The Financial Numbers Game: Detecting Creative Accounting Practices

1 Financial Numbers Game 1

Rewards of the Game 2

Classifying Creative Accounting Practices 8

Plan of This Book 13

Summary 14

Glossary 15

Notes 16

2 How the Game Is Played 19

Accounting Policy Choice and Application 19

Fraudulent Financial Reporting 39

Cleaning Up after the Game 44

Clarifying Terminology 49

Summary 50

Glossary 50

Notes 52

3 Earnings Management: A Closer Look 57

What Is Earnings Management? 58

Incentives and Conditions for Earnings Management 60

Earnings Management Techniques 62

Evidence of Earnings Management 68

Effectiveness of Earnings Management 74

Is Earnings Management Good or Bad? 82

Summary 84

Glossary 86

Notes 88

4 The SEC Responds 93

The Chairman’s Speech 93

The Action Plan 96

Subsequent Developments 99

Enforcing the Securities Laws 108

Summary 120

Glossary 122

Notes 123

5 Financial Professionals Speak Out 127

Survey of Financial Professionals 129

Survey Results 133

Summary 156

Glossary 157

Notes 158

6 Recognizing Premature or Fictitious Revenue 159

Is It Premature or Fictitious Revenue? 160

When Should Revenue Be Recognized? 165

Detecting Premature or Fictitious Revenue 185

Checklist to Detect Premature or Fictitious Revenue 191

Summary 193

Glossary 194

Notes 196

7 Aggressive Capitalization and Extended Amortization Policies 201

Cost Capitalization 202

Detecting Aggressive Cost Capitalization Policies 214

Amortizing Capitalized Costs 220

Detecting Extended Amortization Periods 226

Checklist to Detect Aggressive Capitalization and Extended Amortization Policies 229

Summary 231

Glossary 231

Notes 233

8 Misreported Assets and Liabilities 237

Link with Reported Earnings 238

Boosting Shareholders’ Equity 239

Overvalued Assets 240

Undervalued Liabilities 259

Checklist to Detect Misreported Assets and Liabilities 268

Summary 271

Glossary 272

Notes 275

9 Getting Creative with the Income Statement: Classification and Disclosure 279

Current Income Statement Requirements and Practices 280

Reporting Comprehensive Income 292

Creative Income Statement Classifications 295

Creativity with Other Aspects of the Income Statement 304

Summary 311

Glossary 312

Notes 313

10 Getting Creative with the Income Statement: Pro-Forma Measures of Earnings 317

Recasting the Bottom Line: Pro-Forma Earnings Measures 318

Summary 339

Glossary 340

Notes 341

11 Problems with Cash Flow Reporting 345

Reporting Cash Flow 347

Problems with Reported Operating Cash Flow 354

Using Operating Cash Flow to Detect Creative Accounting Practices 370

Checklist for Using Operating Cash Flow to Detect Creative Accounting Practices 373

Summary 373

Glossary 375

Notes 377

Subject Index 379

Company Index 391