What? The active manipulation of accounting results for the purpose of creating an altered impression of performance. Managers choosing accounting policies so as to maximize their own utility and/or the market value of the firm.
Accounting Tricks - Examples Waste Management Inc. – Understated depreciation and capitalized interest improperly, failed to write down impaired assets. Total restatement $2 billion.
How would you detect this type of fraud? A decrease in the asset turnover ratio. A fictitious asset cannot produce revenue PPE increases while revenue decreases When an expense that is fixed remains constant as a percentage of sales, despite decreases in revenue Possible from disclosures on significant accounting policies Writing off previously capitalized cost
How would you detect? Examine Days in receivables – if this increases because revenue is being recognized significantly earlier than it is collected. The relationship between CFFO and revenue significantly decreases
Accounting Tricks - Examples Adelphia – Hid billions in debt off-balance sheet in unconsolidated subsidiaries, diverted undetermined millions to the family stockholders, inflated subscriber numbers in press reports, overstated earnings.
Signals of this type of fraud Days in Receivables increases An increase in Gross Margin percentage CFFO falls Change to a more aggressive revenue recognition policy Offers large discounts or other inducements to get orders Revenue is recorded despite a right of return
Accounting Tricks - Examples Rite-Aid – Inflated revenues by recording vendor rebates that pertained to future purchases. Reduced expenses by capitalizing expenses, not recording certain expenses, failing to write off inventory shrinkage, understating depreciation.
What is principle-based accounting? –What are its advantages and disadvantages? How? 3. Rule-based versus principle-based accounting What is rule-based accounting? –What are its advantages and disadvantages? Sickening example – SPE’s
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