Chapter 13
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Financial Shenanigans
Financial Accounting for Managers Author: Sanjay Dhamija
Reliability of Financial Statements
• Reliability is an important attribute
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• Free from bias
• All relevant information are disclosed
• Substance more important than form
• Conservatism
Financial Accounting for Managers Author: Sanjay Dhamija
Regulatory Framework
• Standards formats and disclosure requirements
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• Accounting standards to ensure uniformity
• Independent audit
• Listing Agreement
• CEO/ CFO certification
Financial Accounting for Managers Author: Sanjay Dhamija
Motivations for Financial Shenanigans
• Performance-based compensation
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• Earnings expectations
• Conceal deteriorating financial conditions
• Tax evasion
• Raising funds
• Diversion of funds
Financial Accounting for Managers Author: Sanjay Dhamija
Opportunities for Financial
Shenanigans
• Accounting flexibilities
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• Weak internal controls
• Lack of auditors’ independence
• Poor governance structure
Financial Accounting for Managers Author: Sanjay Dhamija
Financial Shenanigans Techniques
• Revenue recognition
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• Treating consignment sales as final sale
• Round tripping
• Selling goods with tacit understanding to buy it back
• Channel stuffing
• Shipping goods to dealers in excess in case of genuine
demand
• Booking future income as current income.
Financial Accounting for Managers Author: Sanjay Dhamija
Financial Shenanigans Techniques
• Revenue recognition
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• Reporting cost overruns as revenue
• Without confirmation from the client
• Percentage completion method
• In case of construction contracts / service contracts
• Sales versus commission
• Booking revenue as sales instead of commission earned.
Financial Accounting for Managers Author: Sanjay Dhamija
Financial Shenanigans Techniques
• Revenue recognition
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• Backdating of transactions
• Keeping book of accounts for an extended period of time
• Fictitious revenue
• Recording revenue by falsifying accounting records.
Financial Accounting for Managers Author: Sanjay Dhamija
Financial Shenanigans Techniques
• Treating operating expenses as capital expenditure
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• Instead of debiting profit and loss a/c as OPEX, the same is
treated as CAPEX and added to assets.
Financial Accounting for Managers Author: Sanjay Dhamija
Financial Shenanigans Techniques
• Under provisioning of expenses, losses or liabilities
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• Under providing depreciation by choice of method and rate
of depreciation
• Not making provision for doubtful debts
• Non-provisioning of warranty costs
• Non-provisioning of employee’s cost
Financial Accounting for Managers Author: Sanjay Dhamija
Financial Shenanigans Techniques
• Cookie Jar Accounting
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• Making excess provisions in `good’ accounting period and
using the same in `bad’ periods for income smoothening
• Big Bath Accounting
• Making one time write-offs of assets especially in view of
expected poor results
Financial Accounting for Managers Author: Sanjay Dhamija
Financial Shenanigans Techniques
• Direct write-off from reserves
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• Writing off certain expenses and losses directly from
reserves rather than debiting to profit and loss a/c.
• Deferred tax assets
• Recording deferred tax assets without assessing the
possibility of reversal.
• Change in accounting policies
• To boost profits.
Financial Accounting for Managers Author: Sanjay Dhamija
Financial Shenanigans Techniques
• Improper classification
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• To hide the real nature of incomes, expenses, assets or
liabilities.
• Linked transactions
• Clubbing transactions to create a false impression.
• Related party transactions
• Entering transactions with related parties at unrealistic
consideration.
Financial Accounting for Managers Author: Sanjay Dhamija
Regulatory Reactions
• Auditors independence
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• Auditors not to provide any other service to the same
company
• CEO/ CFO responsibility
• Certificate in the annual report
• Enhanced financial disclosure
• Increased financial penalties
Financial Accounting for Managers Author: Sanjay Dhamija
How to Detect Financial Shenanigans?
• Governance structure
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• Presence of qualified independent directors
•
• Accounting policies
• Aggressive
• Change in accounting policies
• Without any economic justification
Financial Accounting for Managers Author: Sanjay Dhamija
How to Detect Financial Shenanigans?
• Auditors’ report
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• Qualifications / Observations
• Notes to accounts
• Often used to hide damaging information
• Ratio analysis
• Look for abnormal trends compared to earlier years / peer
group
• Related party disclosure
• Quantum and economic justification
Financial Accounting for Managers Author: Sanjay Dhamija
How to Detect Financial Shenanigans?
• Cash flow statement
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• More objective
• Contingent liabilities
• Hiding real liabilities as contingent
Financial Accounting for Managers Author: Sanjay Dhamija
Prevention of Financial Shenanigans
• High standards of moral value, honesty and ethics
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• Set realistic targets—both internal and external
• Strong internal control environment
• Regular reconciliation and confirmation of outstanding
balances
Financial Accounting for Managers Author: Sanjay Dhamija
Prevention of Financial Shenanigans
• Environment of openness and transparency
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• Strong governance structure
• Proper corporate communication
Financial Accounting for Managers Author: Sanjay Dhamija
