Magazine Financial Statement Analysis: This process of reviewing the financial statements allows for better economic decision making. Globally, publicly listed companies are required by law to file their financial statements with the relevant authorities. For example, publicly listed firms in America are required to submit their financial statements to the Securities and Exchange Commission SEC.
Share Loading the player Financial statement manipulation is an ongoing problem in corporate America. Although the Securities and Exchange Commission SEC has taken many steps to mitigate this type of corporate malfeasancethe structure of management incentives, the enormous latitude afforded by the Generally Accepted Accounting Principles GAAP and the ever-present conflict of interest between the independent auditor and the corporate client continues to provide the perfect environment for such activity.
Due to these factors, investors who purchase individual stocks or bonds must be aware of the issues, warning signs and the tools that are at their disposal in order to mitigate the adverse implications of these problems.
Factors That Contribute to Financial Statement Manipulation There are three primary reasons why management manipulates financial statements. First, in many cases the compensation of corporate executives is directly tied to the financial performance of the company.
As a result, management has a direct incentive to paint a rosy picture of the company's financial condition in order to meet established performance expectations and bolster their personal compensation. Second, it is relatively easy to manipulate corporate financial statements because the Financial Accounting Standards Board FASBwhich sets the GAAP standards, provides a significant amount of latitude in the accounting provisions that are available to be used by corporate management.
For better or worse, these GAAP standards afford a significant amount of flexibility, making it very easy for corporate management to paint a favorable picture of the financial condition of the company.
Third, it is unlikely that financial manipulation will be detected by investors due to the relationship between the independent auditor and the corporate client. While these entities are touted as independent auditors, the firms have a direct conflict of interest because they are compensated by the very companies that they audit.
As a result, the auditors could be tempted to bend the accounting rules to portray the financial condition of the company in a manner that will keep their client happy. Moreover, auditors typically receive a significant amount of money from the companies that they audit.
Therefore, there is implicit pressure to certify the financial statements of the company in order to retain their business. How Financial Statements Are Manipulated There are two general approaches to manipulating financial statements.
The first approach is to inflate current period earnings on the income statement by artificially inflating revenue and gains, or by deflating current period expenses. This approach makes the financial condition of the company look better than it actually is in order to meet established expectations.
The second approach to financial statement manipulation requires the exact opposite tactic, which is to deflate current period earnings on the income statement by deflating revenue or by inflating current period expenses.
The reason behind this approach may not be as obvious as in the previous example because it may seem counterintuitive to make the financial condition of a company look worse than it actually is. However, there are many reasons to engage in such activity, such as making a company look bad in order to dissuade potential acquirerspulling all of the bad financial information surrounding the company into one period so that the company will look stronger going forward, pulling all of the bad financial information into the current period when the poor performance can be attributed to the current macroeconomic environment or to postpone good financial information to a future period when it is more likely to be recognized.
Read more in A Case Study: Howard Schilit, in his famous book "Financial Shenanigans"there are seven primary ways in which corporate management manipulates the financial statements of a company. Let's look at these seven general categories of financial statement manipulation and the typical accounting processes that facilitate the manipulation.
However, what investors also need to understand is that while most of these techniques pertain to the manipulation of the income statement, there are also many techniques available to manipulate the balance sheet, as well as the statement of cash flows. Moreover, even the semantics of the management discussion and analysis section of the financials can be manipulated by softening the action language used by corporate executives from "will" to "might," "probably" to "possibly," and "therefore" to "maybe.
Financial Manipulation via Corporate Merger or Acquisition Another form of financial manipulation can be found during the merger or acquisition process. A classic approach to this type of manipulation occurs when management tries to persuade all parties involved in the decision-making process to support a merger or acquisition based primarily on the improvement in the estimated earnings per share of the combined companies.
Let's look at the table below in order to understand how this type of manipulation takes place.DQ1 ACC/ Why are financial statements important to internal users, such as employees, managers, and directors?
Financial Statements are important to internal users because it provides a window into the company to monitor their performance. The financial statement also provide details to managers that can relay important information to employee 95%(19).
Internal users are people within a business organization who use financial information. Examples of internal users are owners, managers, and employees. Examples of internal users are owners, managers, and employees.
The objective of financial statements is to provide information about the financial position, performance and changes in financial position of an enterprise that is useful to a wide range of users in making economic decisions (IASB Framework). Financial Statements Paper John Doe ACC/ January 3, Introduction In this paper it will go through: Identify the four basic financial statements, describe the purpose of each of the four financial statements, discuss how the financial statements would be useful to internal users such as managers and employees, and discuss how the.
Both of these types of users rely on the same types of accounting information - the financial statements. Owners use information on the financial statements to see how well the company is performing.
Internal Users (such as managers) are the primary users of the information. Fianancial Accounting External Users (such as creditors, stockholders, and government regulators) are the primary users of .