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Cooks The Books
Other income or expense is also the place where companies can hide other expenses by netting them against other newfound income. By accounting for extraordinary events, non-recurring expenses are one-time charges designed to help investors better analyze ongoing operating results. Then, a few quarters later, they “discover” they reserved too much and put an amount back into income . It may appear counterintuitive, but before a merger is completed, the company that is being acquired will pay—possibly prepay—as many expenses as possible.
Financial StatementsFinancial statements are written reports prepared by a company’s management to present the company’s financial affairs over a given period . These statements, which include the Balance Sheet, Income Statement, Cash Flows, and Shareholders Equity Statement, must be prepared in accordance with prescribed and standardized accounting standards to ensure uniformity in reporting at all levels. Worldcom in particular set records as one of the very largest bankruptcies in United States history. Channel stuffing is an improper revenue recognition practice in which a company fraudulently inflates its sales by sending excessive amounts of products to its distributors ahead of demand. This practice typically occurs near the end of reporting periods when a company needs to increase its revenues to meet financial projections and market expectations. A company will oversell inventory to distributors in amounts that far exceed the public’s demand for the products and prematurely recognize revenue on future sales.
The practice deliberately shows less profit or direct losses that are not an accurate representation of the true state of the company’s financial affairs. This is done to either qualify for tax breaks or to evade a larger share of taxes. The fifth title or category deals with the behavior of stock analysts and how they report their analytical opinions to the clients. To combat this, Title V requires that national securities exchanges as well as associations of registered securities develop and implement a framework of rules for governing the conflicts of interests that analysts may run into. The second title or category of the Sarbanes-Oxley act legislates how auditing firms are supposed to behave. One of the most important provisions of this category are set to heavily restrict auditing firms from performing compensated activities of accounting for their clients that are considered to generally be outside of the narrow auditing boundaries.
These are the manipulation in the financial records of the company, which is not allowed and is an illegal act. It is done by the company to present its better picture in front of the stakeholders or hide the facts from the stakeholders, which it doesn’t want them to know. It is wrongdoing, so no advantages are present in this; instead, if someone is found guilty for doing the manipulation in the books of accounts of the company, it will be treated as the fraud, and the person responsible can be punished for such wrongful act.
This resulted in the company improperly recognizing revenue from $1.5 billion in sales to its two largest wholesalers. In addition, the SEC filed charges against two former Bristol-Myers officers for the fraudulent earnings management scheme. Despite a succession of reform legislation, corporate misdeeds still occur. Finding hidden items in a company’s financial statements is a warning sign for earnings manipulation. This does not mean that the company is definitely cooking the books, but digging deeper might be worthwhile before making an investment.
Then, after the merger, the earnings per share growth rate of the combined entity will appear higher compared to past quarters. Furthermore, the company will have already booked the expenses in the previous period. For example, if a company had 1,000,000 outstanding equity shares and recorded net income or profit of $150,000, the company’s EPS would be .15 cents per share ($150,000 / 1,000,000).
One of the requirements states that publicly traded companies must establish an audit committee that is made up of independent board members that have absolutely no financial ties to the business with the exception of being paid for their duties as a board member. There is a theoretical system in place to try and mitigate and potentially stop the fraudulent cooking of the books. Financial auditors have the job but systematically reviewing of businesses accounting and control procedures and additionally testing various business transactions see if the company is following the appropriate procedures and policies in its practice. However, the system is not foolproof there are still a few corrupt and intelligent members of management teams that will do everything in their power the mask of deceptive practices and for the auditors. This can be seen historically and many fast-growing companies that will eventually slow down.
The scheme here is to report the investment gains generated by the plan’s assets as revenue. Accelerated Pre-Merger Expenses involves a company about to be acquired in a merger paying, or even prepaying, all the expenses it possibly can before the merger occurs. When the merger is finalized, these expenses will be on the books for the period before the merger—and earnings per share for the stock of the newly created company will seem much healthier. When a customer buys goods or services on credit, they can be recorded as sales even if the customer’s credit terms allow them to delay payment for 90 days, six months, etc. Companies offering their own financing programs to customers can extend credit terms, too.
Up until 2002, there were certain methods allowed that would help companies practice cooking the books without doing anything illegal. Companies could use money in certain ways that would not have to be noted on financial statements. In some cases debts could be off-balance or not listed on financial statements by creating what are called special purpose entities , actually new companies formed by the parent company.
Title IX also gives the Securities and Exchange Commission the right to seek a court ordered injunctive freeze of any payments to officers, directors, and employees of a business during an SEC investigation. Another provision of this category requires that the auditing partners must be rotated after five years of dealing with an individual client, which tries to mitigate long-term relationships that can lead to oversights. Another action of this title is that it prohibits the auditing of a business where the financial officers of that business had previously been employed by the auditing firm. The theory behind this also follows the same logical progressions and tries to mitigate the likelihood of past personal and professional relationships having any bias the fact and the auditing process or procedures of a company. This title is intended to create an independent public accounting oversight board that is a derivative of the United States Securities and Exchange Commission.