Quality of Information

Interview With a Fraudster

 Irregularities
Unintentional vs.
Earnings Management
Intentional
Errors
Disagreements in
Fraudulent Reporting
Judgment
 Earnings Management

Meet Internal Targets

Income Smoothing (steady growth)
Window Dressing for IPO or Financing
Meet External Expectations (whisper number)
Meet Internal Targets
Some well intentioned
Avoiding restructuring in economic downturn
Myopic or paternal/maternal Sense of community
Surviving a Culture of unrealistic rising expectations
Some more self serving
Maverick managers
Focus on the game
Profit at any cost
Bonus, bonus, bonus
 Earnings Management

Meet Internal Targets

Income Smoothing (steady growth)
Window Dressing for IPO or Financing
Meet External Expectations (whisper number)
Income Smoothing
Strategic Timing of Results
Avoid notable variations in results
Stay off the radar
Avoid volatility in earnings that may impact bonuses
 Earnings Management

Meet Internal Targets

Income Smoothing (steady growth)
Window Dressing for IPO or Financing
Meet External Expectations (whisper number)
Window Dressing

Merger/Sale?

Channel Stuffing? Trade Push/Loading?

Deferred Purchasing?
Reduced/Delayed Maintenance?
Delayed Research and Development?
Reorganization?
Round trip sales/debt? (REPO 105)
 Earnings Management

Meet Internal Targets

Income Smoothing (steady growth)
Window Dressing for IPO or Financing
Meet External Expectations (whisper number)
Meet External Expectations

Avoid being focus of analyst disappointment

Avoid drastic loss in Market Capitalization
Avoid restructuring of corporate leadership
Avoid default on contractual commitments
Bonus, Options
Earnings Management Continuum
Strategic Matching (timing)

Timing of Aggressive Deceptive Fraudulent

Transactions Accounting Accounting Reporting Fraud

Strategic
Marketing/Sales
And Purchases
Strategic Matching

Booking a Reorganization charge in one period

Deferring or accelerating R&D or advertising campaign
Buy or not buy inventory at end of period
Strategically take delivery early or late
Channel Stuffing
Excessive write-off of impaired assets (Intangible assets; tangible
assets; inventory)
Earnings Management Continuum
Strategic Matching (timing)
Change Methods/Estimates with Disclosure

Timing of Aggressive Deceptive Fraudulent

Transactions Accounting Accounting Reporting Fraud

Conveniently
Strategic
Changing
Marketing/Sales
GAAP with Full
And Purchases Disclosure
Change Methods/Estimates
with Disclosure
Bad debt assumptions (more conservative or liberal)
Manipulating the assumed rate of return on pension
fund assets (and therefore on liabilities/expenses)
Manipulating expected useful lives of tangible assets
for depreciation purposes
Adjusting the anticipated salvage values used in
depreciation calculations
Massaging Revenue Recognition assumptions
Earnings Management Continuum
Strategic Matching (timing)
Change Methods/Estimates with Disclosure
Change Methods/Estimates w/o Disclosure

Timing of Aggressive Deceptive Fraudulent

Transactions Accounting Accounting Reporting Fraud

Conveniently Changing
Strategic GAAP
Changing
Marketing/Sales Inadequate
GAAP with Full
And Purchases Disclosure Disclosure
Earnings Management Continuum
Strategic Matching (timing)
Change Methods/Estimates with Disclosure
Change Methods/Estimates w/o Disclosure
Non-GAAP Accounting (intending to deceive)

Timing of Aggressive Deceptive Fraudulent

Transactions Accounting Accounting Reporting Fraud

Conveniently Changing Using

Strategic GAAP
Changing
Marketing/Sales Inadequate NON-GAAP
GAAP with Full
And Purchases Disclosure Accounting
Disclosure
Earnings Management Continuum
Strategic Matching (timing)
Change Methods/Estimates with Disclosure
Change Methods/Estimates w/o Disclosure
Non-GAAP Accounting (intending to deceive)
Outright Fraudulent Activities

Timing of Aggressive Deceptive Fraudulent

Transactions Accounting Accounting Reporting Fraud

Conveniently Changing Using

Strategic GAAP Fictitious
Changing
Marketing/Sales Inadequate NON-GAAP Transactions
GAAP with Full
And Purchases Disclosure Accounting
Disclosure
 The GAAP Oval
Expectations GAP

* * * *
* * * *

Lowest GAAP Highest GAAP

Earnings Earnings
 The GAAP Oval
Expectations GAP

* * * *
* * * *

Lowest GAAP Highest GAAP

Earnings Earnings
The GAAP Oval (Inventory)
Lowest GAAP Highest GAAP
Earnings Earnings

6 7 4 2
3 13 2 8 5

1. Specific Identification ONLY Truthful Result

2. Weighted Average Physically IMPOSSIBLE
3. FIFO - LISH Most Likely Approximates Actual Physical Flow
4. LIFO - FISH Physically IMPOSSIBLE
5. Over Counting (Intentional)
Fictitious - FRAUD
6. Under Counting (Intentional)
7. LIFO (and Weighted Average) STACKING
Manipulation GAAP!
8. LIFO (and Weighted Average) DIPPING
 Materiality

Inevitably new accountants (honestly even OLD

accountants) will raise the issue of
significance or insignificance related to
types of earnings management activities.
 What is Materiality?
SAB 99 Materiality (item 13)

Among the considerations that may well render material an otherwise quantitatively
small misstatementof a financial statement item are

whether that misstatement

arises from an item capable of precise measurement or
whether it arises from an estimate and, if so,
the degree of imprecision inherent in the estimate14
masks a change in earnings or other trends
hides a failure to meet analysts' consensus expectations for the enterprise
changes a loss into income or vice versa
whether the misstatement concerns a segment or other portion of the registrant's business that
has been identified as playing a significant role in the registrant's operations or profitability
affects the registrant's compliance with regulatory requirements
affects the registrant's compliance with loan covenants or other contractual requirements
has the effect of increasing management's compensation for example, by satisfying
requirements for the award of bonuses or other forms of incentive compensation
involves concealment of an unlawful transaction. (etc)
 Keep in mind. . . .
In assessing whether a misstatement results in a violation of a registrant's obligation to
keep books and records that are accurate "in reasonable detail," registrants and their
auditors should consider, the additional factors set forth below:

The significance of the misstatement. Though the staff does not believe that registrants need to make finely
calibrated determinations of significance with respect to immaterial items, plainly it is "reasonable" to treat
misstatements whose effects are clearly inconsequential differently than more significant ones.

How the misstatement arose. It is unlikely that it is ever "reasonable" for registrants to record misstatements or
not to correct known misstatements even immaterial ones as part of an ongoing effort directed by or known
to senior management for the purposes of "managing" earnings. On the other hand, insignificant
misstatements that arise from the operation of systems or recurring processes in the normal course of business
generally will not cause a registrant's books to be inaccurate "in reasonable detail"38

The cost of correcting the misstatement. The books and records provisions of the Exchange Act do not require
registrants to make major expenditures to correct small misstatements.39 Conversely, where there is little cost or
delay involved in correcting a misstatement, failing to do so is unlikely to be "reasonable."

The clarity of authoritative accounting guidance with respect to the misstatement. Where reasonable
minds may differ about the appropriate accounting treatment of a financial statement item, a failure to correct it
may not render the registrant's financial statements inaccurate "in reasonable detail." Where, however, there is
little ground for reasonable disagreement, the case for leaving a misstatement uncorrected is correspondingly
weaker.
Consider the concept of LIFO inventory management from
different perspectives:

What are the fiscal advantages for a company that uses LIFO
to account for inventory cost flows?
Are there operational advantages related to the reduction of
inventory quantities in general, and what would be the affect
on various disclosures and reported results of operations?
Do you consider LIFO to be an appropriate method of
accounting for cost flows of inventory?
The GAAP Oval (Inventory)
Lowest GAAP Highest GAAP
Earnings Earnings

6 7 4 2
3 13 2 8 5

1. Specific Identification ONLY Truthful Result

2. Weighted Average Physically IMPOSSIBLE
3. FIFO - LISH Most Likely Approximates Actual Physical Flow
4. LIFO - FISH Physically IMPOSSIBLE
5. Over Counting (Intentional)
Fictitious - FRAUD
6. Under Counting (Intentional)
7. LIFO (and Weighted Average) STACKING
Manipulation GAAP!
8. LIFO (and Weighted Average) DIPPING
 LIFO Stacking versus Dipping

Is this strategic timing or deceit?

Is this a violation of accounting principles?

Where do we draw a line?

How would you behave?

https://www.stock-analysis-on.net/NYSE/Company/Exxon-Mobil-Corp/Analysis/Inventory
 LIFO is a beautiful thing.
hhhhuuujjjjj great - amazing - fantastic
tremendous believe me just incredible generally
excellent not allowed to be used by those light
weight losers who use IFRS -
Mr. Donald Trump
 Ethical versus Moral versus Legal
Ethical: In accordance with rules or standards for right
conduct or practice Social imperative
Legal: Permitted by law, lawful
Moral: Individuals personal belief in right or wrong

FCPA (1977) - Specifically prohibits U.S. Companies from

paying bribes to official of foreign governments to establish
business relationships.
Is this essentially enforced right conduct?
Is it fair?
Is it ethical?