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Today’s Topics

Today’s Topics. Shenanigan Update #1. Shenanigan #1. Technique #1: Recording revenue when obligations remain Technique #2: Recording revenue in excess of contract value Technique #3: Recording revenue before buyer’s acceptance Technique #4: Recording revenue when payment is not assured.

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Today’s Topics

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  1. Today’s Topics • Shenanigan Update #1 FORENSIC ACCOUNTING - BA124 - Fall 2011 Slide 6-1

  2. Shenanigan #1 • Technique #1: • Recording revenue when obligations remain • Technique #2: • Recording revenue in excess of contract value • Technique #3: • Recording revenue before buyer’s acceptance • Technique #4: • Recording revenue when payment is not assured FORENSIC ACCOUNTING - BA124 - Fall 2011 Slide 6-2

  3. Revenue Red Flags • Aggressive Rev. Rec. Policies • Rise in unbilled receivables • Rising receivables • Rising allowance for doubtful accounts • Increased returns FORENSIC ACCOUNTING - BA124 - Fall 2011 Slide 6-3

  4. Earnings Manipulation Shenanigan #2-Recording Bogus Revenue • Technique #1: • Lack of economic substance • Technique #2: • Lack of arm’s length • Related parties • “Round-trip” transactions • Supplier rebates • Technique #3: • Non-operating revenue transactions • Investment income as operating revenue • Loans recorded as revenue • Technique #4: • Recording revenue at inflated amounts • Priceline.com • Technique #5: • Post merger deferred revenue FORENSIC ACCOUNTING - BA124 - Fall 2011 Slide 6-4

  5. Shenanigan #3-Boosting (Operating) Income • Technique #1: • Boosting income using one-time events • Selling of undervalued assets • Technique #2: • Boosting income through misleading classifications • Including investment gains in ops. income • Reducing opex by investment gains • Reclassifying balance sheet accounts FORENSIC ACCOUNTING - BA124 - Fall 2011 Slide 6-5

  6. Shenanigan #3 Warning Signs • Turning sales proceeds into recurring income • Shifting operating expenses • Recurring “restructuring” costs • Influence misinterpretation impact on income statement FORENSIC ACCOUNTING - BA124 - Fall 2011 Slide 6-6

  7. Shenanigan #4-Expense Shifting with Assets…Think WorldCom • Technique #1: • Capitalizing normal operating costs-AOL • Technique #2: • Slow amortization/depreciation (somewhat subjective)-Time Warner Telecom • Technique #3: • Failing to write-down impaired assets-Coldwater Creek • Technique #4: • Reducing asset reserves-Vitesse FORENSIC ACCOUNTING - BA124 - Fall 2011 Slide 6-7

  8. Shenanigan #4Red Flags • Changes in capitalization policy pre-IPO • Late accounting change announcements FORENSIC ACCOUNTING - BA124 - Fall 2011 Slide 6-8

  9. Shenanigan #5-Liability Games…Failure to record or understatement • Technique #1: • Failure to record current expenses • Technique #2: • Failure to accrue expenses • Technique #3: • Use of aggressive accounting assumptions • Technique #4: • Questionable cookie jar reserves-Chainsaw Al Dunlap and Sunbeam Corporation FORENSIC ACCOUNTING - BA124 - Fall 2011 Slide 6-9

  10. Shenanigan #6 • Shifting revenue to a future period • Why would we want to do this? • What is the benefit? • Fraud vulnerability charting of this fraud FORENSIC ACCOUNTING - BA124 - Fall 2011 Slide 6-10

  11. Why Do It? • Reserves for a “rainy day” • Investor benefit post merger FORENSIC ACCOUNTING - BA124 - Fall 2011 Slide 6-11

  12. Techniques • Technique #1: • Creation of “cookie jar” reserves • Technique #2: • Improperly accounting for derivatives • Technique #3: • Revenue hold back before an acquisition • Technique #4: • Recording current period sales in a later period FORENSIC ACCOUNTING - BA124 - Fall 2011 Slide 6-12

  13. “Cookie Jar” Reserves • MSFT example • Warning signs • Excessive use of reserves • Post-dating of shipping documents • Smoothing income…flat-line even (Stryker) FORENSIC ACCOUNTING - BA124 - Fall 2011 Slide 6-13

  14. Revenue Holdback • Tyco and 3Com • Hold back revenue today • Reverse it into income after the acquisition FORENSIC ACCOUNTING - BA124 - Fall 2011 Slide 6-14

  15. Revenue Shift • Reverse of the previous technique • Simply do not record the revenue • Use this technique even without an acquisition FORENSIC ACCOUNTING - BA124 - Fall 2011 Slide 6-15

  16. Transparency is Key • Are the #s telling the story or making the story? • Is the company managing the business or managing the #s? • What is, is? versus What is. Is! • Recall SFAC #1 • Improved decision making • Insight into future cash flows • Resource information FORENSIC ACCOUNTING - BA124 - Fall 2011 Slide 6-16

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