Guest Author - Consuelo Herrera, CAMS, CFE
One of the ways by which investors, regulators, and the general public have been deceived is by presenting a company’s financial position solid in appearance when in fact such company is in the verge of bankruptcy.
How is this accomplished? It is accomplished through the use of different schemes, all of them aimed to increase earnings or reduce losses.
By using non-standard accounting procedures and practices accountants and finance professionals present a distorted financial position of a corporation seeking funds or being under the pressure of meeting market and analysts expectations. Common practices that have been prosecuted by federal regulators include:
· Overstating companies profits by deferring current period expenses. This is accomplished by a combination of falsely reducing depreciation expense, failing to write off impaired assets, understatement of income tax expenses, using under-accrued reserves, and reserves reversed into income – among other improper accounting practices, to artificially inflate the company’s current earnings.
· Manipulating the company’s gross profit margin and net income by overstating inventory values, falsifying journal entries, and failing to include appropriate charges for obsolete inventory.
Engaging in fraudulent transactions to inflate revenues is present too when executives enter into side agreements to loan money to customers with the understanding that the customers would use the funds to purchase the lender’s products. It inflates revenues and hides losses. In one day, investors lost $1,3 Billion as a result of the charges made to the executives of a corporation that engaged in this scheme.
Through press releases and media appearances, executives assure investors that their corporations’ financial affairs are fine, although they are facing difficulties in keeping up with the day-to-day operations. The goal of these public relation campaigns is to entice investors to put more money in. What is amazing is that investors and analysts fall in the trap of sound financial projections that will grant them a high return on their money.
Powerful public relations campaigns launched by troubled companies sometimes comply with their goal of obtaining additional funds. It was evidenced recently in the news when a defendant engaged in multiple fraudulent schemes and made materially false and misleading statements concerning his company financial and operating conditions. A month later, this company was forced into a bankruptcy proceeding when the true financial position came to the surface.
To re-gain public trust it is necessary that accountants do not engage in these practices that undermine investors’ confidence. Accounting practices should always be marked by ethical standards not by the pressure of attaining economic goals to meet market expectations. It is never emphasized enough. Making up a financial position for a company is unethical and brings discredit to the accounting profession.
Forensic accountants have been hired to investigate fraudulent financial statements because their knowledge and expertise enable them to uncover tactics used by colleagues who decided to direct their career in the wrong direction.