Financial Shenanigans

Financial Shenanigans

TSMC's reported financials test as forensically clean. The accrual ratio is negative every year going back two decades, three-year operating cash flow runs at 1.4x net income, receivables grew 3.7% while revenue grew 31.6% in FY2025, and the auditor (Deloitte & Touche Taipei) has issued unmodified opinions without resignation, late filing, or material-weakness disclosure. The only forensic items that warrant underwriting are governance optics — Chairman and CEO are now the same person (C.C. Wei, since June 2024), the chairman of the audit committee has served 24 years, and FY2026 includes a 8.1 percentage-point sell-down of the Vanguard International Semiconductor stake that the company simultaneously buys wafers from. None rises to the level of an accounting concern. The data point that would most change the grade is a reversal in the accrual ratio toward positive territory while DSO climbs back above 35 days — neither is visible in the current numbers.

The Forensic Verdict

Shenanigans scorecard — all 13 categories tested

The forensic case for TSMC is unusually one-sided: every cash-flow, revenue-quality, and capitalization test is green, the auditor opinion is clean, and there is no short-seller report, regulatory action, or restatement on record. What remains is governance hygiene — combined Chairman/CEO and long-tenured directors — which is a watchlist item but does not, on its own, justify suspicion of the numbers.

Breeding Ground

The breeding-ground profile is normal-to-favorable for a Taiwan-domiciled, NYSE-listed foundry. Seven of ten directors are independent. The Audit and Risk Committee is composed entirely of independent directors. The auditor — Deloitte & Touche Taipei — issued an unmodified opinion in the latest filings, with engagement partners rotated under R.O.C. rules. The single structural concern is that Dr. C.C. Wei has held both Chairman and CEO since June 2024; under the previous regime Mark Liu (Chairman) and Wei (CEO) split the roles.

A specific watch item: the four related-party affiliates (VIS, SSMC, GUC, Xintec) are all foundry/packaging entities in which TSMC holds 27% to 41%, accounted for under the equity method. In FY2025, TSMC purchased NT$878M from VIS, NT$4,113M from SSMC, NT$5,448M from Xintec, and sold NT$31,094M to GUC — combined ~NT$41B against NT$3,809B of revenue (about 1.1%). The pricing terms are disclosed as arm's-length manufacturing and capacity-reservation agreements. In May 2026, TSMC announced a block sale of about 152M VIS shares (8.1% stake) to outside investors, trimming its VIS interest to roughly 19% from 27.6%. The market reaction was a 3% TSM drop on disclosure of the sale, but the move reduces related-party complexity — board representation at VIS already ended in June 2024.

Earnings Quality

Earnings quality is high. The headline check — revenue growth versus receivables growth — passes by a wide margin in FY2025, the most recent year and the year with the most aggressive top-line increase.

In FY2025 receivables grew 3.7% against revenue growth of 31.6%, and inventory grew 0.1%. This is the single strongest possible signal that revenue is real and being collected. Compare to FY2021, when AR grew 35.8% on revenue growth of 18.5% — that gap is what a "stuffed channel" looks like, and it self-corrected in FY2022 as cash arrived. FY2025 shows no such gap.

DSO has compressed from a peak of 47 days in FY2017 to 26.6 days in FY2025. Compression while a business grows is the opposite of a revenue-pull-forward signal — customers are paying faster, not later. DIO peaked at 87 days in FY2023 (industry slowdown year, when inventory built ahead of the AI cycle) and has unwound to 69 days. DPO is normal for a fab operator with large vendor balances.

Gross margin expanded from 56.1% in FY2024 to 59.9% in FY2025 — the highest level in TSMC's history. Management attributes the move to higher capacity utilization and product mix (more 7nm-and-below revenue), partially offset by NT dollar strength. The forensic test for unexplained margin expansion is whether reserves moved oddly or whether inventory was overvalued: inventory grew 0.1% on revenue +32%, which means inventory days fell, not rose. There is no evidence of reserve release or capitalization-driven margin lift.

Capex/D&A ran at 1.85x in FY2025 (down from 2.48x in FY2022), meaning the company is still investing ahead of depreciation — consistent with capacity expansion, not amortization-stretching. Intangibles plus goodwill are 0.31% of total assets, the lowest in the period. There is no acquired-intangible amortization to hide behind.

Cash Flow Quality

Operating cash flow is durable, not cosmetically inflated. Three structural facts drive this conclusion.

First, CFO has exceeded net income every year on record — the ratio has been between 1.34x and 1.88x for the last decade. The gap is depreciation and amortization on owned fabs (NT$688B in FY2025 alone, more than 40% of net income). For a capex-heavy foundry, CFO/NI of 1.3-1.9x is the structurally correct range — anything lower would suggest accruals were being released to flatter earnings.

Second, working-capital changes have been a drag, not a lift, on FY2025 CFO. The MD&A discloses that "income tax payment, net changes in working capital and others" deducted NT$454,775M from CFO. The classic warning sign — operating cash flow inflated by stretching payables or under-buying inventory — is not present.

Third, free cash flow conversion is choppy because capex is choppy. FY2024 FCF (NT$870B) was the highest in TSMC's history; FY2025 FCF was higher still at NT$1,003B. FCF/NI for FY2025 is 0.59. Over the full FY2021-FY2025 window, FCF/NI averages 0.56. This is the right number for a foundry mid-cycle through a capacity build, not a sign of distortion. There are no acquisitions to "adjust out" — the company is not acquisitive.

The accrual ratio — the cleanest single forensic test in the Beneish / Sloan tradition — is negative every year. Negative means cash earnings exceed accounting earnings, which is the opposite of the canonical earnings-management warning sign. The FY2025 figure of -7.9% is the least-negative in five years, but still firmly inside the safe zone. A flip to positive accruals would be the single most meaningful early warning to monitor.

Metric Hygiene

TSMC's metric hygiene is unusually clean for a megacap technology company. The 20-F reports IFRS results only; there is no adjusted EBITDA, no non-GAAP EPS, no organic-growth reconciliation. The operating KPIs management highlights — wafer shipments (12-inch equivalent), revenue mix by technology node, advanced-node revenue share — reconcile directly to the income statement.

Two specific clean tests worth naming. (1) Other operating income and expenses, net, was NT$447M in FY2025 — a rounding error against NT$1.94T of operating income (0.02%). Management is not parking gains in operating income to flatter the headline. (2) Other non-operating items — share of profits of associates, interest income, FX gain/loss — are disclosed line-by-line. Interest income on TSMC's NT$3.1T cash pile was NT$106B in FY2025, but it sits in non-operating income where it belongs.

What to Underwrite Next

The forensic risk does not need a deep diligence list. The five items below are the highest-value monitoring points and the two events that would change the grade.

(1) Watch the accrual ratio for a flip to positive. Currently -7.9% in FY2025. If FY2026 prints a positive accrual ratio while DSO climbs back above 35 days, the earnings-quality picture has materially weakened. Both moves would have to happen together to matter.

(2) Watch the CFO/NI ratio for a fall below 1.0x. Currently 1.34x. This level is supported by D&A. A sustained move below 1.0x — meaning NI exceeds CFO — would imply earnings recognition is running ahead of cash collection.

(3) Watch customer concentration. The top customer is 19% of revenue (FY2025), down from 25% in FY2023 — but the top two combined have risen to 36% from 26% in FY2024 because the No. 2 customer grew from 12% to 17%. If the top-two share crosses 40%, single-customer revenue-recognition risk becomes a real concern rather than a theoretical one.

(4) Watch the Vanguard International Semiconductor relationship. TSMC sold 8.1% of VIS in May 2026 down to ~19%. If the residual stake is sold and the manufacturing-agreement reserved-capacity wind-down is completed, the largest disclosed related-party complexity disappears. Conversely, a renewal at materially different terms would be a yellow flag.

(5) Watch governance signals around the combined Chairman/CEO role. Independent succession planning, lead independent director designation, and audit-committee tenure refresh would each upgrade governance from yellow to green. A reduction in the independent-director count below 7 of 10 would do the opposite.

Upgrade signal: a successful re-separation of Chairman and CEO roles, or addition of a formal lead independent director, would move the grade closer to 10/100 (Clean-Plus).

Downgrade signal: the accrual ratio flipping positive while DSO rises above 35 days and gross margin sustains above 60%, or any disclosure of a material weakness, auditor change with cause, related-party renegotiation that changes pricing materially, or restatement.

Position-sizing implication: none. The accounting risk is a footnote. There is no valuation haircut required for forensic concerns, no covenant-comfort issue, and no thesis-breaking accounting question. The investment case for TSM should be debated on demand cycle, geopolitical exposure, capex returns on overseas fabs, and pricing power — not on whether the reported numbers are real. The numbers are real.