Accounting Fraud: How to get a little bit too creative

Defining Accounting Fraud is very simple. You deliberately set out to make a fake set of financial statements (a.k.a the "books") that lie about the true financial position of a company. You may have heard it being called "cooking the books" or "window dressing the balance sheet". Or some very cynical people just believe that all accounting is a fraud!

Any way you look at it you're trying to avoid detection of your crimes even if the books are subjected to rigorous examination. To whet your appetite here's a list of some of our favorite accounting fraud shenanigans:

Inflating Sales Revenue

Your aim is make your sales look higher than what they really are.

  • So you ship off a pile of products to a good customer even though they haven't actually ordered them.
  • And as they are good customers they'll end up returning them. In the meantime, you record the shipment as a sale (with a corresponding debtor in the balance sheet).

And you time it just before the books close for the financial year-end. A bookkeeping delight. Or a plain out scam. Take your pick.

Misclassification of Assets & Liabilities

  • What if you decided to show an investment you had in an illiquid company as a short term asset? That way investors or analysts reviewing the financial statements would think that you had access to money very quickly in need. But you don't as there's no market to sell the shares.
  • And conversely what if you thought it was a good idea to classify a short-term liability as belonging to the long-term? Again, those poor investors & shareholders could be tricked into thinking that you had plenty of time before you had to pay your debts
  • And if you were really feeling adventurous you simply net off (subtract one from the other) long-term assets and short term liabilities so as they wouldn't even appear in the balance sheet at all!! Now that really is creative

How to minimize expenses: The Balance Sheet

Another bean counter favorite is to put an expense onto the balance sheet and then never release it out to the P&L. Now that may sound a bit odd. How you can pay for something and then not put it through the P&L. Well, it is legitimate to do this with assets that you believe will help you create income for a period of time. 

For example, if you buy an office computer then you can reasonably expect to use it over say, three years. So you're allowed to expense it to the profit & loss over that period as well. This is known as asset depreciation.

And of course, we think you can probably see just how easily you could manipulate it. You could depreciate assets over a far longer period than their real useful life. Now just imagine a factory where you have huge amounts of expenditure in building it in the first place.

Can you imagine the lengths some companies will go to convince their auditors just how long it should take them to expense the costs to the profit & loss?

What's that Debtor Really Worth?

Let's have a look at the world's favorite whipping industry: Banks. Banks have a job to do - they lend money to customers, charge interest and fees. And they collect repayments.

But what if the customer decides to not pay back. And what if the Bank decides to do nothing about it?

The problem here is that the Bank's assets (loans) are now over-valued as the customer won't repay them. The Bank has an obligation to write-that debt off (which means taking a hefty expense to the P&L).

The accounting fraud kicks in when they decide that - in the face of overwhelming evidence to the contrary - that they really will receive the money from the customer. And they make up all kinds of funny stories to the auditors to convince them of the impending repayment. It always never works but you'd be amazed how Bank's will try.

Special Purpose Vehicles. Say hello to the fraud accounting Enron scandal 

We've saved the best for last. Enron perfected the accounting fraud like no other has before.

They simply shoved losses and debts into companies they owned yet didn't have to report in their financial statements. Say what?? These special purpose vehicles (SPV's) had some nifty loopholes that Enron exploited beautifully. It all came crashing down in the end but great party whilst it lasted. And let's not mention that ir was straight out theft of investors money.

So, there you have it - a list of some of our favorite accounting frauds. By no means exhaustive and we certainly look forward to the next biog calamity to be reported.

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