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Today’s Topics

This presentation covers various shenanigans in forensic accounting, particularly focusing on revenue manipulation techniques and their associated red flags. Shenanigan #1 discusses recording revenue under dubious circumstances, such as before buyer acceptance or when obligations remain. In Shenanigan #2, we explore bogus revenue recording through lack of economic substance and inflated amounts. The section on expense shifting and liability games elaborates on how companies may understate liabilities and manipulate valuations. Understanding these tactics is crucial for recognizing potential fraud in financial reports.

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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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