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Durable Competitive Advantage > Financial Shenanigans Ch 1-5 > Flashcards

Financial Shenanigans Ch 1-5 Flashcards

1
Q

Enron used what kind of accounting to give the illusion that it had larger sales than in reality?

A

Mark to market accounting

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2
Q

When reported sales growth far exceeds any normal patterns…

A

Revenue recognition shenanigans may likely have fueled the increase

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3
Q

Earnings manipulation shenanigans…4

A

1 recording revenue too soon
2 recording bogus revenue
3 boosting income using one time/unsustainable activities
4 use techniques to hide expenses or losses

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4
Q

Cash flow shenanigans:

Shifting financing cash inflows…

A

To operating section

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5
Q

Cash flow shenanigans:

Shifting normal operating cash outflows to…

A

The investing section

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6
Q

Cash flow shenanigans:

Inflating operating cash flow using…2

A

1 acquisitions or

2 disposals

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7
Q

Cash flow shenanigans:

Boosting operating cash flow using…

A

Unsustainable activities

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8
Q

Key metrics shenanigans 2

A

1 showcasing misleading metrics that overstate performance

2 distorting balance sheet metrics to avoid showing deterioration

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9
Q

Acquisition driven companies offer investors some of the…

A

Greatest challenges and risks

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10
Q

Aggressive accounting by worldcom involved…4

A

1 making acquisitions
2 writing off much of the costs immediately
3 creating reserves
4 releasing reserves into income as needed

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11
Q

Acquisition driven companies often lack internal engined of growth such as…3

A

1 product development

2 sales

3 marketing

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12
Q

On the statement of cash flows line costs were placed in…

Instead of…

A

The investing section

Operating section

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13
Q

Free cash flow equation

A

Free cash flow =

cash flow from operations - capital expenditures

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14
Q

When free cash flow suddenly plummets…

A

Expect big problems

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15
Q

Red flag is companies profits do not…

A

Do not grow in proportion to company’s sales

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16
Q

Operating cash flow is inflated when acquisitions are…

A

Recorded in the investing section of statement of cash flows

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17
Q

Financial shenanigans

A

Actions taken by management to mislead investors about financial performance or economic health

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18
Q

Management is devoid of checks and balances 2

A

Good when members of management disagree

Bad when one manager runs the show

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19
Q

It is bad, when company management consists of…

A

Family and friends

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20
Q

CEOs who push a culture of win at all costs can lead to…

A

Aggressive accounting

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21
Q

It’s bad when management…

A

Boasts about continuously beating earnings

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22
Q

You should question the auditor’s opinion when…

A

Auditor’s fees are astronomical

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23
Q

How can management avoid the regulatory scrutiny of going public?

A

By merging into an already public company

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24
Q

Red flag when management boasts about being…

A

Ethical

Ethical people rarely brag about such virtues

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25
Q

Madoff’s investment firm did not have a…

A

Third party custodian to safeguard cash and securities

For investors to prevent theft

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26
Q

Warning signs: breeding ground for shenanigans

Absence of checks and balances…

A

Among senior management

27
Q

Warning signs: breeding ground for shenanigans

An extended streak of…

A

Meeting or beating Wall Street expectations

28
Q

Warning signs: breeding ground for shenanigans

Single family dominating…3

A

1 management

2 ownership or

3 board of directors

29
Q

Warning signs: breeding ground for shenanigans

Presence of…

A

Related party transactions

30
Q

Warning signs: breeding ground for shenanigans

Inappropriate compensation structure that encourages…

A

Aggressive financial reporting

31
Q

Warning signs: breeding ground for shenanigans

Inappropriate members placed on…

A

Board of directors

32
Q

Warning signs: breeding ground for shenanigans

Inappropriate business relationships between…

A

Company and board members

33
Q

Warning signs: breeding ground for shenanigans

An unqualified…

A

Auditing firm

34
Q

Warning signs: breeding ground for shenanigans

An auditor lacking…

A

Objectivity and independence

35
Q

Warning signs: breeding ground for shenanigans

Attempts of management to avoid…2

A

Regulatory or legal scrutiny

36
Q

4 requirements for revenue recognition that must be met

A

1 evidence of an arrangement exists
2 delivery of product or service has occurred
3 price is fixed or determinable
4 collectibility of proceeds is reasonably assured

37
Q

For capital leases, by using a low discount rate management could…

A

Aggressively accelerate revenue recognition

38
Q

Be aware of acceptable accounting methods that are meant for different industries, ex.

A

Mark to market used by Enron for premature rev recognition

Percentage completion used for premature rev recognition

39
Q

Bill and hold is considered…

Where can it be found if the company used bill and hold?

A

Premature revenue recognition

Found in the 10-K foot note for revenue

40
Q

Consignment arrangements can be used for…

A

Prematurely recording revenue

41
Q

Sell in

2) sell through

A

Sell in = manufacturer sells to distributor

Sell through = products are purchased by the end user

42
Q

When a company switches from a sell in to a sell through model this is a…

A

More aggressive way to recognize revenue

43
Q

Be mindful of sellers recording revenue before the lapse of the…

A

Right to return

44
Q

Look for revenue recognition changes in…

A

The footnotes

45
Q

Watch for an increase in…

A

Seller provided financing

46
Q

A company is riskier when they have looser…

A

Financing plans

47
Q

Record revenue from transactions that lack economic substance

A

Customer is under no obligation to pay for product

48
Q

For legitimate insurance contracts there must be…

A

A transfer of risk

49
Q

Bogus reserves will often lead to…

A

Bogus revenue or income

50
Q

A rapid increase in accounts receivable is often an indication of…

A

Deteriorating financial health

51
Q

Most related party transactions and joint ventures that lack an arms length exchange produce…

A

Phony revenue

52
Q

If a company has 36 employees, chances are the company is committing fraud by stating…

A

$300 million in revenue

53
Q

If you spot signs of a questionable accounting approach test it by…

A

Comparing results and practices to a similar larger company

54
Q

A principal (owner of inventory) should recognize revenue using…

2) an agent should recognize revenue using…

A

The gross method

2) the net method (fee only)

55
Q

Turning a sale of a business into a recurring revenue stream (ex. Technology companies commonly do this)

A

Company Sells a business unit and agrees to buy it back

56
Q

When a company sells a business unit that it will use future services from, a common shenanigan is…

A

Under reporting the gain from sale in order to over report revenue

57
Q

Companies often try to over report…

How?

A

Operating income

By shifting nonrecurring income to operating income and operating expenses to nonrecurring expenses

58
Q

If an investor possesses significant influence of a company (over 20% ownership), it’s proportionate share of profits should be included as…

A

Non operating income (not as revenue)

59
Q

Switching from the equity method to the available for sale method means…

A

Periodic results of the subsidiary would not affect earnings of the parent

60
Q

If an investment is designated as trading security, changes in fair value are…

A

Reflected on the statement of income

61
Q

If an investment is designTed at available for sale, changes in fair value are…

A

Presented as an offset to equity with no impact to earnings

62
Q

Under the equity method for an investment, a company reports…

A

Proportional share of investment’s earnings on income statement

63
Q

For an over 50% ownership investment in a company…

A

The parent consolidates sub’s financial statements into its own

Durable Competitive Advantage (20 decks)

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