Journal of Forensic & Investigative Accounting Vol. 2, Issue 2
Bankruptcy and Fraud Analysis: Shorting and Selling Stocks
Hugh Grove Tom Cook Eric Streeper Greg Throckmorton*
To auditors, investors, fund managers, short sellers, and other external users, fraud and bankruptcy models may serve as important tools in analyzing the financial information presented by companies. Along with the earnings management ratios, quality of earnings and quality of revenue (Schilit 2003), more elaborate models and metrics (Altman 1968 and 2005, Dechow, Sloan and Sweeney 1996, Sloan 1996, Beneish 1999, and Dechow, Ge, Larson, and Sloan 2007, and Robinson 2007) may serve as a veritable arsenal of techniques for detecting financial problems
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Similar to the quality of earnings ratio, the red flag benchmark is a ratio of less than 1.0 (Schilit 2003). For example, Enron’s quality of revenues went down from 0.98 to 0.92 in its last year of operation. Since manipulation of revenue recognition is a common method for covering up poor results, this simple metric can help uncover schemes used to inflate revenues without the corresponding cash collection. Common methods include extending
increased credit terms to spur revenues but with slow collections, shifting future revenues into the current period, or booking asset sales or swaps as revenue. 3. Sloan Accrual Measure The Sloan accrual measure (1996 and updated as discussed by Robinson 2007) is based on the analysis of accrual components of earnings. It is calculated as follows: net income less free cash flows (operating cash flow minus capital expenditures) divided by average total assets. The red flag benchmark is a ratio of more than 0.10. For example, Sloan calculated that JetBlue had a ratio of 0.50 and his employer, Barclays Global Investors, shorted the stock and made over 12% in less than one year. This ratio is used to help determine the quality of a company’s earnings based on the amount of accruals included in income. If a large portion of a company’s earnings are based more on accruals, rather than operating and free cash flows, then, it is likely to have a negative impact on future stock price since the income is not coming from the company’s
Professional auditing standards discuss the three key “conditions” that are typically present when a financial fraud occurs and identify a lengthy list of “fraud risk factors.”
In accounting there is much to be learned, about the financial aspects of a business. In the past five weeks I have learned the importance of financial reports and how they relate to the success of an establishment. These reports may include balance sheets and income statements, which help accountants and the public grasp the overall financial condition of a company. The information in these reports is really significant to, managers, owners, employees, and investors. Managers of a business can take and deduce financial
Fraudulent financial reporting is one form of corporate corruption and may involve the manipulation of the documents used to record accounting transactions, the misrepresentation of accounting events or transactions, or the intentional misapplication of Generally Accepted Accounting Principles (GAAP) (Crumbley, Heitger, and Smith, 2013). Examples of fraudulent schemes befitting of this category abound and usually involve financial statement items that have been misclassified, omitted, overstated, undervalued, or prematurely recognized. One case involving CEO Bill Smith of Moonstay
Boyle, D., Boyle, J and Carpenter (2014) research titled “The SEC’s Renewed Focus on Accounting Fraud” about the SEC initiative on accounting fraud detection and misleading disclosure by implementing the Accounting Quality Model (AQM) using the Extensible Business Reporting Language (XBRL) (p.68). Boyle et al. mentioned Craig M Lewis, director and chief economist of the SECs Division of Economic and Risk Analysis, described AQM as a highly technical robust tool on detecting fraud and other accounting anomalies, while others called it “Robocop” as the use of XBRL tags is capable of computerized analysis and enhanced access to financial data by the stakeholders, the public and the SEC staff (pp.68-69). Boyle et al. cited that Robocop is a computerized system which takes the firm’s same day financial filings, processed it and keeps it in the database and enable open access of the financial data within 24 hours after being posted on the Electronic Data-Gathering, Analysis, and Retrieval (EDGAR) System. Boyle et al. summarized that accounting fraud and improper disclosures are evident in SEC’s renewed focus on its resources through the technology-based tool AQM as key component, while the SEC Financial Reporting and Audit Task Force initiatives focus on exploring and identifying areas vulnerable to fraudulent activities by increased emphasis on financial reporting fraud detection and disclosure irregularities (p.69). Boyle et al. mentioned David Woodcock, chair of the SEC Task
When analysts question a firm’s earnings quality, it raises concerns regarding under or over aggressive accounting practices that may be allowing the firm to manipulate the earnings. Earnings quality is defined as the strength of the current earnings in being used to predict future earnings and cash flows. Since earning quality is indicative of future performance, analysts are more likely to address issues that have substantial impact on the earnings quality. An issue arises when the nature of the earnings is questioned. While permanent earnings are part of normal operations, any irregular, one time earnings can skew the earnings, making the firm look more profitable than it is. This is due to the inability to recreate similar one-time transactions that will give rise to such numbers. Investors prefer predictable
In this case, there are several conspirators who is involved in the fraud receiving punishment from either SEC or federal government. Robert Levin, the AMRE executive and major stockholder, and Dennie D.Brown, the company’s chief accounting officer, were subject to the punishment in the form of a huge amount of fine by the SEC and the federal government. This punishment came from reasons. After AMRE going public, the company have the obligation to publish its financial reports but its performance did not meet expectation. The investigation by SEC shows that Robert took the first step of this scam, fearing the sharp drop of AMRE’s stock price because of the poor performance of company. He abetted Brown, to practice three main schemes to present a false appearance of profitable and pleasant financial reports. Firstly, they instructed Walter W.Richardson, the company’s vice president of data processing, to enter fictitious unset leads in the lead bank and they originally deferred the advertising cost mutiplying “cost per lead” and “unset leads” amount, so that they deferred a portion of its advertising costs in an asset account. The capitalizing of advertising expenses allowed them to inflate the net income for the first quarter of fiscal 1988. Secondly, at the end of the third and fourth quarters of fiscal 1988, they added fictitious inventory to AMRE’s ending inventory records, and prepared bogus inventory count sheets for the auditors. Thirdly, they overstated the percentage
The auditing firm has been in engagement with the company throughout the period when the fraud was being committed. One of the common and clear indicators of possible fraud was the company’s cash flow statement. The company experienced positive growth in its profits from the year 1996 through to the year 1998. However, a close analysis of the cash flow statement shows that the company had experienced negative figures of cash flow from both operating and investing activities and positive cash flow from financing activities which would not sufficiently offset the negative cash flows from operating and investing. It is therefore evident
Following the risk assessment procedures, substantive procedures are designed and conducted to detect material misstatements of relevant assertions. Substantive procedures include analytical procedures and tests of details. Analytical procedures involve evaluations of financial statement information by a study of relationships among financial and nonfinancial data. Tests of details may be divided into three types. One test is the test of account balances to address whether there are misstatements in the ending balance of an account. In the case of Crazy Eddie, auditors should have put greater attention to inventory and accounts payable accounts. The second test is a test of classes of transactions to determine whether particular types of transactions have been properly accounted for during the period. Crazy Eddies fraudulently classified these transshipping transactions as retail sales to inflate its sales revenue and continue growth at existing stores. A key ratio for retailers is to compare growth in existing stores to growth from new stores. The third and final test is a test of disclosures to evaluate whether financial statement disclosures are properly presented. Crazy Eddie prepared bogus debit memos of over $20 million to understate accounts payable.
Fraudulent, erroneous, and illegal acts committed by a public company, usually at a managerial or executive level, have been a very serious problem for many years and have prompted development of strict and updated regulations, such as the Sarbanes-Oxley Act, in an attempt to prevent these occurrences. Unfortunately, these new or updated regulations are not enough to prevent these acts from happening, thus not alleviating the auditors of their responsibility to detect fraud. Some methods that management and auditors can employ to prevent and detect fraud, errors, and illegal acts are: improving knowledge, improving skills,
Balance sheets and income statements are a snapshot of a company’s stability and financial situation. Combined the statements show the income, expenses, and stockholder’s equity in the company. These statements are often analyzed by financial institutions when a company comes to them needing a loan. Stockholders and other investors also look at these statements to make sure their investment will return a profit for them. This paper will look at four different companies and their balance sheets and income statements. The companies are Eastman Chemical Company, Covenant Transportation
This research paper will explore the fraud at Tyco and focus primarily on accounting and auditing issues related to the fraud. One thing worth noting about this case is that fraudulent financial reporting was not at the core of the fraud, which was the case with majority other big frauds at the time, such as Enron and Waste Management. On the contrary, fraud consisted of misappropriation of assets, and fraudulent financial reporting came as a consequence of trying to hide misappropriation of assets and the use of corporate money for personal benefit.
A number of financial statement frauds went undetected from auditors in past and attracted a high profile attention. The businessmen add fake assets or transfer the assets of companies to their personal assets and result in accounting scandals when the affected companies are bankrupted or are even close of bankruptcy. Just to mention a few names, accounting scandals of Enron, AOL Time Warner and Xerox are among the hottest accounting scandals of the century. This means that despite presence of professional auditors accounting scandals happen and there is a need to learn from the mistakes of the auditors who overlooked these activities. In this report the case study of Xerox is analyzed in detail to highlight violations of accounting principles and present an example from which lessons can be learnt for the future.
Financial statement fraud is usually a means to an end rather than an end in itself. When people "cook the books" they may doing it to "buy more time" to quietly fix business problems that prevent their entities from achieving its expected earnings or complying with loan covenants (Fraud Magazine, 2014. It may also be done to obtain or renew financing that would not be granted or would be smaller if honest financial statements were provided. People intent on profiting from crime may commit financial statement fraud to obtain loans they can then siphon off for personal gain or to inflate the price of the company 's shares, allowing them to sell their holdings or exercise stock options at a profit (Fraud Magazine, 2014). However, in many past cases of financial statement fraud, the perpetrators have gained little or nothing personally in financial terms. Instead the focus appears to have been preserving their status as leaders of the entity - a status that might have been lost
Accounting anomalies result from unusual processes or procedures in the accounting system. Several accounting anomalies are a result of fraudulent transactions. The three common accounting anomaly fraud symptoms involve problems with source documents, faulty journal entries, and inaccuracies in ledgers. In most cases poor accounting records are indications or symptoms of fraud rather than mere errors. With time being spent on fraud scheme it could be difficult to keep a proper accounting record or record transaction properly to cover up the fraud.
Without subjecting these to data analysis, many fallaciousconclusions might be drawn concerning the financial condition of the enterprise. Financialstatement analysis is undertaken by creditors, investors and other financial statement users inorder to determine the credit worthiness and earning potential of an entity.