Sunday, December 14, 2008

How to Commit Fraud

Tomorrow morning I'm taking my Accounting final. Early. We're allowed to use a 3x5 card with whatever we want on it, as long as it is in our own handwriting. I am, of course, writing as much as I possibly can on my card. (I'm using pigma micron 005 pens, which write .20 mm line width = tiny.) To keep things nice and legible, I'm writing four lines between each line on the index card.

I just came across a kind of fun slide that I thought I would mention. It's a page of "Recent Financial Reporting Misstatements" and it was basically our class conversation about how to commit fraud. I guess a bunch of accounting professors won't really talk about fraud in classes, but mine does! He tells us he's teaching us how to commit fraud so that we know not to do it. "If you do it, you'll get away with it for awhile," he says. "But eventually you'll get caught."

So the deal is this: every year public companies have to issue financial statements. People who buy stocks use these financial statements to know how the company is doing, and how it will probably continue to operate, etc. The financial statements don't come out right right after the period that they represent, so even if anything serious changes between when the statements are from and when they're released (like a few months), they're even supposed to mention that. Because as someone buying part of the company, like, you deserve to know.

That's the whole point of this stuff. If you choose to invest in a risky company, that's totally your choice, and maybe you'll make a lot of money or maybe you'll lose a lot of money. BUT, you have to know accurate numbers so that you know which companies are risky or less risky so that you can make that informed decision about where to put your moneys.

But companies can do some shady stuff to make it look like everything is fine or good when it actually is not fine.

Like these things:

Recording revenue too soon. OH NO! The financial year is ending tomorrow and everyone is expecting us to make THIS much money and instead we only made this much money. Well, Joe has paid us for the big order of stuff we're delivering to him next week, so let's just go ahead and count it now instead of next week, since we already know we're going to have it for him next week anyway. And if we count it now then we'll be closer to what people are expecting. [In accounting, this is not okay.]

Boosting income with one time sales. Everyone expected us to make $$$, but we actually sold Suzie that big order, so this year we made $$$$$$. All of us here at the company know that Suzie just needed stuff once, and that our company is not really growing that much or doing any better than we usually do. Next year we'll be back to making $$ or $$$ or mayyyybe $$$$ if we're lucky. Definitely not $$$$$$ like this year. But we just won't really say anything about Suzie's order, or draw any attention to it, and everyone will think we had a great year, and that next year will probably be even better. And they'll buy our stock like it's crack cocaine. Or candy. [Also not fine. They have a fatty notes section at the end of the financial statements where you can say "welllll, we had a great year, but it was mostly business as usual except for Suzie's big one time order" and that way everyone knows that you actually are still the company that they think you are. Or that you're doing worse if you are. Or whatever. But you're not misleading people into thinking that you're making more money if it's actually a one shot deal.]

Shifting current revenue to a later period.
People were expecting us to make $15 and we actually made $35, but next year is going to be rough. So instead of saying we made $35, let's only say we made $20. And then we can count the other $15 next year, because our main product is our chocolate chip cookie, and we know that chocolate chips are on back order everywhere for the next 6 months, so times are going to be rough, but if we just save that $15 and count it later, then it will look like we did fine next year too, no matter how things actually go. [Also misleads people. Like maybe your stock stays the same because you did what everyone expected, so you can buy up lots of stock and then declare your other revenue next time and you'll be way ahead, and the stock will go up, and that would be shady. So, you can't shift current revenue to a later period.]

Recording bogus revenue. Hey look, our contractor sent us a refund because he was able to get the part cheaper! Great! Let's just pretend we sold more of something! [Obviously not fine to pretend you made money when you didn't.]

Shifting current expenses to a later or earlier period. "Well, everyone expected us to make $50, but after we pay Bill for the paper clips we ordered, we'll only have made $40. Blast. Oh, I know! Let's just pretend I didn't actually mail the check to Bill and we'll count it tomorrow so that it's part of our next financial statements. That way we'll have made our $50, and we can just plan to make a little more to cover the paper clips next time." [Just pay for the paper clips now. Let your numbers be a little lower this time, and people may be unhappy, but then you won't have to worry about jail time. For shifting current expenses, anyway.]

Failure to record or improperly reducing liabilities. Liabilities are the things you owe other people. So this is like saying, "Look! We have $25!" and everyone thinks you sold $25 of whatever, but you don't tell them that you also owe the bank $25, and you maybe didn't sell anything at all. Or maybe you sold stuff but you didn't charge enough to make a profit. You could be saying, "Look at our great company! We have $25!" and actually you have a loan that you still have to pay off that's $50, and you're losing money. [Don't do this.] [Lose money OR commit fraud.]

Shifting future expenses to the current period as a special charge. Well, if we have more expenses, it will make sense that we have less money than people expected. So, let's just pretend we paid all of our electric bills for the rest of the year. We'll put it on our statements as "Electricity Fee" (or, you know, whatever) and then when we have to pay them later we'll just know that we already counted them. Or we'll count them again under their normal utility category. Similar to shifting revenue; it makes it look like you're making more or less than you actually are. [Bad idea.]

Interesting, huh. The magician clip art I actually copy/pasted from the slide because I thought that was kinda funny.

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