Financial Statement Manipulation

Today’s financing is increasingly complex with securities having the hybrid characteristics of debt and equity and hedging tools must also be accounted for. Corporate structure is evolving as well, according to the CFA Inquirer. Subsidiaries were used to separate businesses in the past but are used now for the short-term transfer of assets in the case of asset-backed securities, for example. With all these independent factors, describing individual corporate structure can be varied and not descriptive to most investors.

Journalists, as well as both institutional and individual investors, have voiced their anguish in analyzing financials. The CFA Inquirer reports that the length of post-Enron or post-WorldCom reports has helped make the task time-consuming and more complex than ever. The addition of new disclosures that may or may not be required under current accounting rules, add to the job.

With this complexity of statements with potentially exaggerated financial numbers, the barrier between legal accounting rules and outright fraud may blur. High expectations from Wall Street, perspective industries and even shareholders, help fuel aggressive accounting, as with Tyco, Adelphia or Global Crossing.

The pressure to post short-term results is sometimes driven by management incentives, performance targets and high share prices. No one wants to be left behind in a market or industry boom. These pressures can be forces for positive accounting practices, as well as aggressive accounting practices.

Generally Accepted Accounting Principles (GAAP) leaves room for interpretation. For example, one-time charges or investment gains can represent a company’s position properly or exaggerate, according to Investopedia.com. One-time charges are supposed to be non-reoccuring but are used to bury charges and investments not meant for the bright lights of corporate financials. Investment gains can reflect diversified revenue streams but at the same time, are unsteady in nature.

In 2004, KPMG commissioned their Survey on the Risk of Manipulation of Financial Statements. The results of this survey came from the directors of 75 large Canadian corporations. One striking point was that 46 percent of these executives thought that financial statement manipulation could occur on their own boards.

In their report, KPMG Forensic President James Hunter wrote, “It’s illuminating that our survey results show that this type of fraudulent behaviour carried out as a conspiracy by a group of senior people to deceive directors, auditors, lenders and other stakeholders to line their own pockets, has come to be seen as commonplace.”