5 common ways companies "cook the books"
We've all heard jokes about 'cooking the books'. This is a term generally used to describe 'accounting tricks' that make a company's financials look better than they really are. There are several ways companies go about doing this, below are some of the most common examples.
You'll notice that many of these items overstate income. This article relates to how companies might 'cook the books' from the perspective of GAAP (Generally Accepted Accounting Principles). Their goal (which is illegal of course) would be to overstate the company's success for investors, lenders, etc. The opposite would generally be the goal of someone trying to report false information for tax purposes. You can click here for an article related to the most common types of tax fraud.
Important (and obvious) note: This is for informational/entertainment purposes only and should not be used to generate ideas to use in your company. These are illegal acts of fraud.
Fictitious revenue Companies might book revenue that simply doesn't exist in order to make the company look like it is performing better than it actually is.
Improper timing of revenue recognition This is perhaps the most common of all the methods. Revenue should be recognized when it has been both earned and realized. Companies can accelerate income that has been realized but is not yet earned (which should be reported over time as it is earned) in order to meet earnings targets. Alternatively, a company may inappropriately delay the recognition of income if they had a profitable period and expect the following period to be less successful.
Channel stuffing This is another type of improper revenue recognition. Sales are inflated when the company sends and invoices excessive product to a distributor. This would typically happen near the end of a reporting period to prematurely recognize revenue. Either the distributor orders less in the next period because they have excess inventory, thereby accelerating revenue in an improper manner or the inventory is returned in the following period, in which case revenue is intentionally overstated in the current period.
Fraudulent estimates Companies that report their finances in accordance with GAAP (Generally Accepted Accounting Principles) must often make reasonable accounting estimates for some of their financial figures. These can be intentionally misstated in order to report more income or less expenses. For example, estimates for bad debt (noncollectable receivables) could be manipulated to show higher net income.
Expense recognition schemes There are many potential schemes in this category, here are just a few. Companies can improperly defer expense recognition in order to overstate net income. Expenses that should be written off currently could be added to the balance sheet as an asset and amortized over time in order to understate expenses and overstate net income. Reserves for things such as bad debt can be over-accrued in the current period, when income is high, in order to create a reserve or cushion in later periods when income is lower.
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