Window dressing & false accounting

Lesson objectives By the end of the lesson, students should be able to: - Understand the limitations of final accounts Know the different ways that accountants can be creative with accounting

Recap How are accounts used by the following stakeholders? Shareholders Directors, managers and employees Customers Suppliers Citizens or residents Competitors Bankers What is a Profit and Loss Account What is a Balance Sheet

Case Study- MCI WORLDCOM MCI WORLDCOM replaced Enron as a symbol for US corporate crisis when it revealed in 2001 that it had hidden expenses of $2.8 billion. The WorldCom deception became one of the biggest scandals in US corporate history. For a while, WorldCom was the second largest US phone company after AT&T. However, between 1999 and May 2002 WorldCom used illegal accounting methods to cover up declining revenues by falsely recording financial growth and inflating profitability to increase the price of its shares. By the end of 2003 it was estimated the company’s total assets had been overstated by nearly $11 billion. In 2005, Bernard Ebbers, the company’s former CEO was convicted of fraud, conspiracy and filing false accounts. He was sentenced to 25 years in prison. Other WorldCom officials were charged with criminal penalties and also imprisoned. The company came out of bankruptcy in 2007, nearly $6 billion in debt and was later acquired by Verizon Communications. Most of its debtors never received payment. When published accounts mislead us over the real level of profits and debt levels, which stakeholders suffer and why? If the British government is not showing in its public accounts the loans it provided Northern Rock plc, can we really expect companies to be more honest?

Window dressing Final accounts must be handled with some caution. There is no single accounting standard that is universally accepted, accountants can be creative in the compilation of final accounts. Creative Accounting or Window Dressing, is the legal manipulation of accounting statements based on the accounting principles and rules of that country to make the figures look more flattering

Examples Show an overdraft that is repayable after twelve months as a long-term liability to improve the working capital figure of the business. This is legal as the firm could simply apply for an extension in repaying the overdraft. Optimistic valuation of intangible assets Using sale and leaseback just before the final accounts are due will show a sudden hike in the liquidity of the firm. Outstanding loans and other bills that are about to be paid are postponed until a few days after the date of the accounts. Declare Sales Revenue figures for items pad on credit for which payment has not yet been received. The method to which depreciation figures are reported.

Limitations of final accounts A set of financial accounts must be used together. Using a single account in isolation is of no value as there is no way of judging financial performance. Instead a series of accounts would be more useful to show trends over time. Human resources are totally ignored. It often argued that Human Resources are a company’s most valuable asset, yet this is not represented in the final accounts. Final accounts do not consider non-financial factors such as ethical objectives . There needs to be access to the accounts of other businesses in order to benchmark Whilst financial reports need to be lawfully produced , it does not mean that they report the whole truth. Profit and Loss accounts Balance Sheets and Cash Flow statements are a historical account of the financial performance of an organisation. Past performance is not necessarily indicative of current or future performance.

JOIN KHALID AZIZ ECONOMICS OF ICMAP, ICAP, MA-ECONOMICS, B.COM. FINANCIAL ACCOUNTING OF ICMAP STAGE 1,3,4 ICAP MODULE B, B.COM, BBA, MBA & PIPFA. COST ACCOUNTING OF ICMAP STAGE 2,3 ICAP MODULE D, BBA, MBA & PIPFA. CONTACT: 0322-3385752 R-1173,ALNOOR SOCIETY, BLOCK 19,F.B.AREA, KARACHI, PAKISTAN