Chapter 1 - As Bad as it Gets
|
1.
|
In the Creative Accounting Award category, the award for "Most shameless heist by senior management" goes to: 3
|
|
  Enron
|
|
|
Informix
|
|
|
Tyco
|
|
|
WorldCom
|
|
|
|
|
2.
|
Even though Enron made the 2000 list of largest companies ranked by sales, it's reported profits paled in comparison to the others. 5
|
|
|
|
|
3.
|
The first signs of a massive fraud were revealed when an Enron audit committee & the firm's auditor reviewed the accounting for several unconsolidated "off-balance sheet" partnerships. 7
|
|
|
|
|
4.
|
WorldCom embarked on aggressive shenanigans by moving ordinary business expenses from it's Statement of Income to its Balance Sheet. 9
|
|
|
|
|
5.
|
WorldCom moved expenses from its Income Statement to its Balance sheet by: 10
|
|
|
Backdating license sale agreements
|
|
|
Expensing line costs which are required to be capitalized
|
|
|
Recognizing amounts due under software maintenance agreements as software license revenues
|
|
|
Capitalizing line costs, fees paid to third party telecommunication network providers for the right to lease their networks
|
|
|
|
|
6.
|
Frequent acquisitions allowed Tyco to show strong operating cash flow, even though it merely resulted from an accounting loophole. 14
|
|
|
|
|
7.
|
Adjusting the free cash flow calculation for acquisitions would make a company's true performance even more difficult to identify, 16
|
|
|
|
|
8.
|
Symbol would record bogus adjustments to the company's financial statements at the end of each quarter to align its results with Wall Street expectation. 18
|
|
|
|
|
Chapter 2 - Just Touch Up the XRays
|
9.
|
Financial shenanigans trick investors into believing: 24
|
|
|
the company's earnings are stronger
|
|
|
the company's cash flows are more robust
|
|
|
the company's Balance Sheet position is more secure
|
|
|
All of the above
|
|
|
|
|
10.
|
One technique for shifting revenue to a later period is to create reserves and release them into income in a later period.
|
|
|
|
|
11.
|
The following is (are) Earnings Manipulation (EM) Shenanigan: 25
|
|
|
Recording bogus revenue
|
|
|
Shifting current income to a later period
|
|
|
shifting future expenses to an earlier period
|
|
|
All of the above
|
|
|
|
|
12.
|
Shifting current expenses to a later period is an example of a Cash Flow Shenanigan. 25
|
|
|
|
|
13.
|
The following is NOT a Cash Flow Shenanigan: 26
|
|
|
Shifting financial cash inflows to the operating section
|
|
|
Inflating operating cash flow using acquisitions or disposals
|
|
|
Boosting operating cash flow using unsustainable activities
|
|
|
Showing misleading metrics that overstate performance
|
|
|
|
|
14.
|
Management teams devoid of checks and balances can encourage financial shenanigans. 28
|
|
|
|
|
15.
|
Adelphia is a good example of a single family dominating management and the board. 29
|
|
|
|
|
16.
|
Investors should be skeptical of: 30
|
|
|
Senior executives who push for winning at all costs
|
|
|
Boastful or promotional management
|
|
|
Boards lacking competence or independence
|
|
|
All of the above
|
|
|
|
|
17.
|
Boards should challenge management on related-party transactions, 32
|
|
|
|
|
18.
|
The following recipient(s) of CFO magazine's respected Excellence Awards has served jail time: 32
|
|
|
WorldCom's Scott Sullivan
|
|
|
Enron's Andrew Fastow
|
|
|
Tyco's Mark Schwartz
|
|
|
All of the above
|
|
|
|
|
19.
|
Astronomical fees can conflict auditor independence. 35
|
|
|
|
|
20.
|
Italian regulations concerning auditor change precipitated the discovery of: 36
|
|
|
the booking of fictitious sales at Kanebo
|
|
|
fraud at Parmalat
|
|
|
lack of competence at WorldCom
|
|
|
All of the above
|
|
|
|
|
21.
|
Regulators are not a line of defense for investors. 37
|
|
|
|
|
22.
|
Investors should never give an investment manager their money when the manager's performance seems "too good to be true". 39
|
|
|
|
|
23.
|
An extended streak of meeting or beating Wall Street expectations is a warning sign of Financial Shenanigans. 40
|
|
|
|
|
24.
|
The following is NOT a warning sign for a Financial Shenanigan breeding ground: 41
|
|
|
inappropriate members placed on the board of directors
|
|
|
An unqualified auditing firm
|
|
|
A third party custodian to safeguard cash and securities for investors
|
|
|
An inappropriate compensation structure that encourages aggressive financial reporting
|
|
|
|
|
Chapter 3 - Earnings Manipulation Shenanigan No 1: Recording Revenue Too Soon
|
25.
|
Recording revenue before a buyer's final acceptance of the product is a technique used to manipulate earnings. 48
|
|
|
|
|
26.
|
According to accounting guidelines, this condition must be met in order for revenue to be recognized: 50
|
|
|
Evidence of an arrangement exists
|
|
|
Delivery of the product or service has occurred
|
|
|
The price is fixed or determinable and the collectability of the proceeds is reasonable assured
|
|
|
All of the above
|
|
|
|
|
27.
|
An investor should be wary of companies that extend their quarter end date. 50
|
|
|
|
|
28.
|
A sharp jump in accounts receivable, especially long-term and unbilled ones is a red flag that a company may be inappropriately recognizing revenue before work is completed on a contract. 51
|
|
|
|
|
29.
|
A change in a company's revenue recognition policy can falsely appear to be growth in revenue. 52
|
|
|
|
|
30.
|
Cash flow from operations materially preceding net income is a warning of premature revenue recognition. 53
|
|
|
|
|
31.
|
Seller-Provided financing could be a way for companies to accelerate revenue by enabling customers to pay for their products. 69
|
|
|
|
|
32.
|
Companies that are found to be recognizing revenue prematurely must restate the beginning retained earnings on the Balance Sheet. 71
|
|
|
|
|
33.
|
Investors should take note when a company changes accounting principles for no apparent reason. 65
|
|
|
|
|
34.
|
Changes to more aggressive revenue recognition policies should be a red flag for detecting financial shenanigans. 65
|
|
|
|
|
35.
|
One common sign of aggressive revenue recognition is when Cash Flow From Operations (CFFO) starts to materially lag behind reported net income. 53
|
|
|
|
|
36.
|
A jump in long-term receivable could indicate: 54
|
|
|
A company has overstated expenses
|
|
|
A company has recorded revenue when future services remain to be provided.
|
|
|
A company has understated liabilities
|
|
|
All of the above
|
|
|
|
|
37.
|
A key warning sign for improper or aggressive accounting is when unbilled receivables grows substantially faster than billed receivables. 53
|
|
|
|
|
38.
|
Revenue can properly be recognized for customers who lack the wherewithal to pay on seller-financed deals. 67
|
|
|
|
|
39.
|
Service companies, whose projects generally a short-term, may appropriately use Percentage of Completion to recognize revenue. 56
|
|
|
|
|
40.
|
Revenue is considered bogus if the customer has no obligation to keep the product or to pay for the product. 65
|
|
|
|
|
Chapter 4 - Earnings Manipulation Shenanigan No 2:  Recording Bogus Revenue
|
41.
|
Cash flow from investment income should be recorded as revenue from sales. 76
|
|
|
|
|
42.
|
It would be improper to record cash from asset sales and other investment income as revenue. 76
|
|
|
|
|
43.
|
Bogus reserves will often lead to bogus revenue or income. 79
|
|
|
|
|
44.
|
Credits received from suppliers for returns should be recorded: 86
|
|
|
As revenue
|
|
|
As a purchase return
|
|
|
As a reduction of an expense
|
|
|
None of the above
|
|
|
|
|
45.
|
A prudent investor would question revenue recorded when cash is received in lending transactions. 85
|
|
|
|
|
46.
|
Unlike principles, agents recognize revenue: 89
|
|
|
at the net amount (sales price paid by customer less cost)
|
|
|
at the gross amount (cost of product plus markup)
|
|
|
at the minimum amount (the lesser of sales price and cost plus markup)
|
|
|
as disclosed in the agent contract
|
|
|
|
|
Chapter 5 - Earnings Manipulation Shenanigan No 3:  Boosting Income Using One-Time or Unsustainable Activities
|
47.
|
Transactions that commingle the sale of a business with the sale of products to customers create opportunities for financial shenanigans. 96
|
|
|
|
|
48.
|
On the Statement of Income, income from operations is often referred to as "above-the-line". 101
|
|
|
|
|
49.
|
A one time charge to write-off inventory shifts operating expenses above the line. 102
|
|
|
|
|
50.
|
Frequent one time or re-structuring charges on a company's Statement of Income should be investigated further. 102
|
|
|
|
|
51.
|
Under the equity method of accounting for investments, if an investor possesses the "ability to exercise significant influence", it's share of profits should be reported as nonoperating investment income and not as revenue. 105
|
|
|
|
|
52.
|
Classifying equity holdings as "trading securities" as opposed to "available for sale" allows a company to mark the securities up to a higher market value. 107
|
|
|
|
|
53.
|
Under GAAP, one time income should be separated on the financial statements from income that stemmed from ordinary continuing operations. 109
|
|
|
|
|
Chapter 6 - Earnings Manipulation Shenanigan No 4:  Shifting Current Expenses to a Later Period
|
54.
|
Normally, advertising expenses are capitalized. 114
|
|
|
|
|
55.
|
Improperly capitalizing normal operating expenses allows a company to shift current expenses to a later period. 112
|
|
|
|
|
56.
|
Repair and maintenance expenses are normal operating costs and should be charged against income. 113
|
|
|
|
|
57.
|
An enterprise should expense costs incurred that produce a future benefit and capitalize those that produce no such benefit. 113
|
|
|
|
|
58.
|
Investors should be alert for companies that capitalize a disproportionately large amount of their software costs or companies that change their accounting policies and begin to capitalize costs. 117
|
|
|
|
|
59.
|
Capitalizing training costs and other operating costs associated with opening a new store is generally considered aggressive accounting. 116
|
|
|
|
|
60.
|
Failure to establish sufficient reserves on accounts receivable would overstate expenses and inflate profits. 131
|
|
|
|
|
61.
|
A quick calculation of Coldwater Creek's Days' Sales of Inventory (DSI) would have revealed that inventory growth exceeded recent business growth signifying future diminished profits. 128
|
|
|
|
|
62.
|
Allowance for obsolescence is an inventory contra account. 129
|
|
|
|
|
63.
|
According to the author, when all reserve accounts are moving in the wrong direction (i.e. declining), a wise investor should head for the hills. 130
|
|
|
|
|
Chapter 7 - Earnings Manipulation Shenanigan No 5:  Employing Other Techniques to Hide Expenses or Losses
|
64.
|
An enterprise has incurred a liability if it is obligated to make future sacrifices. 138
|
|
|
|
|
65.
|
Existing obligations that have resulted from past transactions must be reported as liabilities with a corresponding charge to an expense. 139
|
|
|
|
|
66.
|
Loss contingencies should be accrued when: 147
|
|
|
There is a probable loss
|
|
|
The amount of the loss can be reasonable estimated
|
|
|
Both a and b exist
|
|
|
The loss is identified
|
|
|
|
|
67.
|
Changes in self-insurance assumptions can be used to manipulate earnings. 153
|
|
|
|
|
68.
|
Creating reserves allows a company to shift revenue to a future period. 154
|
|
|
|
|
69.
|
Sunbeam used a large restructuring plan to create improper restructuring and "cookie jar" reserves to allow for later reversal into income, thereby inflating profit margins and creating the illusion of a successful reorganization. 155
|
|
|
|
|
Chapter 8 - Earnings Manipulation Shenanigan No 6:  Shifting Current Income to a Later Period
|
70.
|
Smoothing income is not an uncommon strategy as Wall Street rewards solid and predictable profit growth. 162
|
|
|
|
|
71.
|
Investors should be alert for lower revenue at a Target Company just before it is acquired. 170
|
|
|
|
|
Chapter 9 - Earnings Manipulation Shenanigan No 7:  Shifting Future Expenses to An Earlier Period
|
72.
|
Improperly writing off inventory as obsolete would allow a company to show deflated profit margins in the future. 178
|
|
|
|
|
Chapter 10 - Cash Flow Shenanigan No. 1: Shifting Financing Cash Inflows to Operating Section
|
73.
|
Information included in the Operating section of the Statement of Cash Flows can be used as an alternative performance measure to the accrual based net income on the Statement of Income. 190
|
|
|
|
|
74.
|
A company could shift Financing Cash Inflows to the Operating section by: 198
|
|
|
Improperly capitalizing normal operating expenses
|
|
|
Purchasing less inventory
|
|
|
Selling receivables before the collection date
|
|
|
None of the above
|
|
|
|
|
75.
|
Enron used Enron-controlled special purpose entities to borrow money to buy Enron commodities which strengthened its Cash Flow from Operations by moving the cash inflow from the Financing section to the Operations section. 201
|
|
|
|
|
76.
|
Cash received from the sale of receivables is an Operating inflow not a Financing inflow. 203
|
|
|
|
|
Chapter 11 - Cash Flow Shenanigan No. 2: Shifting Normal Operating Cash Outflows to the Investing Section
|
77.
|
Improperly capitalizing normal operating expenses allows a company to shift operating cash outflows to the investing cash outflows. 214
|
|
|
|
|
78.
|
Boomerang transactions: 215
|
|
|
Occur when a company improperly capitalizes normal operating expenses
|
|
|
Occur when a company sells products or services to a customer and simultaneously buys the same amount of products or services FROM the same customer.
|
|
|
Should be reported as an investing outflow
|
|
|
None of the Above
|
|
|
|
|
79.
|
Improperly capitalizing normal operating expenses not only embellishes earnings, it inflates operating cash flow as well. 218
|
|
|
|
|
80.
|
As of this writing, Netflix records the purchase of DVDs as Cost of Goods Sold, but does not report the cash outflow as Operating, but instead reports the cash outflow as Investing. 221
|
|
|
|
|
Chapter 12 - Cash Flow Shenanigan No. 3: Inflating operating Cash Flow Using Acquisitions or Disposals
|
81.
|
Paying for an acquisition with cash is recoded as an Investing outflow on the Statement of Cash Flows. 229
|
|
|
|
|
82.
|
The collection of cash from "acquired" receivables must be reported as an Investing inflow. 230
|
|
|
|
|
83.
|
Gaining customers through an acquisition provides a benefit to Cash Flow from Operations as compared to growing a customer base organically. 230
|
|
|
|
|
84.
|
By selling everything but the receivables when Tenet Healthcare sells hospitals, it is able to boost Operating inflows. 239
|
|
|
|
|
Chapter 13 - Cash Flow Shenanigan No. 4: Boosting Operating Cash Flow Using Unsustainable Activities
|
85.
|
Paying vendors more quickly allows a company to boost operating cash flow. 242
|
|
|
|
|
86.
|
Collecting from customers more quickly boosts operating cash flow and could easily be confused with increasing sales. 242
|
|
|
|
|
87.
|
In order to more accurately understand a company's operating cash flow a prudent investor should: 247
|
|
|
Watch for new disclosures about prepayments
|
|
|
Watch for elaborate strategies to influence the timing of cash flow
|
|
|
Be wary of dramatic improvements in Cash Flow from Operations
|
|
|
All of the above
|
|
|
|
|
88.
|
Taxes, interest and one-time events are considered to be part of operating cash flow but not of operating income. 251
|
|
|
|
|
Chapter 14 - Key Metrics Shenanigan No. 1: Showcasing Misleading Metrics That Overstate Performance
|
89.
|
The calculation of the same store sales metric is defined by GAAP. 263
|
|
|
|
|
90.
|
An accelerating Same Store Sales and a shrinking Revenue per Store could indicate that the company has changed its definition of Same Store Sales. 264
|
|
|
|
|
91.
|
An investor should be alarmed if a key metric suddenly goes missing from a company's financials. 265
|
|
|
|
|
92.
|
The Book-to-Bill disclosure compares current period bookings to current period revenue. 269
|
|
|
|
|
93.
|
The following types of orders should be included in a Book-to-Bill calculation: 269
|
|
|
Cancelable orders
|
|
|
Orders with longer term service or construction contracts
|
|
|
Orders of noncore operations
|
|
|
None of the above as each company defines how they calculate bookings.
|
|
|
|
|
Chapter 15 - Key Metrics Shenanigan No. 2: Distorting Balance Sheet Metrics to Avoid Showing Deterioration
|
94.
|
Selling Accounts Receivable lowers the Days' Sales Outstanding reported to investors. 283
|
|
|
|
|
95.
|
Investors typically view an unexpected rise in inventory as a sign of upcoming margin pressure through markdowns or write offs or a falling product demand. 287
|
|
|
|
|
96.
|
New Century Financial Corp grouped its loan loss reserve with an allowance for real estate owned reserve in order to: 290
|
|
|
Show that asset quality was deteriorating
|
|
|
Tidy up the look of the financial statement disclosures
|
|
|
More accurately report earnings
|
|
|
Trick investors into thinking its charge offs were steady
|
|
|
|
|
97.
|
Financial shenanigans are at play when a company distorts debt metrics to hide liquidity problems. 292
|
|
|
|
|
Chapter 16 - Shenanigans Recap and Recommendations
|
98.
|
The following is (are) a breeding ground for financial shenanigans: 300
|
|
|
Absence of checks and balances among senior management
|
|
|
Presence of related-party transactions
|
|
|
Inappropriate members placed on the board of directors
|
|
|
All of the above
|
|
|
|
|
99.
|
Investors can sniff out Earnings Manipulation shenanigans by scrutinizing the Balance Sheet and Statement of Cash Flows. 299
|
|
|
|
|
100.
|
Investors can detect signs of misleading operating cash flow by identifying unusual or troubling changes on the Statement of Income and the Balance Sheet. 299
|
|
|
|
|
