Documente Academic
Documente Profesional
Documente Cultură
Heba Kamel Ajlouni Corporate Governance MBA Talal Abu Gazaleh College Of Business
Accounting Background
The most important documents that a company puts together are its financial statements. These include a balance sheet, a cash flow statement, and a profit and loss statement. These documents quantitatively describe the financial health of a company and are used by almost every entity that deals with the company, including the company executives and managers themselves. The following financial statements are usually compiled on a quarterly and annual basis:
Dr.Heba Kamel Ajlouni Corporate Governance MBA Talal Abu Gazaleh College Of Business
The balance sheet gives a snapshot or bird's eye view of the company's financial situation at a given date in time. It includes assets and liabilities and tells the business's net worth. The cash flow statement shows cash that is coming in as well as the cash needed to go out over a period of time. It is very helpful for planning for large purchases, or to help be prepared for slow periods in the business. In simple terms, the cash flow equals cash receipts minus cash disbursements. The profit and loss statement (also referred to as an income statement) lists revenues and expenses. It also lists the profit or loss of the business for a given period of time. It is helpful for planning and helps to control operating expenses. The New York Stock Exchange Banks review the financial statements to decide if they will lend the company money (and at what interest rate if they choose to lend it). Investors review the documents to decide if they feel confident in the company enough to invest their hardearned money. Company managers use them to analyze the business and determine how well they are doing. Many others also use the documents, so it is critical that they are accurate. For public companies, these documents are audited by outside accounting firms that certify that the documents are compiled according to generally accepted accounting principles, or GAAP. These firms are still at the mercy of the information provided by the company, however. They are also interested in keeping their largest customers happy. We'll look at the Sarbanes-Oxley Act of 2002 in the next section.
The Securities and Exchange Commission (SEC): The U.S. Securities and Exchange Commission (SEC) protects investors by maintaining the integrity of the securities markets, based on the idea that all investors should have access to certain basic facts about an investment. The SEC requires public companies to disclose meaningful financial information (and other types of information) to the public so all investors can determine whether or not a company's securities are a good investment. The SEC also oversees stock exchanges, broker-dealers, investment advisors, mutual funds, and public utility holding companies. Each year the SEC files between 400-500 civil enforcement actions against individuals and companies that break securities laws. Financial Accounting Standards Board (FASB): The Financial Accounting Standards Board establishes standards for financial accounting and reporting. Those standards dictate how financial reports must be prepared.
Dr.Heba Kamel Ajlouni Corporate Governance MBA Talal Abu Gazaleh College Of Business
Generally Accepted Accounting Principles (GAAP): GAAP is the accepted method for accountancy (the practice of accounting). It works with the authority of the FASB and establishes a common set of procedures for compiling financial statements.
The details of the Sarbanes-Oxley Act address many of the tactics companies have used to "cook the books" over the years. In the next few sections, we'll go over some of the more popular methods of improving a company's bottom line -- if only on paper.
Dr.Heba Kamel Ajlouni Corporate Governance MBA Talal Abu Gazaleh College Of Business
Expense Manipulation
Accelerating a company's expenses may not seem to be the way to boost the appearance of earnings, but it depends on when those earnings need to be boosted. There are legitimate and illegitimate reasons to accelerate expenses. A legitimate example would be making equipment purchases when earnings are high rather than when they were planned. Here's an example of a less legitimate earnings acceleration. A manager's bonus is based on his meeting a certain earnings goal. Once the target earning level has been exceeded, that manager might decide to spend money now that was budgeted to be spent in the next year because having higher earnings this year won't mean a bigger bonus for him. Spending money this year that was budgeted for next year, however, could help ensure he meets next year's level as well.
While this may seem like the same thing as making purchases when earnings are high, it depends on the circumstances. If making those purchases earlier than planned has no adverse affect on the business, then perhaps there is no problem. In many instances there is an adverse affect, however. For instance, buying computer equipment six months earlier than expected can mean a big difference in the actual equipment purchased -- power, features, and price can all change dramatically. Delaying Expenses Companies that are cooking the books have been known to capitalize expenses that are really everyday expenses. AOL was charged with engaging in various acts of securities fraud -- among other things -between 1992 and 1996. In one part of a larger case, AOL was accused of listing advertising expenses (the cost of creating those CDs and diskettes they send out) as capital expenses rather than regular expenses. This presented a false picture of the company's profitability and boosted the stock price. The disks should have been expensed as they were mailed. In an upcoming case study, you'll see that WorldCom capitalized expenses that should have been operating expenses to the tune of billions of dollars. When companies land a big contract to provide a product or service over a long period of time, they're supposed to spread the revenue over the cost of the service contract. Some companies have been known to show the sale and revenue in the quarter in which the contract was signed. Here are some other examples of premature revenue booking:
Recording sales after the products were ordered but before they were shipped to the customer Recording revenues when the sales involved contingencies that allowed the customer to return the merchandise Overstating revenues by speeding up the estimated percentage of completion for a project in process Recording revenues by shipping products that weren't ordered by the customer or by shipping defective products and recording revenues at full rather than discounted prices. Recording revenues when unassembled products are shipped from the manufacturing plant -- they must set up a separate assembly Photo courtesy MorgueFile location and assemble the products before the products can actually go to the customers Trying to improve future earnings by "front loading" future expenses and booking them in the current quarter is another example. This has been done during the acquisition of a company. The company will pay off (or
Dr.Heba Kamel Ajlouni Corporate Governance MBA Talal Abu Gazaleh College Of Business
even pre-pay) expenses in order to increase the earnings per share (EPS) over that of previous quarters for the combined company.
Dr.Heba Kamel Ajlouni Corporate Governance MBA Talal Abu Gazaleh College Of Business
Dr.Heba Kamel Ajlouni Corporate Governance MBA Talal Abu Gazaleh College Of Business
SEC began an investigation into Enron's accounting procedures and partnerships. In November, Enron officials admitted to overstating company earnings by $57 million since 1997. Enron, or "the crooked E," filed for bankruptcy in December of 2001. Where Are They Now? Enron's CFO, Andrew Fastow, was behind the complex network of partnerships and many other questionable practices. He was charged with 78 counts of fraud, conspiracy, and money laundering. Fastow accepted a plea agreement in January 2004. After pleading guilty to two counts of conspiracy, he was given a 10-year prison sentence and ordered to pay $23.8 million in exchange for testifying against other Enron executives. Jeff Skilling and Ken Lay were both indicted in 2004 for their roles in the fraud. According to the Enron Web site, "Enron is in the midst of liquidating its remaining operations and distributing its assets to its creditors. " On May 25, 2006, a jury in a Houston, Texas federal court found both Skilling and Lay guilty. Jeff Skilling was convicted of 19 counts of conspiracy, fraud, insider trading and making false statements. Ken Lay was convicted of six counts of conspiracy and fraud. In a separate trial, Lay was also found guilty on four counts of bank fraud. Kenneth Lay died of a heart attack on July 5, 2006, and a federal judge ruled that his conviction was void because he died before he had a chance to appeal. On October 23, 2006, Skilling was sentenced to 24 years in prison. Next, we'll learn how WorldCom and Tyco cooked the books.
Dr.Heba Kamel Ajlouni Corporate Governance MBA Talal Abu Gazaleh College Of Business
former CFO Scott Sullivan were charged with fraud and violating securities laws. Ebbers was found guilty on all counts in March 2005 and sentenced to 25 years in prison, but is free on appeal. Sullivan pleaded guilty and took the stand against Ebbers in exchange for a more lenient sentence of five years.
Dr.Heba Kamel Ajlouni Corporate Governance MBA Talal Abu Gazaleh College Of Business
Sources
Beasley, M., Carcello, J., and Hermanson, D. "COSO's new fraud study: what it means for CPAs." Journal of Accountancy, May, 1999. FindArticles.com. http://www.findarticles.com/p/articles/mi_m6280/is_5_187/ai_54636916 Corporate Scandal Primer. Washington Post. http://www.washingtonpost.com/wp-srv/business/scandals/primer/index.html Domash, Harry. "3 'creative accounting' flags for investors." MSN Money, 2005. http://moneycentral.msn.com/content/Investing/Simplestrategies/ P82399.asp?Printer Donaldson, William H. "SEC Testimony: Impact of the Sarbanes-Oxley Act." Securities and Exchange Commission. April 21, 2005. http://www.sec.gov/news/testimony/ts042105whd.htm Elstrom, Peter. "How to Hide $3.8 Billion in Expenses." Business Week Online, June 28, 2002. http://www.businessweek.com/bwdaily/dnflash/jun2002/nf20020628_9459.htm The Enron Fraud. http://www.enronfraud.com/ Ferraro, S. and C. McPeak. "Managing Earnings...or Cooking the Books?" Graziadio Business Report, Summer 2000. http://gbr.pepperdine.edu/003/reporting.html Howard v. AOL Order. AOL Legal Department. http://legal.web.aol.com/decisions/dlpriv/howardorder.html Jensen, Bob. "Accounting Scandal Updates and Other Fraud." Trinity University, June 30, 2004. http://www.trinity.edu/rjensen/fraud063004.htm Katz, David M. "Pension Plans Underfunded, Says Survey." CFO.com, April 1, 2003. http://www.cfo.com/article.cfm/3008870?f=related Longley, Robert. "Enron: Crouching Profits, Hidden Debt." About.com. http://usgovinfo.about.com/library/weekly/aa011402a.htm Mayer, David. "Leasing 101: What is "Variable Interest Entity?" Business Leasing News, February, 2003. http://www.pattonboggs.com/Newsletters/Bln/Release/bln_2003_02.htm#6 McDonald, Elizabeth. "Tyco's Goodwill Games." Forbes.com, June 13, 2002. http://www.forbes.com/2002/06/13/0613tycaccount.html Puplava, Jim. "A Penny Less, A Penny More." Financial Sense Online: Stormwatch, November 9, 2001. http://www.financialsense.com/stormwatch/oldupdates/2001/110901.htm "Secretary of Labor Chao's Lawsuit Involving Enron Corporation Retirement Plans." US Department of Labor Factsheet PDF. http://www.dol.gov/_sec/media/announcements/factsheet-lawsuit.pdf Tyco Fraud Infocenter. http://www.tycofraudinfocenter.com/information.php Tyco International Report TXT file. Securities Exchange Commission, September 10, 2002. http://www.sec.gov/Archives/edgar/data/833444/000091205702035700/ 0000912057-02-035700.txt Ussery, Michael J. "Enron: The Implosion." AccountingFailures.com, January, 2003. http://www.accountingfailures.com/Enron/enron.htm U.S. GAAP. CPAClass.com, 2004. http://cpaclass.com/gaap/gaap-us-01a.htm Walsh, Anthony F. "The Synthetic Lease: An Introduction and Practice Guide." FindLaw, 1999. http://library.findlaw.com/1999/Dec/1/131133.html Weinberg, Ari. "The Tyco Follies." Forbes.com, September 18, 2002. http://www.forbes.com/2002/09/18/0918tyco.html