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The Financial Numbers Game

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The Financial Numbers Game

Detecting Creative Accounting Practices

Wiley,

15 min read
10 take-aways
Text available

What's inside?

Creativity is a good thing in business, but not in accounting. Here’s what to look for to be sure the numbers don’t lie.

Editorial Rating

8

Qualities

  • Applicable

Recommendation

A special note in the preface of this book explains that it went to press just as the Enron story was beginning to break. Three of its chapters provide almost all the information anyone would have needed to spot the problems at Enron, not to mention at the other big corporations whose scandals made recent headlines. Spotting fraud isn’t that hard. The authors provide a very useful toolkit that even a novice investor can use. Some of their coverage of the regulatory apparatus will no doubt have to be changed in future editions, as the regulations themselves keep changing, but this enlightening introduction to the nitty-gritty of skeptical financial statement analysis will have enduring utility. It’s written by accountants, so it gets a bit plodding in spots, but their anecdotes relieve the tedium and their information is invaluable. getAbstract.com recommends this reality check for every investor’s bookshelf, as well as every employee’s and every financial reporter’s. Anyone who depends on corporate performance or who uses corporate financial statements should read it.

Summary

Controlling, Not Pushing, the Envelope

Companies have strong incentives to push the envelope of accepted accounting practices. Good-looking financial reports can result in higher stock prices, and many executives get fat bonuses when stock prices move up. Healthy-looking financials can also result in lower borrowing costs. Sometimes firms even manipulate their financial reporting to avoid government regulation or taxes. Common moves in the numbers game include:

  • Aggressive accounting - Intentionally using accounting not to reflect real performance but to enhance apparent performance, whether or not the accounting is in line with Generally Accepted Accounting Principles (GAAP).
  • Earnings management - Manipulating accounting statements so that earnings hit a target forecast, or so that earnings look less volatile and more predictable.
  • Income smoothing - Earnings management designed to make performance look stable and steady. In good years, the reported earnings number is craftily lowered. The excess is "stored" to be drawn on to make earnings look higher in bad years.
  • Fraudulent reporting - Fraud, deliberately deceptive accounting, has to ...

About the Authors

Both authors are professors of accounting in the DuPree College of Management at the Georgia Institute of Technology in Atlanta. Charles W. Mulford holds the Invesco Chair and Eugene E. Comiskey holds the Callaway Chair. They also wrote Financial Warnings and Guide to Financial Reporting and Analysis.

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