FINANCIAL SHENANIGANS
THIRD EDITION
Howard M. Schilit
Jeremy Perler
Copyright 2010 by Howard Schilit. All rights reserved. Except as permitted under the United States Copyright Act of 1976, no part of this publication may be reproduced or distributed in any form or by any means, or stored in a database or retrieval system, without the prior written permission of the publisher.
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To Diane and Andrea
CONTENTS
PREFACE
What has been will be again, what has been done will be done again; There is nothing new under the sun.
ECCLESIASTES 1:9
Senior management at publicly traded companies, no doubt, yearn to report positive news and impressive financial results that will please investors and drive the share price higher. While most companies act ethically and follow prescribed accounting rules when reporting their financial performance, some take advantage of gray areas in the rules (or worse, ignore the rules altogether) in order to portray their financial results in a misleadingly positive way.
Managements desire to put a positive spin on financial results has been around as long as corporations and investors themselves. Dishonest companies have long used these tricks to prey on unsuspecting investors, and it is unlikely that they will ever cease to do so. As King Solomon observed in the book of Ecclesiastes, What has been will be again, what has been done will be done again. With the never-ending need to please investors, the temptation for management to exaggerate the positive through the use of financial shenanigans will always exist. The lure of accounting gimmickry is particularly strong at companies that are struggling to keep up with their investors expectations or their competitors performance. And while investors have become more savvy to these gimmicks over the years, dishonest companies continue to find new tricks (and recycle old favorites) to fool investors.
The original 1993 edition of Financial Shenanigans introduced readers to the world of corporate chicanery in the form of the seven Earnings Manipulation Shenanigans. The 2002 edition built on the original framework by identifying new techniques and presenting the worst offenders of the 1990s. With the wave of accounting frauds, restatements, and other financial reporting improprieties over the last decade, this third edition identifies many new techniques companies use to mislead investors. This book expands the discussion of Earnings Manipulation Shenanigans, introduces entirely new categories of shenanigans (Cash Flow Shenanigans and Key Metrics Shenanigans), and investigates new industries (banks and insurance companies) and new regions of the world (Europe and Asia) that have been hit with financial frauds.
Structure of the New Edition
This edition goes far deeper into the corporate bag of tricks than the earlier ones did, to give readers a comprehensive look at the various kinds of scams that are prevalent today. We have grouped these financial reporting shenanigans into three categories:
Earnings Manipulation Shenanigans reveals how companies manipulate the Statement of Income to report higher revenue, inflated profits, or improperly smoothed income.
Cash Flow Shenanigans discusses tricks used by companies to report misleadingly high cash flow measures, including cash flow from operations and free cash flow.
Key Metrics Shenanigans exposes how companies fool investors by showcasing misleading metrics that are being billed as key measures of business performance or economic health.
Postmortem: Lessons Learned from Financial Reporting Failures
We believe that the best training for professionals who are involved in preparing, auditing, or evaluating financial reports is an immersion in case studies to learn lessons from real-world financial reporting failures. Robert J. Sack, former chief accountant of the Division of Enforcement at the U.S. Securities and Exchange Commission (SEC), underscored this point by suggesting that accountants be trained more like medical students, who study cadavers to learn from history, stating: