Dealing with Distortion on Financial Statements

“You’ve got to look for the numbers,” said Dubos Masson, Ph.D,
CTP. “You’ve got to be aware that there are problems.”

Credit and financial managers use financial statements on a
regular basis, operating under the belief that past financial performance tends
to be a good indicator of future financial performance. However, as Masson
indicated in his recent NACM-sponsored teleconference, “Advanced Issues in
Financial Analysis,” what’s on the statement might not always be the truth.
Masson noted why customers creatively adjust their numbers, also called “window
dressing,” in order to paint a prettier picture for their vendors, analysts and
shareholders and how these alterations don’t always necessarily constitute
fraud.

Masson noted that the four primary reasons that companies use
“creative” accounting methods on financial statements are to positively affect
company share prices, the cost of borrowing, bonus plans and political costs. He
also discussed the specific ways that companies engage in these alternative
accounting methods, including premature recognition of revenue and aggressive
capitalization.

In his presentation, Masson noted that these misleading changes
are often the result of the general nature of guidelines like U.S. Generally
Accepted Accounting Principles (GAAP) in addition to the pressure put on
companies to make their expected earnings. “The thing we want to understand with
GAAP is that they’re general guidelines,” he said. “At the end of the statement,
there is still management discretion. A lot of times they’re trying to meet a
forecast.”

Fraud, as Masson noted, only occurs when there is intent to
defraud the company, making many of these misstatements the result of a lack of
control. “Some cases may appear to be fraud, but when we go back and look at
them, they’re not,” he said, citing the instance of Tyco International, whose
CEO and CFO were found guilty of financial fraud. “It was a lack of control” in
this instance, said Masson.

The presentation also offered attendees tips on what documents
offer the best company financial information, other sources for tips on how to
approach financial analysis and also trends and changes in accounting
regulations.

Source: Jacob Barron, NACM staff writer

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