Saturday, May 7, 2016

Top 8 Ways Companies Cook The Books



Courtesy : Investopedia


Every company maneuvers the numbers to a certain extent to achieve budgets and get bonuses. This is nothing new. But sometimes companies take the fact-fudging too far. Factors such as greed, desperation, immorality and bad judgment drive some executives to corporate fraud.
Enron, Aldelphia and WorldCom are extreme examples of companies who cooked the books. They are the few bad apples that get all the headlines. Most companies are run by ethical people. They may bend the rules, but few take the process to the extremes of Enron or WorldCom - companies that claimed billions in assets but promptly went bankrupt when their false claims were exposed. If every company used fraudulent accounting, Wall Street would be empty and we'd all be investing in government bonds. 


What can you do to protect your investments from Enron-style disasters? You need to learn the basic warning signs of earnings manipulation. While the details are usually hidden - even from the accountants - learning these money-manipulation methods will keep you alert to companies who may be cooking the books:

1. Accelerating Revenues

One way to accelerate revenue is booking lump-sum payment as current sales when services will be provided over a number of years. For example, a software service provider receives upfront payment for a four-year service contract but records the full payment as sales of only the period that the payment is received. The correct, more accurate, way is to amortize the revenue over the life of the service contract. (A recent change in accounting standards lead to a revenue boost for many companies that were required to defer revenue over several years. 


A second revenue-acceleration tactic is called "channel stuffing." Here, a manufacturer makes a large shipment to a distributor at the end of a quarter and records the shipment as sales; however, the distributor has the right to return any unsold merchandise. Because the goods can be returned and are not guaranteed as a sale, the manufacturer should keep the products classified as a type of inventory until the distributor has sold the product.

2. Delaying Expenses
 
AOL got in trouble for this in the early 1990s when it capitalized the costs of making and distributing its CDs. AOL viewed this marketing campaign as a long-term investment and capitalized the expense. This transferred the costs from the income statement to the balance sheet where it was going to be expensed over a period of years. The more conservative (and appropriate) treatment is to expense the cost in the period the CDs were shipped. (The balance sheet is an important tool for gaining insight into a company's operations.


3. Accelerating Expenses Preceding an Acquisition


This may sound a little counter intuitive, but before a merger is completed, the company that is being acquired will pay, possibly prepay, as many expenses as possible. Then, after the merger, the EPS growth rate of the combined entity will be easily boosted when compared to past quarters. Furthermore, the company will have already booked the expense in the previous period.


4. "Non-Recurring" Expenses


By accounting for extraordinary events, these one-time charges were meant to help us better analyze ongoing operating results. It seems, however, that some companies take one of these each year. Then a few quarters later, they "discover" they reserved too much and are able to put something back into income (see next tactic).


5. Other Income or Expense


This category can house a multitude of sins. Here companies book any "excess" reserves from prior charges (non-recurring or otherwise). This is also the place where companies can hide other expenses by netting them against other newfound income. Sources of other income include selling equipment or investments.


6. Pension Plans


If a company has a defined benefit plan, it can use some special techniques to smooth earnings. During a bull market, the company can improve earnings by reducing its pension expense. If the investments in the plan grow faster than the company's assumptions, the company could record this gain as revenue. During the late 1990s, this was done by a number of large firms, some of them blue chips.


7. 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 that 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.


8. Synthetic Leases


A synthetic lease can be used to keep the cost of new building from appearing on a company's balance sheet. The lease is a long-term (five- to 10-year) agreement under which a company will pay a fixed lease expense to be in a new headquarters. At the end of the lease, the company is obligated to buy the building, but because of the nature of the lease, this liability is not included on the balance sheet. (Who said accountants were boring and uncreative?) At the time the lease was made, the company may have been in fine financial shape and the economy may have been booming; however, the ability of the company to meet this huge obligation is hard to determine until shortly before maturity (one to two years). 


The Bottom Line

If you tune into the items hidden in a company's financial statements, you may be able to spot some of the warning signs that point to earnings manipulation. This doesn't mean that the company is definitely cooking the books, but if a company makes you suspicious, that's a sure sign that you should dig deeper before making an investment.

138 comments :

  1. Your views on recent developments regarding IDFC ?? Thank you

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    Replies
    1. What is the new development happened in it ?

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    2. There could be a reverse merger

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  2. Hello VP sir
    What are your views on DHP India and Nath bio-genes?

    ReplyDelete
    Replies
    1. DHP is an already suggested stock @Rs.41 and requested to exit at higher level.as of now not tracking.

      Delete
  3. Thanks sir for this valuable post .... Please your view upon istreet network and Deccan cement

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  4. Sir, really you to find some way to communicate to your followers on your findings of the best company . A very good book sitting in the library of no use, not saying you should break the rule, but there is will there is a way.

    ReplyDelete
    Replies
    1. That 'Some' is the difficult question.

      Delete
  5. Dear VP, Claris life science seem to be a good proposition at the CMP. I did read few of your old posts about this. Do you recommend to invest or stay out because of management ?

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    Replies
    1. Since they start to divest assets one buy One, I am not tracking Claris.

      Delete
    2. Thank you.

      Delete
  6. what is ur opinion about Lovable lingery, selan oil exploration, anant raj

    ReplyDelete
    Replies
    1. Tracking only Selan , not bad nut may test patience.

      Delete
  7. Hi Sir your view on one of your old recommendation Nitta gelatine as it came up with great result again this quarter and also on India gelatine..can one add at cmp

    ReplyDelete
  8. I like to know ur opinion about Crompton greaves @Rs 50 level

    anil

    ReplyDelete
    Replies
    1. More interested in their consumer business portion.

      Delete
  9. Dear VP sir, pls share your views on rupa & company after French connection authorization.

    ReplyDelete
  10. thanks for taking time and helping us...appreciate it.

    ReplyDelete
  11. Sir, can I buy granules India? I know its your old recommendation but I'm just starting to invest.
    Please advise.

    ReplyDelete
    Replies
    1. Granules suggested around Rs.70 before stock split.It already turned as a 20 bagger , not suggesting at CMP

      Delete
  12. Good informative post. Seeking your view on surana solar for long term.

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    Replies
    1. Dear VP sir,

      Belated Happy B'day to you.

      could you please advise on SKM and Pioneeer Emb for fresh entry.

      I am holding Donear from 19 Level, Should I book there and get in Pioneer emb?

      could you please also if any other good stock for investment in near term growth?

      Waiting for your advise.

      Delete
  13. Please guide me about assoc alcohal

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  14. Sir, saw a good article on shaily engg plastics..
    would like to know if u have any views on the points raised in article especially ..the lack of pricing power and concentration risk..

    http://www.moneylife.in/article/shaily-engineering-plastics-leap-of-faith/46849.html

    ReplyDelete
  15. Hai VP sir kindly post ur views on talbros automotive. Thanks.

    ReplyDelete
  16. Pls share your thoughts on indo tech trans

    ReplyDelete
    Replies
    1. Positive on sector , tracking only IMP Powers from this sector.

      Delete
  17. Sir,
    Your views on Lakhsmi Energy results.??

    ReplyDelete
    Replies
    1. Expecting worst is over for the co.

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    2. Corporate video - Lakshmi Energy & Foods

      https://www.youtube.com/watch?v=Q-0pj_JunwQ

      Delete
  18. sir your view on Lincoln Pharma for long term investment

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    Replies
    1. Not positive about their corporate governance standards.

      Delete
  19. sir in new filling with bse mic is alloting fresh equity to his promoters @ rs 3 only is it gud for minority shareholders or company playing with small shareholders please guide us

    ReplyDelete
    Replies
    1. They are converting the warrants they took when the share prices are just Rs.3 . We all had opportunities to buy shares at Rs.3 at that time.

      Delete
  20. Dear Sir, Panacea Biotec, what is the current opinion?

    ReplyDelete
    Replies
    1. Not performed as per my expectation.

      Delete
  21. Dear VP Sir,

    Can you please advise on Gateway Distriparks Ltd.

    ReplyDelete
  22. Hi VP Sir,
    Nice to see you active in the comments sections .
    Please share your view on Technvision Ventures Ltd and Saksoft Ltd

    ReplyDelete
    Replies
    1. Not tracking TechNVision .

      Saksoft suggested @ Rs.82 ,not suggesting at CMP

      Delete
  23. Wishing you a very happy birthday sir.

    ReplyDelete
  24. Happy Birthday VP Sir , may god bless you always!

    ReplyDelete
  25. Wish you a very happy birthday my dear valuepick sir
    Regards
    Senthil

    ReplyDelete
  26. Many many happy returns of the day sir..

    Regards,
    chetan

    ReplyDelete
  27. Wish you a very happy birthday sir.

    ReplyDelete
  28. Wish you many more happy returns of the day sir.

    ReplyDelete
  29. Dear VP sir I am holding 7000 fcel@22. Is it a value holding or shift to some other stock? Plz guide me. Thanks.

    ReplyDelete
  30. Many more happy returns of the day sir

    ReplyDelete
  31. Many Many Happy returns of the day VP ji. May you thrive and continue to be our leading light in the ocean of darkness !

    ReplyDelete
  32. Happy birthday sir!!may you have a wonderful year ahead!

    ReplyDelete
  33. Many many happy returns of your Birthday sir.
    जीवेत शरद: शतम।

    ReplyDelete
  34. many more returns of the day VP ji

    ReplyDelete
  35. Thanks to all for your wishes

    ReplyDelete
  36. Sir

    Happy Birthday

    Does SEBI restrict one from expressing and sharing view on a company which doesn't purport to be a recommendation. So many analysts are doing through media and social media
    Please share your views if not through blog either through Twitter or FaceBook or some financial sites like moneylife.in

    ReplyDelete
    Replies
    1. That so many analysts may have support of strong institutions with enough influence and connections to deal with the situation if something go wrong , as an individual and one among you I lack the same.

      Delete
  37. Happy birthday sir. Have a wonderful year ahead.

    ReplyDelete
  38. This comment has been removed by the author.

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  39. Many many Happy returns of the day VP sir.. God bless you with great health n happiness..

    ReplyDelete
  40. Happy birthday sir!! May god bless you forever!

    ReplyDelete
  41. Hellow VP Sir, Happy birthday

    ReplyDelete
  42. Happy birthday sir. God bless you with the best

    ReplyDelete
  43. Respected Sir,

    Wish you a "Very Happy Birthday"

    ReplyDelete
  44. Many Happy Returns of the Day:)

    ReplyDelete
  45. Wish You many returns of the Day!!

    ReplyDelete
  46. hoping my query gets answered this time. Is International Travel House still a hold given its not so good quarterly results twice in a row.

    ReplyDelete
    Replies
    1. It is a value buy and hold , but the issue is its business is not growing , that is why it range bound for long time.

      Delete
  47. Many more happy returns of the day VP sir
    U Sundar

    ReplyDelete
  48. Happy Birthday VPji! Have a bullish, profitable and healthy years ahead.

    Need your thoughts on Store one owned by parents India bulls Wholesale, under UC this week. Hope you are tracking this script.

    ReplyDelete
    Replies
    1. Thanks for wishes

      Not tracking any company from Indiabulls group.

      Delete
  49. Sir do u feel we should book losses in skm or pateintly hold on ?? I know u dont want us to buy more...

    ReplyDelete
    Replies
    1. I don't know why my readers are still asking this question despite several attempts to convey what I mean in case of SKM !!

      Delete
    2. Sorry sir... I did not understand u advised to get out of SKM. I thought we should wait till results. Will do accordingly

      Delete
  50. Hi VP,
    Hope you had wonderful day on your birth day!
    Wish You Many Many Happy Returns Of The Day!
    Warm Regards, Veera Brahmam
    "What you are is God's gift to you. What you make of yourself is your gift to God"

    ReplyDelete
  51. Belated wishes VP ji. Many more happy returns. Wishing you a healthy and happy life

    ReplyDelete
  52. Sir, any comments on Jaypee Infratech?

    ReplyDelete
  53. Sir, What's your opinion on Vinati Organics Ltd ?

    ReplyDelete
  54. Happy Belated Birthday Sir! Wish you health, wealth and all-round success!

    ReplyDelete
  55. Respected vp sir
    What is your views in sanghi industry?

    ReplyDelete
    Replies
    1. Company is OK , sector revival is important.

      Delete
  56. Sir, Can We accumulate SKM egg at CMP ? holding at 193 now

    ReplyDelete
  57. many more happy returns of the day sir...

    ReplyDelete
  58. Hi Sir,

    Wat is your view on old reco Talwakars Fitness?

    ReplyDelete
    Replies
    1. Neutral on Talwalkar.They are planning some big fun raising and their plans yet to disclose.

      Delete
  59. Belated happy birthday sir

    ReplyDelete
  60. Sir any views on Swelect Energy Systems Limited considering the upcoming thrust on Solar Energy sector ?

    Thanks

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    Replies
    1. Only the thrust on solar energy will not bring profit to Indian companies , the policy should be changed in order to help Indian manufacturers otherwise it will benefit mainly Chinese companies.

      Delete
    2. Sir, i agree with you....considering the current policies and changes in favor of indian companies, would be able to provide your views on Swelect ?

      Thanks,
      Ramesh

      Delete
  61. Wish you a very happy birthday sir

    ReplyDelete
  62. Dear Sir

    wish u a very happy belated Birthday. i pray to god that you stay well, strong & good human being.

    as a turnaround case can e-waste management company(cerebra ) makes a good sense for long term investment. ??

    sir if not tracking please tell your views on this.

    ReplyDelete
  63. Dear Sir, your comments on pioneer embroidery after result. In the result there is substantial portion of extraordinary loss due to doubtful trade receivable. Sir this is usual thing or some red flag because they are not able to collect money. Please reply sir.

    ReplyDelete
    Replies
    1. Seems they are cleaning their balance sheet ,no meaning in keeping it there if they believe it is difficult to recover.

      Delete
    2. Dear VP,

      I think Pioneer investors would like to know your valuable opinion if you are POSITIVE on the results and whether we can HOLD for Long term. Kindly advice.

      - On behalf of all PEM investors. Darshan S.

      Delete
    3. Dear VP, gentle reminder. Have a wonderful day.

      Delete
  64. Happy birthday Dear VP sir...let me know your view of IOL CHEMICALS AND PHARMA...it has good product portflio and biggest ibuprofen manufacturer.it looks good for long term. yr views are importnat

    ReplyDelete
    Replies
    1. Recently company expanded the capacity of its manufacturing facilities . It is a potential turn around candidate.

      Delete
    2. Sir,
      kindly give the link about its expansion i tried but not found the announcement of expansion....thanks

      Delete
  65. Dear VP Sir,

    Plz share your valuable views on Meghmani Organics at current market price.

    ReplyDelete
  66. Sir, whats your opinion on
    1.Ramkrishna Forgings Ltd
    2.Sanghvi Movers Ltd
    3.Raunaq EPC International

    ReplyDelete
    Replies
    1. Sorry not tracking above mentioned stocks.

      Delete
  67. Sir pls share your view on Zicom sercurities.Stock has fallen from 180 level to just Rs60.

    ReplyDelete
    Replies
    1. Sizable business in middle east countries which may get affected due to fall in crude oil prices where the economy of these companies are closely linked with it.

      Delete
  68. Value pick sir wish you many many happy returns of the day i am tracking stock market since o years i have never seen an ethical blogger like you sir i wish i cud meet you some day just to take your blessing

    Thanks
    Dialwealth

    ReplyDelete
  69. Sir thanks for the wonderful post. I have small doubt. In small cap companies, receivable days and inventory days vary a lot and we all know how much disclosures those companies give. In those case is it better to avoid them even if they are posing 20-25% growth consistently?
    Your experience will be the key to the answer I think.
    Belated Happy Birthday :)

    ReplyDelete
    Replies
    1. Difficult to generalise,depends on the nature of business.

      Delete
  70. VPJI-can u look omnitex industries?

    ReplyDelete
  71. Happy Birthday Sir. Thanks for all your inputs in the blog. It is very great site for investor education.

    ReplyDelete
  72. Hello VP Sir,
    Could you please give your views on Career Point.
    I invested in career point 1.5 years ago, thinking its turning around and there were some articles which mentioned that it would get back to there peak level of students within 2 years, since exam format has changed back to old one.
    But every quarter there is some wipe off of the non performing division, last quarter they closed some loss making divisions, this quarter automobile venture.
    They have opened schools, university and also kids play school recently.
    Venturing into NSDC program is recent move and some rajasthan govt training programs. 6 months ago they also planned to open financing for educations.
    Financing is not there expertise but others are related ones.

    ReplyDelete
    Replies
    1. Generally speaking there is lot of opportunities in education sector , but reality proves this sector is equally challenging .

      Delete
  73. Belated Happy Birthday Wishes Sir!!! May god shower his blessing for your longer healthier and wealthier life.

    thanks
    Siva

    ReplyDelete
  74. https://m.youtube.com/watch?v=-Idk7n_XAE0
    Please watch this video by chairman of mic electronics

    ReplyDelete
  75. Thanks to everyone for the birthday wishes.

    ReplyDelete
  76. Dear VP Sir
    Belated wish u Happy Birthday sir !!!
    What is your view on Bank of India at CMP ?
    Can we buy some qty. for 4-5 yrs. view.
    Your opinion is valuable for us. Plz. reply.
    Regards
    Dinesh

    ReplyDelete
  77. Sir Allsec is performing really good. thank you very much
    i am sure there is more to come, should we book partial profits?

    ReplyDelete
  78. Sir, is sugar sector boom genuine?
    any favorites in the sector?

    ReplyDelete
  79. Hi sir, need ur view on Action construction equipment, saregama

    ReplyDelete

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