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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.
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.
That’s because the purchases customers make on credit can be booked as sales even if the company allows the customer to postpone payments for six months. In addition to offering in-house financing, companies can extend credit terms on current financing programs. So, a 20% jump in sales could simply be due to a new financing program with easier terms rather than a real increase in customer purchases. These sales end up being reported as net income or profit, long before the company has actually seen that income—if it ever will. Practiced by some Hollywood film studios, creative accounting can be used to conceal earnings of a film to distort the profit participation promised to certain participants of the film’s earnings.
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.
This category was developed coincide with legal regulations and makes the destruction of financial documents and the creation of fraudulent documents that would aid in the deception of any federal investigations a felony crime. Term whistleblower refers to anybody who helps disclose any fraudulent information regarding the transactions and reports for publicly traded companies. Previously being a whistleblower was in a way de-incentivized because it lacked many of the legal protections that it now has from tortious and criminal litigation. Many of the interesting numbers present in the financial statements of the company can motivate the investors for a quick decision about the financial health of the company and investment. But this should not be done as just by seeing the number, the exact idea about the company cannot be gathered.
Enron, Adelphia, and WorldCom are extreme examples of companies who cooked the books claiming billions in assets that just didn’t exist. Companies can manipulate their financial records to improve their financial results using a multitude of tactics. Some companies don’t record all of their expenses that incurred in a period until the next period. By recording a portion of Q1’s expenses in Q2, for example, a company’s Q1 earnings or profit will look more favorable. They want to show high revenues and profits so that investors remain committed to their company. When such is the case, they may practice cooking the books by purposefully altering financial accounts to show the company is performing much better than it really is.
In 2014, the Bermuda deal with Dutch authorities expired, and Nike shifted the profits to another offshore subsidiary, a Netherlands-based Limited Liability Partnership . Through a Dutch tax loophole, CV’s owned by individuals that are residing in the Netherlands are tax-free. Exploiting this structure saved Nike more than $1Bn in taxes annually and reduced its global tax rate to 13.1%; the company is currently being pursued for billions of dollars worth of back taxes in litigation by multiple governments for this multinational tax avoidance. The balance sheet can improperly inflated by increasing assets or equity through the reporting of gains on the exchange of similar assets. The income statement can be improperly inflated by lowering costs or expenses through depreciating assets too slowly.