Accounting Frauds Of Our Times

1. ITM Executive MBA, Batch 13B, Term 1, Subject: Accounts Accounting Frauds Of Our Times V0.1 Ashish Nangla ashishnangla@msn.com KH08JUNMBA 63

2. Balance Sheet: Sneak Peek • A balance sheet or statement of financial position is a summary of a person's or organization's balances. • A balance sheet is often described as a snapshot of a company's financial condition • A Balance sheet is a Report or a Statement (Not an account). • Assets, liabilities and ownership equity are listed as of a specific date, such as the end of its financial year. • Balance Sheet will not have Debit side nor Credit side, instead it consists of assets and liabilities (along with equity).

3. Balance Sheet: Sneak Peek

4. Income Statement: Sneak Peek • An Income Statement, also called a Profit and Loss Statement (P&L), is a financial statement for companies that indicates how Revenue is transformed into net income • Purpose of the income statement is to show managers and investors whether the company made or lost money during the period being reported. • Top line: Money received from the sale of products and services before expenses are taken out. • Bottom Line: The result after all revenues and expenses have been accounted for.

5. Income Statement: Sneak Peek - INCOME STATEMENT BOND LLC - For the year ended MARCH 31 2007 $ $ Revenues GROSS PROFIT (including rental income) 496,397 -------- Expenses: ADVERTISING 6,300 INSURANCE 750 LEGAL & PROFESSIONAL SERVICES 1,575 RENT 13,000 UTILITIES 491 PRINTING, POSTAGE & STATIONERY 320 ENTERTAINMENT 5,550 LICENSES 632 BANK & CREDIT CARD FEES 144 BOOKKEEPING 3,350 EMPLOYEES 88,000 RENTAL MORTGAGES AND FEES 74,400 -------- TOTAL EXPENSES (194,512) -------- NET INCOME 301,885 ========

6. Typical Tricks for Creative Accounting Accounts Receivable The accounts receivable number that shows up in the asset section of a balancer sheet is almost always an estimate of what accounts are actually collectable. Why is the number an estimate? Because even if management can identify the precise amount its customers or clients owe the business, usually it is less than certain that this is the actual number that will ultimately be collected. Accounts Payable Management may have a motive to understate payables, as this understates expenses and overstates net income. Usually the amount of payable understatement is not too great and such understatement can easily be detected. Deferred Revenue A manager can overstate income and understate liabilities by treating deferred revenue as earned revenue. Essentially, this shady practice seeks to recognize revenue before it is actually earned. Such mischief often is not easy to detect, because it is not always clear when the earnings process is fully complete.

7. Typical Tricks for Creative Accounting Prepaid Expenses A manager also can understate current year expenses by claiming they are prepaid expenses. This amounts to a fraudulent claim that payments for a certain service benefit future accounting periods when, in fact they do not. Fixed Assets Because accounting practices allows so many different methods of depreciation and the useful life of assets is subject to varying estimates, there is plenty of opportunity for management mischief. Management can make a firm appear more profitable than it really is by understating depreciation expense. Inventory Inventory offers a big opportunity for management to air brush their financial statements. If they want gross profits and, hence, operating profits to appear higher, the value of ending inventory simply needs to be overstated. There are many ways this can be done. The ending inventory value can be fudged upward by overstating the amount of inventory on hand. Unit costs assigned to ending inventory can be inflated as well. Or obsolete or damaged inventory can be included in the ending inventory count.

8. Why Fudge Numbers ? • Stock or Share value directly get affected by • a company’s earnings. • Top management is largely paid by Stock. • There is constant pressure on CEOs and CFOs from Directors and Shareholders to perform better. • Wall Street is not all that forgiving in terms of lower earnings.

9. ENRON • Enron was one of the world's leading electricity, natural gas, pulp and paper, and communications companies, with claimed revenues of $111 billion in 2000. After a series of revelations involving irregular accounting procedures bordering on fraud perpetrated throughout the 1990s involving Enron and its accounting firm Arthur Andersen, Enron stood on the verge of undergoing the largest bankruptcy in history by mid-November 2001. Enron had created offshore entities, units which may be used for planning and avoidance of taxes, raising the profitability of a business. This provided ownership and management with full freedom of currency movement, and full anonymity, that would hide losses that the company was taking. These entities made Enron look more profitable than it actually was, and created a dangerous spiral in which each quarter, corporate officers would have to perform more and more contorted financial deception to create the illusion of billions in profits while the company was actually losing money. This practice drove up their stock price to new levels, at which point the executives began to work on insider information and trade millions of dollars worth of Enron stock. *Fortune named Enron "America's Most Innovative Company" for six consecutive years.

10. Worldcom WorldCom (WCOM) was the United States' second largest long distance phone company. • The fraud was accomplished primarily in two ways: • Underreporting ‘line costs’ (interconnection expenses with other telecommunication companies) by capitalizing these costs on the balance sheet rather than properly expensing them. • Inflating revenues with bogus accounting entries from ‘corporate unallocated revenue accounts’. • Rather than subtracting certain costs which were for maintaining telecom systems from profit, it called them long-term investments. Doing this allowed WorldCom to inflate earnings because the costs of long-term investments are subtracted from earnings over time, rather than all at once up front.

11. Worldcom

12. Worldcom The company showed a $1.4 billion profit in 2001, rather it was actually in a loss In June 2002, It was uncovered that approximately $3.8 billion of fraud during an examination of capital expenditures. On July 21, 2002, WorldCom filed for Chapter 11 bankruptcy protection in the largest such filing in history. ($103bn) By the end of 2003, it was estimated that the company's total assets had been inflated by around $11 billion.

13. Auditors ? Arthur Andersen LLP, based in Chicago, was once one of the "Big Five" accounting firms providing auditing, tax, and consulting services to large corporations. • Andersen struggled to balance the need to maintain its faithfulness to accounting standards with its clients' desire to maximize profits, particularly in the era of quarterly earnings reports. Andersen has been alleged to have been involved in the fraudulent accounting and auditing. • On June 15, 2002, Andersen was convicted of obstruction of justice for shredding documents related to its audit of Enron. • The Andersen indictment also put a spotlight on its faulty audits of other companies, most notably Waste Management, Sunbeam and WorldCom.

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