounting if it's not tax fraud.
TAX FRAUD! OH MY GOD! Far be it from me, dear reader, to point out that this quote is actually a screen shot from the Deadspin article linked within the quote above, and that the authors of that article are actually looking at the financial statement of the Texas Rangers, not that entity's tax return. Furthermore, doesn't this entire quote seem to be building one unsubstantiated assumption on top of another until they have talked themselves into assuming TAX FRAUD has been committed? That they can allege tax fraud by looking at the Rangers financial statements and not their tax return? It is here, dear reader, that I leave it up to you to decide for yourselves. As fledgling accountants, it is now time for you to spread your wings and soar.
In the author of this fanpost's opinion, the Royals Review article referenced above should be thoroughly edited, failing that, the entire second half of the article should be removed. The author of this fanpost believes that they have shown a great many instances where the applicable section of the Royals Review article misrepresents, misleads, or misinforms the naive reader (not the reader of this fanpost [if any have even made it this far], who, I now consider to be versed in accounting enough to not be misled by the article under investigation) by misunderstanding basic accounting fundamentals, over reliance on articles that lack proper authority, primary sources that are also guilty of relying on each other in some sort of sordid tangled web, reminiscent of an inbred royal family tree, one that is diseased and plagued with genetic maladies resulting from a preponderance of recessive genes, and few, if any sources that cite actual accounting standards or IRS code sections. It also, is guilty, just as many of the other cites it links to, of mixing between GAAP, and tax methods of accounting in a confusing mish-mash of terminology, failing to remain within one standard of accounting even in the same paragraph. That it also states a misinformed belief that not only can enterprises deduct the same expense twice, that it is Generally Accepted Accounting Principles to do so, displaying a lack of understanding of why those principles even exist in the first place. Finally, in this author's opinion, it also displays an obvious error in simple logic by seeming to state that by following a tax law an enterprise may violate tax law. Sadly, it appears that the problems of the Royals Review article are not alone, and seems to be a rampant problem among sports-business related articles and books, and this author would recommend that in the future any article on this subject rely on sources with an authority more substantial than simply other sports-business related articles.
These are the charges as recorded this day, December 20, 2017. Faithfully submitted, 1040X, Sergeant-at-Arms.
[Comments and questions are welcome. Please forgive this author for any mistakes, as any are unintentional, this author is open to suggestions for corrections and revisions and will take any such comments under due consideration. The author will note any subsequent edits, should there be any, within the body of the text.]