Cooking the Books: Recipes from around the world!

Cooking the Books in the Outback

When discussing the Enron scandal in class a question was asked: Would a corporate scandal of this scandal still have been hatched had it not been for the ‘smartest guys in the room’? The general opinion was that yes, it would have happened sooner or later. What happened at Enron was not new to the corporate world, what made it ‘special’ was the scale at which this fraud was conducted. 

That night I went home and began searching the Web for other instances in which individuals or organizations had been found guilty of cooking the books. The results surprised me. Not because there were so many of them, but because some of these scandals involved very large organizations – like Enron – and had been involved frauds of similar magnitudes. I even found one that I heard a lot about while growing up in Pakistan – Bank of Credit and Commerce Internationa (BCCI). 

Before looking at all the c(r)ooks in the kitchen, I decided to take a sneak peek at some of the recipes that they had been using. I was able to find a beginner’s guide to these at Investopedia and HowStuffWorks? Presented below are the basics of this particular culinary style and some of the most widely appreciated recipes:

  • Revenue Accelaration – Failure to Ammortize Income: Recording future income in the current period as a lump-sum as opposed to ammortizing (spreading) it over the period when it is being earned. 
  • Revenue Accelaration – Channel Stuffing: Recording shipments to distributers as confirmed sales even though some of the shipped goods may be returned due to defects or inability to sell them. 
  • Delaying Expenses: To treat an expense as a capital item and only charge it as an expense over a longer period. 

  • Pre-Acquisition Expense Accelaration: The company being acquired will prepay expenses and record them in the period preceding the acquisition. This will make post-acquisition profits look much better than pre-acquisition profits. 
  • Non-Recurring Expenses: These miscellaneous expenses are sometimes used by companies as a measure to overstate future profits. This is done by over-reporting these expenses, and later correcting these ‘mistakes’ in less profitable periods. 
  • Other Income or Expenses: This income may stem from corrections made to overstated non-recurring expenses or selling equipment or investments. 

  • Pension Plans: If pension expenses have been ‘allowed for’ (i.e. recorded as an expense allowance) then earnings in following periods can be smoothed by reporting a reduction in the pension expense. 
  • Off-balance Sheet Items: A company can create separate legal entities that can “house” liabilities or incur expenses that the parent company does not want to have on its financial statements. Because the subsidiaries are separate legal entities, which are not wholly owned by the parent, they do not have to be recorded on the parent’s financial statements and are thus hidden from investors. This is what Andy Fastow at Enron had been doing. 
  • Synthetic Leases: This is a very creative way of hiding the cost of buying large assets, e.g. new building for company headquarters etc. Instead of recording the purchase of assets, they are recorded only as expenses incurred from long-term leases, and don’t make an appearance as an asset until the very end of the lease term! 

For those interested in learning about what happened at BCCI – much of which is surprisingly unkown to date – can use the Wikipedia page as a starting point. BCCI was at one point the seventh largest privately owned bank in the world. When it was forced to close, it was accused of many crimes – from money laundering, tax evasion, and bribery to arms trafficking and support of terrorism. Similar to Enron, when discrepancies were found by investigators, lawsuits were filed against Price Waterhouse and Ernst and Young which – the bank’s auditors. A lawsuit was also filed against the Bank of England which was the regulatory body that the BCCI operated under. Last, but not the least, this scandal too had its fishy political connections. One of the American men named as an accomplice, Marc Rich, was never indicted for his alleged part in the scandal, but was found guilty of tax evasion in other cases. Marc fled the country but was granted a controversial pardon by the then President of the United States, Bill Clinton. This is also interesting because the new Attorney General – Eric Holder – aided the pardons received by Marc Rich and other terrorists. Mar Rich had been been No. 2 on the FBI’s Most Wanted list for 17 years, but was pardoned by the President following large donations that he made to the ClintonLibrary Fund. 

 

Sources and Related Links:

  1. Investopedia
  2. HowStuffWorks
  3. The Phrase Finder
  4. Forbes – The Corporate Scandal Sheet
  5. Wikipedia – Accounting Scandals

 

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5 Responses

  1. Wow. Awesome post.

    How can we verify the soundness of investopedia?

  2. My basic ‘sanity check’ for the information in Investopedia was cross-checking with the listed scandals on Wikipedia and Frobes, the latter being the more reliable source. Most of the items listed as popular methods for cooking the books have been reported in the cases that were discussed on Wikipedia and Forbes.

    Also, I have about three years of Accounting behind me and some of these practices have been discussed in the classes that I took in high school and in college.

    One of the biggest differences in the UK GAAP (the system in which most of my study of Accounting took place) and the US GAAP is that the former is principle-based and the latter is rule-based.

    This is a crucial difference because when rules have not been written for some scenarios, it leaves a much bigger room for loop-holes that are not quite ‘illegal’. However if we look at the principles of Accounting it is simple enough to see that with the concepts of prudence and matching costs, many of these tactics for mis-representing information will immediately be deemed bad practice. Both systems have their merits and demerits though.

    The one interesting scandal I wanted to look deeper into was the BCCI closure. This was investigated in both the UK and the US, and therefore would be a good case to look at to compare the accounting practice and regulations in the two countries at the time.

  3. This is frightening. I think it is legitimately absurd that there are so many ways for companies to report their performance. That alone should be a red flag that something about the system is inherently flawed. I understand that when you invest in a company, the responsibility to know what you are putting your money into should be your own. But there’s a fine line between expecting a “well-read” audience (the audience being the investors) and completely manipulating the system in order to capitalize on sheer ignorance. Hopefully scandals like Enron at least encourage investors everywhere to do a little more homework before they pour gobs of money into a corporation that they know little to nothing about.

  4. There will be always ways to “work the system”, and just like in the Enron case, the people that were supposed to say ‘no’ (lawyers and accountants) were closing their eyes to what was happening, so they could keep on receiving their paychecks.
    Unfortunately, scandals like these will always be a part of the financial world because there will be always someone well connected (in this case Clinton) that will make the claims “go away.”

  5. […] of Feb 16-Feb 2… on About UsJordi on Where do I want to work…annabu on Cooking the Books: Recipes fro…zuffola on Rock Bottom: How Enron dug a h…annabu on Where is the […]

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