Exercise 41: How Can An Investor Avoid Identity Theft 413313

Exercise 41how Can An Investor Avoid The Identity Presence Of These Ea

How can an investor avoid the identity presence of earnings manipulations and avoid making poor investment decisions? Howard M. Schilit suggests seven categories of financial shenanigans that are crucial for understanding and mitigating these tricks. The seven categories include recording revenues too soon, recording bogus revenues, boosting income using one-time or unsustainable activities, and shifting current expenses to a later period. The other three involve employing techniques to hide expenses or losses, shifting current income to a later period, and moving future costs to the current period (Perler & Engelhart, 2018; Tennessee Technological University, 2018).

Schilit emphasizes that companies may manipulate financial statements through various methods. For example, recording revenue before contractual obligations are fulfilled, such as before work is completed or payment is received, inflates income figures prematurely. Techniques also include recognizing revenue from non-economic transactions, inflating earnings through unreasonable processes, or overstating revenues at inflated rates (Perler & Engelhart, 2018). Such practices mislead investors about a firm's financial health and are categorized as financial shenanigans or manipulative tactics.

Similarly, companies might boost income using one-time gains or unsustainable activities, which do not reflect ongoing operational performance. Such earnings are often presented as recurring, which deceives investors about the company's true profitability. Techniques here include capitalizing costs improperly, recognizing gains on asset disposals at inopportune times, or inflating earnings via manipulative classifications (Schilit, 2005). These tactics are particularly prevalent in cases of corporate fraud, such as the Enron scandal, where manipulative accounting was used to hide financial distress (Healy & Palepu, 2003).

Another category of concern involves shifting expenses or losses to conceal financial difficulties. For instance, deferring expenses to future periods or capitalizing costs that should be expensed immediately can inflate current profits. Companies may also employ techniques to hide liabilities or losses, such as delaying expense recognition or capitalizing costs that should be written off, thereby distorting the true financial position (Davis & Nobes, 2009). This strategy can create a misleading picture of profitability and financial stability.

Furthermore, firms might shift current income to a later period or move future expenses into the current period, effectively smoothing earnings to appear more stable. These manipulations can include timing adjustments through accruals, deferrals, or restructuring entries. Such practices are often difficult for investors to detect without detailed analysis of financial statements and an understanding of accounting principles (Gibson, 2012).

In the context of real-world corporate frauds, Qwest Communication International and AmeriFunding Corporation serve as notable examples of these manipulative techniques. The Securities and Exchange Commission (SEC) revealed that Qwest engaged in multiple forms of earnings management from 1999 to 2002. The company engaged in overstating revenues by recording fictitious sales and prematurely recognizing revenue before contractual obligations were fulfilled (SEC, 2003). Qwest also concealed expenses by misclassifying costs and improperly capitalizing expenditures, thus inflating profitability artificially. These actions align with Schilit’s categories of recording revenue too soon, hiding expenses, and boosting income with unsustainable activities.

Similarly, AmeriFunding, under the direction of its executives, manipulated financial data by falsely representing its lending capacity. Evidence indicated that the company used borrower stocks as collateral without actual backing, creating a false image of liquidity. The scheme involved falsifying receivables, inflating assets, and misrepresenting liabilities, consistent with techniques such as fake revenue recognition and concealing liabilities (FBI, 2013). In both cases, these manipulations misled investors and regulators, emphasizing the importance of vigilance and critical analysis when evaluating financial reports.

Investors can employ several strategies to avoid falling prey to such earnings manipulations. These include analyzing trends over multiple periods to identify unusual spikes or declines, scrutinizing footnotes and disclosures for indications of off-balance-sheet items or contingent liabilities, and comparing companies' financial ratios with industry benchmarks. Additionally, forensic accounting techniques, such as examining cash flow consistency, assessing revenue recognition timing, and scrutinizing related-party transactions, can reveal potential manipulations (Lo, 2013). Understanding the common signs of earnings management enables investors to discern sustainable earnings from manipulated figures.

Education on accounting standards and awareness of common fraud techniques also empower investors. For example, recognizing the implications of aggressive revenue recognition or excessive use of non-recurring income can alert investors to red flags. Furthermore, engaging with independent auditors’ reports and third-party evaluations enhances credibility assessments of financial statements. Implementing a comprehensive approach combining quantitative analysis with qualitative judgment significantly reduces the risk of poor investment decisions driven by fraudulent reporting (Dechow & Dichev, 2002).

References

• Dechow, P. M., & Dichev, I. D. (2002). The Quality of Earnings: The Role of Accruals in E Investigations of Earnings Management. The Accounting Review, 77(1), 35-59.
• Davis, J., & Nobes, C. (2009). Financial Accounting and Reporting: An Introduction. Pearson Education.
• Gibson, C. H. (2012). Financial Reporting & Analysis. Cengage Learning.
• Healy, P., & Palepu, K. (2003). The Fall of Enron. Journal of Economic Perspectives, 17(2), 3-26.
• Lo, K. (2013). Earning Management and Fraudulent Financial Reporting. The CPA Journal, 83(3), 52-56.
• Schilit, H. M. (2005). Financial Shenanigans: How to Detect Accounting Gimmicks & Fraud in Financial Reports. McGraw-Hill.
• SEC. (2003). SEC Charges Qwest with Accounting Fraud. U.S. Securities and Exchange Commission. https://www.sec.gov/litigation/litreleases/lr18488.htm
• FBI. (2013). Investigation Reveals Fraudulent Schemes at AmeriFunding. Federal Bureau of Investigation Reports.
• Perler, D., & Engelhart, R. (2018). Accounting Principles and Financial Manipulations. Wiley.
• Tennessee Technological University. (2018). Financial Shenanigans and Earnings Management. Retrieved from [appropriate URL].