Book - Financial Shenanigans Flashcards
What was the problem in Waste Management, and how did one-time gains come into the picture?
Waste management: Investors cannot trust auditors, with one-time charges connected to acquisitions being so frequent, and by investors not agreeing on the practice but still allowing it. Also netted one-time gains against special charges and did not disclose this.
How did Enron manage to inflate revenue 10-fold?
The revenue grew “too” fast, it was unprecedented. They counted trading activities as sales, which created modest profit but huge revenues (hypergrowth).
if it looks too good to be true, it probably is, and should be investigated further.
In World Com, what was the problem with the accounting for so-called “line costs”?
fees paid to third-party telecom network providers for the right to access their network, these should be expensed and not capitalised, which they did not follow and inflated their earnings.
How did the management in Valeant managed to fool investors?
Making acquisitions, writing off too much of the costs immediately, and creating reserves which were released when needed. If companies have a strategy relying on aggressive acquisitions and accounting, one should be particularly thorough.
There are seven financial Shenanigans recognised in the book, relating to earnings manipulations. How many of them relate to revenue accounting or gains, and which are they?
3: Recording revenue too soon, Recording bogus revenue, Boosting income using one-time or unsustainable activities
How many relates to expense accounting or losses?
4: Shifting current expenses to a later period, Employing other techniques to hide expenses or losses, Shifting current income to a later period, Shifting future expenses to the current period
Which are the shenanigans relating to cash flow? How many of them relates to the operating section of the cash flow statement?
Shifting Financing cash inflows to the operating section, Moving cash outflows from the operating section to other sections, Boosting operating cash flow using unsustainable activities
Explain how Key Metrics Shenanigans are created.
Business results are presented to cater to a wider range of company- and industry-specific measures (ROIC etc.), and since they are often non-GAAP, companies have more freedom to calculate and report them.
What are the Acquisitions Accounting Shenanigans?
3: Artificially boosting revenue and earnings, Inflating reported cash flow, manipulating key metrics
By what does the authors mean when they state “the auditors can be either a friend or a foe to investors”?
A friend is competent, independent, and fastidious in sniffing out problems, a foe is incompetent, lazy, or a rubber stamp for the management (high fees and relationship might be an issue)
There are four techniques to record revenue too soon; which?
Recording revenue before completing material obligations under the contract, Recording revenue far in excess of work completed on the contract, Recording revenue before the buyer’s final acceptance of the product, Recording revenue when the buyer’s payment remains uncertain or unnecessary
What are the key lessons for investors in the “boomerang” transactions in MSTR?
1) funds flowing back and forth between a customer and seller should raise suspicions about the legitimacy of both transactions
2) the suspicious timing of press releases announcing new sales should raise questions about whether revenue might have been recognised too early
Explain in general terms, the background to the percentage of completion (POC) method?
It was introduced so that firms working on long-term construction-type contracts could report business activity each period, even if a product was not delivered to the customer. Have to estimate how large portion of the project that has been completed.
What is a “bill-and-hold” arrangement and when do accounting guidelines allow revenues to be recognized?
When the seller bills the customer and recognizes revenue but continues to hold the product. For most sales, revenue recognition requires shipment of the product to the customer.
Explain how Sunbeam managed to record revenue too soon.
They sold products six months before they were needed, in exchange for major discounts and longer payment terms.
What is a consignment arrangement and how does it affect the recognotion of revenue?
Products are shipped to an intermediary, who has the task of finding a buyer, and it should not be recorded as revenue, bur Sunbeam did.
Explain what the risk might be if the seller accepts an exceptionally long time to pay or if the seller provides the financing for the sale. What key-ratio might be useful in spotting too aggressive accounting?
May indicate the acceleration of revenue into the current period, tepid customers interest in the product or the buyer’s ability to pay. Can use DSO as a measure of this.
Which are the four techniques, involving recording bogus revenue?
Recording revenue from transactions that lack economic substance, Recording revenue from transactions that lack reasonable arm-length process, Recording revenue on receipts from non-revenue-producing transactions, Recording revenue from appropriate transactions, but at inflated amounts
How did the “finite insurance” issued by AIG, work in the case of Brightpoint.
If they did not reach a target, a revenue to AIG could be recorded (insurance), This was not a real transaction, since it was only a financing arrangement - bright point deposited cash at AIG which was refunded as insurance claim payments eventually.
What part of the balance sheet could have been used as a warning signal to spot problems in Peregrines “parking” of transactions?
High accounts receivables. They counted transactions as revenue when customers still could withdraw
What is a Barter transaction in in what way is it risky, when it comes to revenue recognition?
It is a non monetary arrangement, where no money switch hands, it is risky since they can inflate the value easily
How did Enron managed to record rapidly expanding revenue by the help of commodity brokerage transactions?
They counted the full value of the transaction as revenue, instead of recording the results only. Hereby they recorded 101 million on a 100 mill transaction instead of the 1 “profit”.
Which are the two techniques described in the chapter? (boosting income using one-time/unsustainable act.)
Boosting income using one-time events and boosting income through misleading classifications
Large discrepancies between revenue and operating earnings growth, is a warning sign. How did IBM managed to have a 30.2 per cent growth in operating earnings on only 7.2 per cent revenue growth?
They included a gain from selling a business in the S&Am which boosted operating earnings.
Describe the technique used for turning the sale of a business in to recurring revenue stream.
By selling it and at the same time enter into an agreement to buy back products from the sold BU, they can thus take less money to get a good future deal on the purchases.
How did Softbank managed to increase future revenue when selling the modem rental business?
entered into an agreement to service the buyer in the future, they consider part of the purchase price as future revenue which could be utilised later.
Which are the three types of financial classifications that could inflate operating (above-the-line) income?
1 - shifting normal open to non operating section
2 - shifting non operating or nonrecurring income to operating section
3 - using questionable management decisions regarding BS classification to help offload bad stuff or upload good stuff
What is the most common way to shift normal operating expenses below the line?
one-time write-offs of costs that would normally appear in the operating section
In what way can the recording of restructuring charges be an abuse?
By doing it many times, and bundling normal open in these
Give an example of how companies can shift losses to the presentation of discontinued operations.
they can put nonprofitable divisions below the line and look more profitable above the line.
In what way can consolidated subsidiaries with a minority interest produce misleadingly strong growth in revenue growth and operating earnings?
They will look more profitable since full revenue and expenses is included above the operating part, while the deduction is put below.
Which are the four techniques used to shift current expenses to a later period?
Excessively capitalising normal opex
Amortising costs too slowly
Failing to write down asetts with impaired value
Failing to record expenses for uncollectible receivables and devalued investments
What are the two main categories of assets, explained in the Accounting capsule?
1 those that produce future benefit (inventory)
2 tase that are ultimately expected to be exchanged for another asset (cash)
Which are the three warning signs of improper use of capitalization?
- Unwarranted improvement in profit margins and a large jump in certain assets
- A big unexpected decline in FCF, with an equally sizeable increase in CFFO
- Unexpected increases in capex that belie the company’s normal guidance and market conditions
How did AOL managed to increase operating earnings by changing the soliciting costs for new customers?
They treated it as an asset, called deferred membership acquisition costs.
Describe how the accounting of software costs can increase earnings.
By capitalising this development costs are understated.
Describe how improper capitalization has an effect on operating cash flow.
capitalised costs are normally presented in the capex, in the investment section of the CF
How can a change in depreciations be used to inflate earnings and how can you spot if this technique is being used?
BY increasing the depreciation period, the costs are reduced and earnings inflated.
How can the allowance for doubtful accounts be used as a warning sign?
a sharp decline in the allowance coupled with a rise in receivables often signals that a company has failed to record enough bad debts expense and has therefore overstated profit.
