The Hindu Business Line : If only touching up X-rays could mend fractures

FIGHT fire with water, ruse with counter-ruse, and trick with a better trick. But what do you do if accountants play their dirty games and financial reports are full of frauds you know are there in the hiding? Howard Schilit gives you the appropriate weapons in Financial Shenanigans, the second edition of which is out from Tata McGraw-Hill (www.tatamcgrawhill.com). The book deals with "seven fundamental tricks that companies have used to fool auditors and investors for decades". You would also know how you can sidestep expense traps and liability scams, and look through inflated profits and questionable write-offs.

"You can fool some of the people all of the time" is the title of chapter 1 which starts with Cendant, a company that sold various types of club memberships, and ultimately ended up as `the biggest accounting fraud ever' in the pre-Enron days, causing investors lose $19 billion.

"Seek and ye shall find," is chapter 2, where the author provides the building blocks for identifying companies that are using accounting tricks.

Among the "thirty techniques grouped into seven categories," identified by the Centre for Financial Research and Analysis (CFRA) are giveaways such as: creating sham rebates, boosting profits by selling undervalued assets, amortising costs too slowly, creating income by reclassification of balance-sheet accounts, grossing up revenue, reducing liabilities by changing accounting assumptions, and so forth.

"Certain shenanigans can be fairly benign, whereas others may be more harmful for investors," observes Schilit. "In general, shenanigans that inflate revenue should be considered more serious than those that affect expenses."

Why do shenanigans exist in this world, disturbing our peace? "Three reasons," states the author. "It pays to do it. It's easy to do. And it's unlikely that you'll get caught."

Well, you don the role of Sherlock Holmes to trail them, but where do you search? The book gives a list of places to light up and see. Footnotes are one such. "Some footnotes should lead you to question not only the validity of the financial statements, but also the integrity of management."

Then, turn to the front of the annual report, the author advises. "Many professional analysts agree that the letter from the president is used to bias the reader into thinking that the company is doing better than it really is."

As Thornton O'glove put it, "It is designed to serve as a veil for the striptease — namely to offer a hint of what is underneath, to indicate shape and form but not to permit too much insight." Warren Buffett has this to say as analogy for managements that paper-over operating problems with accounting manoeuvres: "A seriously-ill patient tells his doctor: `I can't afford the operation, but would you accept a small payment to touch up the X-rays?'"

How can shenanigans be prevented? The book offers a four-pronged strategy. Improve auditors' ability to audit (will their training equip them with trick-catching tricks?), improve training for users of financial reports (teach them to read better), improve the control environment within organisations (internal control, audit committee, independent directors and so on), and restructure managers' incentives (reward the honest and punish the rest).

And then it is not `happily ever after' because you can't wish these deceits away. To rephrase a famous quote: "Eternal vigilance is the price of truth in accounting."

BooksOfAccount@rediffmail.com

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