A former SEC chairman called the problem a "numbers game" and stepped up enforcement actions the Commission had taken against accounting practices it deemed improper. As an example of the SEC's newfound diligence, the agency took action against 68 individuals at 15 different companies over the course of a month. It examines the SEC's role in enforcing the securities laws and identifies the specific statutes used to prosecute those it believes have gone beyond the flexibility inherent in GAAP.
It provides the results of a survey of key financial professionals, including equity analysts, lenders and chief financial officers, among others, on their views on the appropriateness of many financial reporting practices and on the steps they use to implement creative accounting practices. to trace . The results of the survey are not always predictable and show disagreement not only between the groups, but also within the groups about which practices are appropriate and within GAAP limits, which ones go beyond them, and which ones actually constitute fraud. As we go to press, the details of the accounting and reporting deficiencies at Enron Corp.
Due to our publication deadline, we were unable to incorporate a full account of the events that took place at the company.
CHAPTER ONE
Financial Numbers Game
However, many creative and fictitious accounting practices played a role in the company's supposed bright future that boosted the company's prospects. However, when knowledge of the arrangements made with the non-profit organizations became widely known, the company's stock price dropped rather suddenly to about $20 per share. With such plans, employees receive stock or the right to acquire stock, or cash, tied to the company's stock price.
In 1991, the company's plan called for a bonus to be paid to certain key company executives if net revenues exceeded $16 million. Whether it was the bonus plan that encouraged questionable behavior by the company's management is not clear. An examination of the company's accounting policies reveals examples where it has adopted a very conservative stance.
Instead, such unearned income is reported as a current liability on the company's balance sheet.
CHAPTER TWO
How the Game Is Played
Rather, in the company's view, this method of calculation gives a fairer picture of its financial results. Also included in the company's restructuring costs were reserves or liabilities for future environmental and litigation costs. Over the past 12 months, we have set new records in almost every facet of the company's operations.
The diverse nature of the company's product and service mix certainly provides a diversification effect that yields a more stable earnings stream. The ultimate goal of the procedure was to align the company's earnings with previously set targets.39. Although not presented in the company's display of its acquisitions, purchased in-process research and development accounted for an average of 63% of the total acquisition prices paid by the company during fiscal 1999.
The company originally planned to allocate between $6 billion and $7 billion of the purchase price to ongoing research and development activities.
CHAPTER THREE
Earnings Management
A Closer Look
However, there is a reference to abusive earnings management in the third definition in the appendix. Note that only in the case of items 8 and 9 is an earnings management technique identified. Many examples of earnings management abuse are cited in the SEC's Accounting and Auditing Enforcement Statements (AAER).
Some of the items in Exhibit 3.5 represent very dramatic shifts from aggressive to abusive earnings management. The increasing stream of SEC enforcement actions provides some concrete evidence of the existence of earnings management. The effectiveness of earnings management depends on the combination of earnings management techniques used, motivational conditions and incentives.
The assessment of the merits of earnings management depends on the nature of the steps taken to manage earnings and the objective of the earnings management. Those shareholders who sell their shares before the discovery of earnings management can benefit from the practice.
CHAPTER FOUR
The SEC Responds
In Item 8 of the SEC's Action Plan, the Chairman announced the formation of a blue ribbon panel sponsored by the New York Stock Exchange and the National Association of Securities Dealers. The SEC's Division of Enforcement is responsible for investigating potential violations of the Securities Acts. Administrative Procedures and Litigation Disclaimers published by the SEC include all violations of the Securities Acts, whether accounting-related or not.
The purpose of these rules is to clarify and sharpen the accounting and reporting requirements of the Securities Act. Financial reports are considered fraudulent when they violate the anti-fraud provisions of the Securities Acts. To demonstrate how the SEC applies the aforementioned sections and rules of the 1934 Act, specific details of three enforcement actions are provided.
The SEC maintained that the manner in which these transactions were recorded violated § 13(a), the periodic reporting provision, § 13(b)(2)(A), the books and records provision, and § 13( b )(2)(B), the internal control provision of the 1934 Act. The SEC also alleged that FastComm and DesLaurier violated Section 10(b), an anti-fraud provision of the Act of 1934. Accounting matters that depend on judgment and, in the SEC's opinion, move beyond.
However, when fraud is detected, the SEC does not hesitate to include alleged violations of anti-fraud provisions of the Securities Act in its complaints. The SEC has a wide range of penalties available to punish violations of the securities laws. However, it is important to note that SEC fines are not necessarily the end of the matter.
Concerned about the integrity of the financial reporting system in the United States, the SEC has launched a direct attack on what it considers to be the causes of questionable reporting. Anti-Fraud Provisions Specific sections and rules of the 1933 Act and the 1934 Act designed to reduce fraud and deception in financial filings with the SEC.
CHAPTER FIVE
Financial Professionals Speak Out
Shipments close to year-end are delayed in order to provide an increase in sales for the first quarter of the next year
This is another real action, and the average score of 1.73 matches the rankings of the other real actions. However, the delay in shipments could be seen as an underestimation of the current year's performance and possibly an overestimation of the next year's performance. Although this may not be the intention, this could be misleading even if it does not violate GAAP.
Investments are sold to recognize a gain in order to offset a special charge aris- ing from an asset write-down
The average ranking of 3.82 was the most severe ranking for all 20 earnings management actions. Survey respondents provided a total of 227 examples of earnings management techniques they had observed. To the extent that meeting or exceeding expectations reduces volatility.—ACPA The common goal of earnings management is to support or increase stock prices.
Behavior is predictable.—FA The common goal of earnings management is to achieve consensus earnings forecasts. No, mild earnings management intended to reduce earnings volatility might be beneficial, but not otherwise.—ACPA. The SEC's Fair Disclosure Regulation will increase earnings management to meet consensus earnings forecasts.
We also asked respondents to indicate how earnings management practices could be detected. However, it is important to note that none of the detection techniques provided by respondents in the survey or presented elsewhere in the book provide compelling evidence of earnings management. High probability conditions represent conditions that are often associated with the presence of earnings management.
Similarly, a divergence of cash flow and accrual ratios can be a sign of earnings management activity. Earnings Management is Terrible for Investors - The CFO's Earnings Management, to the extent that it distorts the true picture of the company's operations, is harmful to investors. To the extent that it is not transparent, earnings management can support artificially high stock prices - ACPA.
Earnings management hurts investors because the company will eventually get caught and the stock will be punished - CFO. Some definitions of earnings management may include useful activities, such as risk management through the use of derivatives—ACPA.
CHAPTER SIX
Recognizing Premature or Fictitious Revenue
The shipped units were later returned to the company and the revenue was reversed.8 The revenue should not have been recognized in the first place. To facilitate increased, albeit fictitious, sales of the company's medical equipment, commercial warehouses were leased and unsold goods shipped there. While the procuring company's representative has verbally agreed to the terms of the contract, it may not have signed the agreement until it has been approved by the company's legal department.
These estimated cancellations were properly excluded from income and reported as part of the company's membership cancellation reserve, a liability account. To a reader of the company's annual report, the sale looked like an even transaction. For example, significant amounts of the company's revenue were for sales to about 30 start-up companies located in Singapore and Belgium.
Upon receipt of a valid order, the company traditionally recognized revenue at the time of shipment. The company recognized revenue at the time of shipment from its warehouse to its field representative. In the SEC's view, the company earned its revenue from these contracts over time.
The company's share price fell 62% after the accounting change was announced and had not recovered at the time of writing. Membership fee revenue represents the annual membership fees paid by substantially all of the company's members. The company claims that it meets all requirements for recognizing revenue and costs of goods sold in the transactions it arranges.
However, the company misrepresented its progress towards completion and overstated the amount of revenue recognized.63. Note the significant buildup in accounts receivable as the company became more aggressive in its revenue recognition policy.
