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What Is Cooking The Books?
Unfortunately, banks often lend, in part, based on the value of a company’s accounts receivables and can fall victim to lending off false receivables. During a detailed audit, the bank auditors would match the AR invoices to customer payments into the company’s bank accounts, which would show any amounts not being collected. Lehman Brothers utilized repurchase agreements to bolster profitability reports with their Repo 105 scheme under the watch of the accounting firm Ernst & Young. Public prosecutors in New York filed suit against EY for allowing the “accounting fraud involving the surreptitious removal of tens of billions of dollars of fixed income securities from Lehman’s balance sheet in order to deceive the public about Lehman’s true liquidity condition”.
Newspaper and television journalists have hypothesized that the stock market downturn of 2002 was precipitated by reports of “accounting irregularities” at Enron, Worldcom, and other firms in the United States. Do not click that link; instead, allow your browser to automatically open the eLearning window on its own, which should happen after a few seconds. This will log you in automatically so that you can access your online exam.
Italian dairy giant Parmalat employed a number of creative accounting and wire fraud schemes before 2003 that lead to the largest bankruptcy in European history. It sold itself Credit-linked notes with the help of Merrill Lynch through a Cayman Islands special-purpose entity and over-accounted for their value on the balance sheet. The publicly listed company stated to investors that it had about $2Bn in liabilities , but once audited more vigorously during the bankruptcy proceedings, it was discovered that the company’s debt turned out to actually be $14.5Bn. This massive debt was largely caused by failed operations in Latin America and increasingly complex financial instruments used to mask debt—such as Parmalat “billing itself” through a subsidiary called Epicurum. It was also discovered that its CEO Calisto Tanzi had ordered the creation of shell accounts and diverted 900M Euros worth into his private travel company.
The Securities Act of 1933 prohibits untrue statements or omissions in the offer or sale of securities. A company’s management may improperly adjust and inaccurately report accounting estimates to favorably impact financial statements. For example, management may use inappropriate methodologies to determine and report write-offs or other key metrics, resulting in inaccurate accounting and misstatement of income. In SEC v. Tangoe Inc. et al., telecommunications expense management company Tangoe paid $1.5 million to settle charges that it reported revenue prematurely for work that had not been performed and for transactions that did not produce any revenue at all. The SEC alleged the company counted customers’ prepayments for future services as current revenue, prematurely recorded revenue from contingent fee arrangements, and prematurely counted revenue from long-term contracts with continuing obligations.
The most common way that companies cook the books is through improper revenue recognition schemes. According to a study by the Committee of Sponsoring Organizations of the Treadway Commission , more than 60 percent of SEC enforcement actions against companies for financial statement fraud relate to improper revenue recognition. In the Matter of Brixmor Property Group Inc., the SEC charged real estate investment company Brixmor and four former senior executives with manipulating a non-GAAP metric that analysts and investors relied on to evaluate the company’s financial performance. The company agreed to pay $7 million to settle the charges, and in a parallel action, the U.S. Attorney’s Office for the Southern District of New York filed criminal charges against the ex-executives.
The transactions that are most susceptible to fraud include bill and hold sales, consignment sales, side letter agreements and other contingency sales. In the Matter of L3 Technologies, Inc., the SEC charged aerospace and defense company L3 with failing to maintain accurate books and records and failing to maintain adequate internal controls. The company had improperly recorded $17.9 million in revenue from a contract by creating invoices associated with unresolved claims that had not yet been delivered when the revenue was recorded. Smith and his CFO hatch a scheme when they will inflate revenues by accelerating revenues. For instance, a company that uses Smith’s services can pay on a month-by-month basis.
These schemes were popular in the 1980s in Japan before the government instituted harsher civil laws and eventually criminalized the practice. The Enron scandal revealed that Enron had extensively made use of sub-corporations to offload debts and hide its true losses in a Tobashi fashion. According to critic David Ehrenstein, the term “creative accounting” was first used in 1968 in the film The Producers by Mel Brooks, where it is also known as Hollywood accounting. The JFQA publishes theoretical and empirical research in financial economics. Topics include corporate finance, investments, capital and security markets, and quantitative methods of particular relevance to financial researchers. The income statement can be improperly inflated by raising revenues through recording sales before they are final and complete.
One should look into the financial records of the company with the due diligence to understand the correct picture of the company and to get satisfied that no cook the books have been done. In SEC v. Monsanto, the commission announced that Monsanto agreed to pay an $80 million penalty for inadequate internal accounting controls. According to the SEC’s order, the company failed to properly account for millions of dollars in rebates offered to retailers and distributors of Roundup after generic competition had undercut its prices and caused the company to lose significant share in the market. Monsanto booked substantial amounts of revenue from sales incentivized by the rebate program but failed to recognize all of the related program costs at the same time. A whistleblower received a more than $22 million award for disclosing this fraud to the SEC. In SEC v. Bristol-Myers Squibb, biopharmaceutical company Bristol-Myers Squibb agreed to pay a $150 million fine for selling excessive amounts of pharmaceutical products to its wholesalers ahead of demand in order to falsely inflate earnings.