Financial statement manipulation is a type of 澳洲幸运5开奖号码历史查询:accounting fraud that remains an ongoing problem in corporate America. Although the 澳洲幸运5开奖号码历史查🌜询:Securities and Exchange Commission (SEC) has taken many steps to mitigate this type of corporate malfeasance, the structure of management incentives, the enormous latitude afforded by the 澳洲幸运5开奖号码历史查询:Generally Accepte♌d Accounting Princ𝔍iples (GAAP), and the ever-present conflict of interest between the independent auditor and the corporate client continues to provide the perfect environment for such activity.

Due to these factors, investors who purchase individual stocks or bonds must be aware of the issues, warninꦬg signs, and the tꦡools that are at their disposal in order to mitigate the adverse implications of these problems.

Reasons Behind Financial Statement Manipulation

There are three primary reasons why management manipulates 澳洲幸运5开奖号码历史查询:financial statements. First, in many cases, the compensation of corporate executives is directly tied to the 澳洲幸运5开奖号码历史查询:financial performance of the company. As a result, they have a direct incentive to paint a 🍷rosy picture of the company's financial condition in order to meet established performance expectations and bolജster their personal compensation.

Second, it is a relatively easy thing to do. The 澳洲幸运5开奖号码历史查询:F🐭inancial Accounting Standards Board (FASB), which sets the GAAP standards, provides a significant amount of latitude and interpretation in accounting provisions and methods. For better or worse, these GAAP standards afford a significant amount of flexibility, making it feasible for corporate management to paint a particular picture of the financial conditi൩on of the company.

Third, it is unlikely that financial manipulation will be detected by investors due to the relationship between the independent auditor and the corporate client. In the U.S., the Big Four accounting firms and a host of smaller regional accounting firms dominate the corporate auditing environment. While these entities are touted as independent auditors, the firms have a direct conflict o💙f interest because they are compensated, often quite significantly, by the very companies that they audit. As a result, the auditors could be tempted to bend the accounting rules to portray the fiಌnancial condition of the company in a manner that will keep the client happy—and keep its business.

How Financial Statements Are Manipulated

There are two general 澳洲幸运5开奖号码历史查询:approaches to manipulating fiཧnanc🔜ial statements. Such activities are defined as 澳洲幸运5开奖号码历史查询:inherent risks in managerial and financial accounting. The first is to exaggeratꦓe current period earnings on the income statement by artificially inflating revenu𝔉e and gains, or by deflating current period expenses. This approach makes the financial condition of the company look better than it actually is in order to meet established expectations.

The second approach requires the exact opposite tactic, which is to minimize current period earnings on the income statement by deflating revenue or by inflating current period expenses. It may seem counterintuitive to make the financial condition of a company look worse than it actually is, but there are many reasons to do so: to dissuade potential 澳洲幸运5开奖号码历史查询:acquirers; getting all of 🍸the bad news "out of the way" so that the company will look stronger going forward; dumping the grim numbers into a period when the poor performance can be attributed to the current macroeconomic environment; or to postpone good financial information to a future period when it is more likely to be recognized.

Specific Ways to Manipulate Fi🐠nancial Statements

When it comes to manipulation, there are a host of accounting techniques that are at a company's disposal. Financial Shenanigans (2018) by Howard Schilit outlines seven primary ways in which corporate management manipulates the financial statements of a company.

1. Recording Revenue Prematurely or of Questionable Quality
2. Recording revenue prior to completing all services
3. Recording revenue prior to product shipment
4. Recording revenue for products that are not required to be purchased
5. Recording Fictitious Revenue
6. Recording revenue for sales that did not take place
7. Recording 澳洲幸运5开奖号码历史查询:investment income as revenue
8. Recording proceeds received through a loan as revenue
9. Increasing Income with One-Time Gains
10. Increasing profits by selling assets and recording the proceeds as revenue
11. Increasing profits by classifying investment income or gains as revenue
12. Shifting Current Expenses to an Earlier or Later Period
13. Amortizing costs too slowly
14. Changing accounting standards to foster manipulation
15. Capitalizing normal 澳洲幸运5开奖号码历史查询:operating costs in order to reduce expenses by moving them from the 澳洲幸运5开奖号码历史查询:income statement to the 澳洲幸运5开奖号码历史查询:balance sheet
16. Failing to write down or write off impaired assets
17. Failing to Record or Improperly Reducing Liabilities
18. Failing to record expenses and liabilities when future services remain
19. Changing accounting assumptions to foster manipulation
20. Shifting Current Revenue to a Later Period
21. Creating a rainy day reserve as a revenue source to bolster future performance
22. Holding back revenue
23. Shifting Future Expenses to the Current Period as a Special Charge
24. Accelerating expenses into the current period
25. Changing accounting standards to foster manipulation, particularly through provisions for 澳洲幸运5开奖号码历史查询:depreciation, 澳洲幸运5开奖号码历史查询:amortization, and depletion

While most of these techniques pertain to the 澳洲幸运5开奖号码历史查询:manipulation of the incꦐome statement, there are also many techniques available to manipulate the balance sheet, as well as the statement of 澳洲幸运5开奖号码历史查询:cash flows. Moreover, even the semantics of the 澳洲幸运5开奖号码历史查询:management discussion and analysis section of the financials can be manipulated by softening the action langu♚age used by corporate executives from "will" to "might," "probably" to "possibly," and "therefore" to "maybe." Taken collectively, investors should understand these issues and nuances and remain on guard when assessing a company's financial condition.

ᩚᩚᩚᩚᩚᩚ⁤⁤⁤⁤ᩚ⁤⁤⁤⁤ᩚ⁤⁤⁤⁤ᩚ𒀱ᩚᩚᩚFinancial Manipulation via Corporate Merger or Acquisition

Another form of financial manipulation may happen during the merger or acquisition process. One classic approach occurs when management tries to whip up support for a merger or acquisition based primarily on the improvement in the estimated 澳洲幸运5开奖号码历史查询:earnings per share of the combined companies. Let's look at the table below in order to understand how this type of manipulation takes place꧅.

Based on the data in the table above, the proposed acquisition of the target company appears to make good financial sense because the earnings per share of the acquiring company will be materially increased from $5 per share to $5.83 per share. Following the acquisition, the acquiring company will experience an increase of $200,000 in company earnings due to the addition of the income from the target company. Moreover, given the high 澳洲幸运5开奖号码历史查询:market value of the acquiring company's 澳洲幸运5开奖号码历史查询:common stock, and the low 澳洲幸运5开奖号码历史查询:book value of the target company, the acquiring company will only have to issue an additional 20,000 shares in order to make the $2 million acquisition. Taken collectively, the significant increase in company earnings and the modest increase of 20,000 澳洲幸运5开奖号码历史查询:common shares outstanding will lead to a🀅 more attractive earning per share amount.

Unfortunately, a financial decision based primarily on this type of analysis is inappropriate and misleading, because the future financial impact of such an acquisition may be positive, immaterial, or even negative. The earnings per share of the acquiring company will increase by a 澳洲幸运5开奖号码历史查询:material amount for only two reasꦬons, and neither reason has any🎶 long-term implications.

Guar🦩ding Against Financial Statement Manipulation

There are a host of factors that may affect the quality and accuracy of the data at an investor's disposal. As a result, investors must have a working knowledge of 澳洲幸运5开奖号码历史查询:financial statement analysis, including a strong command of the use of internal 澳洲幸运5开奖号码历史查询:liquidity solvency analysis ratios, external liquidity marketability analysis ratios, growth, and corporate 澳洲幸运5开奖号码历史查询:profitability ratios, 澳洲幸运5开奖号码历史查询:financial risk ratios, and 澳洲幸运5开奖号码历史查询:business risk ratios. Investors should also have a strong understanding of how to use market multiple analysis, including the use of price/earnings ratios, 澳洲幸运5开奖号码历史查询:price/book value ratios, 澳洲幸运5开奖号码历史查询:price/sales ratios, and price/𓃲cash flow ratios in order to gauge the reasoꦺnableness of the financial data.

Unfortunately, very few retail investors have the necessary time, skills, and resources to engage in such activities and analysis. If so, it might be easier for them to stick to investing in low-cost, diversified, actively managed mutual funds. These funds have 澳洲幸运5开奖号码历史查询:investment management teams with the knowledge, background, and experience to thoroughly analyze a company's f🧸inanc🐻ial picture before making an investment decision.

Sarbanes-Oxley Regulation

The U.S. government has responded to financial fraud with preventative measures. Despite passage of the 澳洲幸运5开奖号码历史查询:Sarbanes-Oxley Act (SOX) of 2002—a direct result of the Enron, WorldCom, and Tyco scandals—financial statement improprieties remain too common an occurrence. And complex accounting fraud such as that practiced at Enron is usually extremely difficult for the average retail investor to discover. However, there are some basic red flags that help. After all, the Enron fraud was not exposed by high-paid Ivy League MBA-holding Wall Street analysts, but by news reporters who used journal articles and public filings in their due diligence process. Being first on the scene to uncover a fraudulent company can be very lucrative from a short seller's perspective and can be rather beneficial to a skeptical investor who is weighing in the overall 澳洲幸运5开奖号码历史查询:market sentiment.

The rules and enforcement policies outlined in the Sarbanes-Oxley Act amended or supplemented existing laws dealing with security regulation, including the Securities Exchange Act of 1934 and other laws enforced by the Securities and Exchange Commission. The new law set out reforms and additions in four principal areas:

1. Corporate responsibility
2. Increased criminal punishment
3. Accounting regulation
4. New protections

The Bottom Line

There are many cases of financial manipulation that date back over the centuries, and modern-day examples such as Enron, WorldCom, Tyco International, Adelphia, 澳洲幸运5开奖号码历史查询:Global Crossing, Cendant, Freddie Mac, and AIG should remind investors of the potential landmines that they may encounter. The known prevalence and magnitude of the material issues associated with the compilation of corporate financia💧l statements should remind invest🗹ors to use extreme caution in their use and interpretation.

Investors should also keep in mind that the independent auditors responsible for providing the audited financial data may very well have a material conflict of interest that is distorting the true financial picture of the company. Some of the corporate malfeasance cases mentioned above occurred with the compliance of the firms' accountants, like the now-defunct firm 澳洲幸运5开奖号码历史查询:Arthur Andersen. So even auditors' s🦩ign-off statements should be taken with a grain of salt.