Today’s TopicsShenanigan #1Revenue Red FlagsEarnings Manipulation Shenanigan #2- Recording Bogus RevenueShenanigan #3- Boosting (Operating) IncomeShenanigan #3 Warning SignsShenanigan #4- Expense Shifting with Assets… Think WorldComShenanigan #4 Red FlagsShenanigan #5- Liability Games… Failure to record or understatementShenanigan #6Why Do It?Techniques“Cookie Jar” ReservesRevenue HoldbackRevenue ShiftTransparency is KeyFORENSIC ACCOUNTING - BA124 - Fall 2011 Slide 6-1Today’s TopicsShenanigan Update #1FORENSIC ACCOUNTING - BA124 - Fall 2011 Slide 6-2Shenanigan #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 assuredFORENSIC ACCOUNTING - BA124 - Fall 2011 Slide 6-3Revenue Red FlagsAggressive Rev. Rec. PoliciesRise in unbilled receivablesRising receivablesRising allowance for doubtful accountsIncreased returnsFORENSIC ACCOUNTING - BA124 - Fall 2011 Slide 6-4Earnings 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 revenueFORENSIC ACCOUNTING - BA124 - Fall 2011 Slide 6-5Shenanigan #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 accountsFORENSIC ACCOUNTING - BA124 - Fall 2011 Slide 6-6Shenanigan #3 Warning SignsTurning sales proceeds into recurring incomeShifting operating expenses Recurring “restructuring” costsInfluence misinterpretation impact on income statementFORENSIC ACCOUNTING - BA124 - Fall 2011 Slide 6-7Shenanigan #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-VitesseFORENSIC ACCOUNTING - BA124 - Fall 2011 Slide 6-8Shenanigan #4Red FlagsChanges in capitalization policy pre-IPOLate accounting change announcementsFORENSIC ACCOUNTING - BA124 - Fall 2011 Slide 6-9Shenanigan #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 CorporationFORENSIC ACCOUNTING - BA124 - Fall 2011 Slide 6-10Shenanigan #6Shifting revenue to a future periodWhy would we want to do this?What is the benefit?Fraud vulnerability charting of this fraudFORENSIC ACCOUNTING - BA124 - Fall 2011 Slide 6-11Why Do It?Reserves for a “rainy day”Investor benefit post mergerFORENSIC ACCOUNTING - BA124 - Fall 2011 Slide 6-12Techniques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 periodFORENSIC ACCOUNTING - BA124 - Fall 2011 Slide 6-13“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 6-14Revenue HoldbackTyco and 3ComHold back revenue todayReverse it into income after the acquisitionFORENSIC ACCOUNTING - BA124 - Fall 2011 Slide 6-15Revenue ShiftReverse of the previous techniqueSimply do not record the revenueUse this technique even without an acquisitionFORENSIC ACCOUNTING - BA124 - Fall 2011 Slide 6-16Transparency 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