CFA Level 1 - Red Flags
Under GAAP a company’s management has many options from which to choose to record certain economic events. These options are called “accounting rules” and, when used are referred to as “accounting events.” Because the various choices will have differing effects on reported earnings management has the opportunity to manipulate its financial results.
- Incentives and pressures: when compensation is heavily tied to the overall company’s performance and the escalation of the stock price, pressure can be created to increase those incentives
Opportunities: While it may be instinctual, if the opportunity presents itself, those with less than ethical practices may steer toward taking them if they feel they will not get caught or the effects on the company will be minimal - Attitudes and rationalizations: this is often considered to come from the top down, but it can be engrained in a company’s culture for long periods of time. Those who follow the lead of senior management can easily rationalize their improper behavior with the justification that the attitudes of their superiors are the same way.
The implementation of SOX in 2002 was prompted by the wide spread abuse that was occurring in the reporting and financial markets. Whether or not it has proven successful remains to be seen. Sarbanes-Oxley Act Of 2002 - SOX
Weblink 10.5 - To spot the signs of earnings manipulation, you need to know the different ways companies can inflate their figures, read Cooking The Books 101, or check out the definition for Sarbanes-Oxley Act Of 2002 - SOX.
Even with more strict regulations, the incentive to cook the books remains because it pays to do so. ,In the right hands it can be relatively easy. Shenanigans and manipulation are often unearthed, but it sometimes does not occur until well after the fact. A good example of this is when companies go back and restate earnings for prior periods once their less than proper accounting decisions are uncovered.
Other Motives Behind Financial Shenanigans
Another aim of financial shenanigans is to improve liquidity. By inflating revenues or hiding debt, companies can obtain funding with lower borrowing costs and fewer restrictive financial covenants when they issue bonds; they may also get preferred lower rates from financial institutions for short- and long-term loans, and if they are able to issue private placement debt the unsuspecting investors should make due diligence a priority.
Another aim of financial shenanigans is to improve liquidity. By inflating revenues or hiding debt, companies can obtain funding with lower borrowing costs and fewer restrictive financial covenants when they issue bonds; they may also get preferred lower rates from financial institutions for short- and long-term loans, and if they are able to issue private placement debt the unsuspecting investors should make due diligence a priority.
0 comments:
Post a Comment