Inside Track-Investors rediscover
old recipes for cooking books

June 28, 2002 04:33 AM ET
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By Mark Bendeich

LONDON, June 28 (Reuters) - As
investors reel from a string of huge
accounting scandals, it is easy to
forget that the art of cooking the
books is as old as the books
themselves.

Long before U.S. telecoms firm
WorldCom WCOM.O and U.S.
energy trader Enron revealed
gaping holes in their accounts,
Wall Street and other financial
centres were swimming in shame.

Just 20 years ago, when many of today's up-and-coming traders and
fund managers were still in short pants, profits also had a hollow ring
about them.

In the late 1980s, for example, media firms revalued their assets to
mask the burden of crippling debts as interest rates soared. In the early
1990s, UK newspaper baron Robert Maxwell, owner of the Mirror Group,
even took money from the company pension fund to prop up his
tottering empire.

In the 1960s, the accounts of International Telephone and Telegraph,
which had grown through hundreds of acquisitions to become one of the
biggest U.S. firms, were under the spotlight.

Going as far back as London's South Sea Company, which saw a boom in
its shares in 1720, companies have massaged the truth.

After so many years of cooking the books, some favoured recipes have
emerged for making accounts seem more palatable. They vary from
country to country, but here are some of the more popular.

HIDING EXPENSES

This is an age-old way of bringing down costs and inflating profits.
Under accounting principles, it is okay to defer some costs and account
for them later: for example, a mining company can spend heavily on
building a new mine but not actually record the development costs in its
profit statement right away.

The costs are instead recorded as an asset in the balance sheet and --
when the new mine starts generating revenue -- is depreciated over
time. The temptation is for a company to tuck costs away in the balance
sheet that do not belong there. Some companies have been known, for
example, to record interest costs on borrowings as an asset in the
balance sheet.

RUBBERY REVENUES

In many service industries, the point at which a company can book a
sale is a very grey area -- and fertile ground for dubious accounting.
Unlike a supermarket retailer, many companies do not receive cash on
delivery -- and at times, in the service industry, it is even uncertain
when something has been delivered.

The software industry has taken some of the most liberal interpretations
of revenue recognition in the high-tech boom in its eagerness to show
sales growth.

INVENTING INVENTORY

This is plain fraud and has led to some colourful episodes in accounting.
The idea is to make your inventory seem bigger than it actually is -- a
feat which has the effect of reducing costs and inflating profits.

Because of the way some basic operating costs are calculated --"cost of
goods sold" in accounting jargon -- the higher your inventory at the end
of the year, the lower your cost base.

It has been known, for example, for a wine-making company to declare
its vats full of expensive vintages when in fact they were empty. Only
an inquisitive auditor (of the type apparently lacking these days)
discovered the truth when he tapped the side of a supposedly full vat.

CHANGING THE GOAL POSTS

This is a favourite technique of finance directors. Because the value of
inventory at the end of the year is so crucial, companies have been
tempted at times of lean profitability to change the way they value it.

Another is to change the way a company values its unlisted associate
companies, where the firm typically has less than a 50 percent stake.
One way to account for associates is for companies to record the value
of their stakes at cost in the balance sheet and treat the dividends as
income.

Another is to recognise the parent's share of the associate's RETAINED
profits, which is usually greater than the portion that is distributed by
way of dividend. This latter method is known as equity accounting and
becomes very popular when associate companies are outperforming their
parents.

BALANCE SHEET SHUFFLE

Just as companies inflate asset values, they are also adept at shifting
liabilities off it. The game was up for Enron when it was found to be
exposed to billions of dollars in potential liabilities hidden away from
view.

Problems can come when firms guarantee the debts of a third party, but
the debts themselves do not appear on their balance sheets. For
example, an aerospace company may sell a plane to an airline with a
flimsy credit rating and, to ensure the sale goes through, guarantees
the airline's lender against default. But the potential liability is nowhere
to be found IN the manufacturer's consolidated balance sheet. The cash
from the sale is, however.

There are many, many more ways to tweak company accounts but there
are bound to be few that have not been tried before.

The numbers involved in the latest outbreak of creative accounting may
be larger than ever before but, says fund manager Noel O'Halloran of
Ireland's KBC Asset Management, it should not be a surprise to anybody
that the numbers sometimes lie.

"The fundamental problem is that people always believe that it's
different this time," he said."There are different companies and
different industries but at the end of the day you are dealing with
humans and humans go through cycles of greed and fear."

Quelle: Reuters

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