Accounting Frauds

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ITM Executive MBA, Batch 13B, Term 1, Subject
Accounts
Accounting Frauds Of Our Times
V0.1
Ashish Nangla ashishnangla_at_msn.com KH08JUNMBA 63
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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).

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Balance Sheet Sneak Peek
Sample Balance Sheet as on 31st March 2008 Sample Balance Sheet as on 31st March 2008 Sample Balance Sheet as on 31st March 2008 Sample Balance Sheet as on 31st March 2008 Sample Balance Sheet as on 31st March 2008
Assets Assets Liabilities and Owners' Equity Liabilities and Owners' Equity Liabilities and Owners' Equity
Cash 6,600 Liabilities Liabilities Liabilities
Accounts Receivable 6,200 Notes Payable 30,000
Accounts Payable
Total liabilities Total liabilities 30,000
Tools and equipment 25,000 Owners' equity Owners' equity Owners' equity
Capital Stock 7,000
Retained Earnings 800
Total owners' equity Total owners' equity 7,800
Total 37,800 Total Total 37,800
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Income Statement Sneak Peek
An Income Statement, also called a Profit and
Loss Statement (PL), 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.

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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
 
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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. Account
s 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.
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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.
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Why Fudge Numbers ?
Stock or Share value directly get affected by a
companys 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.

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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.
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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.

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Worldcom
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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.
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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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