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Financial Shenanigans: How to Detect Accounting Gimmicks & Fraud in Financial Reports
Techniques to uncover and avoid accounting frauds and scams Inflated profits . . . Suspicious write-offs . . . Shifted expenses . . . These and other dubious financial maneuvers have taken on a contemporary twist as companies pull out the stops in seeking to satisfy Wall Street. Financial Shenanigans pulls back the curtain on the current climate of accounting fraud. It presents tools that anyone who is potentially affected by misleading business valuationsfrom investors and lenders to managers and auditorscan use to research and read financial reports, and to identify early warning signs of a company's problems. A bestseller in its first edition, Financial Shenanigans has been thoroughly updated for today's marketplace. New chapters, data, and research reveal contemporary "shenanigans" that have been known to fool even veteran researchers.
296 pages, Hardcover
First published February 1, 1993
About the author
Howard Schilit
5 books20 followersDr. Howard M. Schilit
Founder and CEO of Financial Shenanigans Detection Group, LLC.
Dr. Howard M Schilit is an international leader in forensic accounting and corporate governance and author of Financial Shenanigans: How to Detect Accounting Gimmicks & Fraud in Financial Reports (McGraw-Hill) 3rd Edition, May 2010. He has been a leading spokesman before Congress, the SEC, and media outlets about causes and early warning signs of accounting tricks in public filings.
Follow me: http://twitter.com/HowardSchilit"
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Displaying 1 - 30 of 123 reviews
September 18, 2007
Financial Shenanigans is by Howard Schilit, president of the Center for Financial Research and Analysis. It is a very readable step-by-step guide to detecting fraud by reading financial statements.
Most of the big corporate scandals in the past few years have been in one way or another accounting scandals. Either accounting was the primary method of committing fraud, or else accounting was used to cover up other malfeasance. Schilit identifies seven "shenanigans" and the ways they are typically performed. They are:
1. Recording revenue too soon or of questionable quality
2. Recording bogus revenue
3. Boosting income with one-time gains
4. Shifting a current expense to a later or earlier period
5. Failing to record or improperly reducing liabilities
6. Shifting current revenue to a later period
7. Shifting future expenses to the current period as a special charge
All of this has to do with accounting arcana, which is what makes these kinds of scandals so opaque to the public. The public understandably doesn’t understand what's been done, much less how anyone was hurt by it. One misunderstanding that one sees in newspapers occasionally is what a reserve is, and why not having one or underestimating one is bad. The impression given is that reserves are actual money--rainy day funds to pay for future litigation or bad debt.
That's why a readable book like this is useful. It really goes into accounting detail, and explains what the various financial statements are, and how to read them. It gives lots of examples of specific companies caught engaging in specific shenanigans. (Some, like Sunbeam, seems to have engaged in about every kind of shenanigan possible.) He always shows stock price graphs so one can see what the result is to equity when the chickens come home to roost. (He also uses the graphs as a way to brag on the CFRA's ability to see trouble early. They always seem to issue warnings well before the shenanigan is discovered. But, Cassandra-like, their warnings are ignored by investors. If their record at detecting shenanigans is so good, you would expect stock prices to drop every time they issue a warning on a company. Hmm.) Occasionally he offers a pungent detail or two on the company's story, but it would be better if he gave a little more--like this executive went to jail, or that executive was forbidden by the SEC to ever run a publicly traded company again, etc.
I think this would be a good book for undergraduate and graduate business students, especially those interested in becoming analysts. Aside from giving a lot of practical advice, it would be an entertaining counterweight to the (let's face it) fairly tedious accounting textbooks that one necessarily has to read.
Most of the big corporate scandals in the past few years have been in one way or another accounting scandals. Either accounting was the primary method of committing fraud, or else accounting was used to cover up other malfeasance. Schilit identifies seven "shenanigans" and the ways they are typically performed. They are:
1. Recording revenue too soon or of questionable quality
2. Recording bogus revenue
3. Boosting income with one-time gains
4. Shifting a current expense to a later or earlier period
5. Failing to record or improperly reducing liabilities
6. Shifting current revenue to a later period
7. Shifting future expenses to the current period as a special charge
All of this has to do with accounting arcana, which is what makes these kinds of scandals so opaque to the public. The public understandably doesn’t understand what's been done, much less how anyone was hurt by it. One misunderstanding that one sees in newspapers occasionally is what a reserve is, and why not having one or underestimating one is bad. The impression given is that reserves are actual money--rainy day funds to pay for future litigation or bad debt.
That's why a readable book like this is useful. It really goes into accounting detail, and explains what the various financial statements are, and how to read them. It gives lots of examples of specific companies caught engaging in specific shenanigans. (Some, like Sunbeam, seems to have engaged in about every kind of shenanigan possible.) He always shows stock price graphs so one can see what the result is to equity when the chickens come home to roost. (He also uses the graphs as a way to brag on the CFRA's ability to see trouble early. They always seem to issue warnings well before the shenanigan is discovered. But, Cassandra-like, their warnings are ignored by investors. If their record at detecting shenanigans is so good, you would expect stock prices to drop every time they issue a warning on a company. Hmm.) Occasionally he offers a pungent detail or two on the company's story, but it would be better if he gave a little more--like this executive went to jail, or that executive was forbidden by the SEC to ever run a publicly traded company again, etc.
I think this would be a good book for undergraduate and graduate business students, especially those interested in becoming analysts. Aside from giving a lot of practical advice, it would be an entertaining counterweight to the (let's face it) fairly tedious accounting textbooks that one necessarily has to read.
April 24, 2021
Great book on the technical ins and outs of accounting tricks, complete with many examples and step-by-step explanations of the specific methods used by corporate executives to dress up their operating results. This book requires some basic familiarity with accounting and a general interest in the subject, but it really contains many fascinating examples of accounting tricks big and small over the years, from well-known ones during the dotcom bubble like Enron & Worldcom to modern day examples like Valeant and Hertz. Many of the tricks described in the book can be identified with a focus on reconciling to free cash flow (CFO-CFI), rather than management's reported earnings. The most helpful sections were the chapters which described cash flow shenanigans, and ways that management teams can boost CFFO by tricks such as (1) shifting receivables to financing section by converting A/R to notes receivable (2) sale of receivables to cover up increases in DSO (3) "sale" of receivables that have recourse to the company if the customers don't pay (4) boosting of CFFO through acquisitions by shifting all the expenses into CFI, and many more. Taking the time to read the book in detail and really understand what the authors have to say will strengthen both your understanding of accounting and corporate executive behavior. Great book for any practitioner in the investing industry.
December 24, 2018
What makes this book unique is that there is not a lot of material out there on this topic which is easily relatable to a practicing analyst. While the book could be even mote detailed, I think it serves well to identify and address the main methods companies to use for aggressive accounting to mislead investors. Must read for someone interested in this topic but not very experienced. The book uses not just theory but numerous examples and case studies to drive home the point.
What makes this book unique is that there is not a lot of material out there on this topic which is easily relatable to a practicing analyst. While the book could be even mote detailed, I think it serves well to identify and address the main methods companies to use for aggressive accounting to mislead investors. Must read for someone interested in this topic but not very experienced. The book uses not just theory but numerous examples and case studies to drive home the point.
What makes this book unique is that there is not a lot of material out there on this topic which is easily relatable to a practicing analyst. While the book could be even mote detailed, I think it serves well to identify and address the main methods companies to use for aggressive accounting to mislead investors. Must read for someone interested in this topic but not very experienced. The book uses not just theory but numerous examples and case studies to drive home the point.
January 23, 2022
The book provides a comprehensive framework / guide on how companies can dub misinformed or careless investors. Hence, it is quite a technical book if you do not have financial analysis background (for b-sch students, this would be a simple read). As with all technical / theoretical books, it is the examples that make all the difference. I would say the examples are decent though some are dated.
Regardless, for non b-sch students, very well worth your time. There are surely some nuggets of information you can pick up.
For me, the biggest key take away is - when numbers change (esp in a big way), question "why?". Being sensitive to numbers can be a big advantage when it comes to downside protection (i.e. might not make you returns but can save you from ideas that end up being detractors to the portfolio).
breadth ~5/5
depth ~4/5
applicability ~4/5
Regardless, for non b-sch students, very well worth your time. There are surely some nuggets of information you can pick up.
For me, the biggest key take away is - when numbers change (esp in a big way), question "why?". Being sensitive to numbers can be a big advantage when it comes to downside protection (i.e. might not make you returns but can save you from ideas that end up being detractors to the portfolio).
breadth ~5/5
depth ~4/5
applicability ~4/5
August 5, 2022
Wish I read this at the start of my financial reporting career. Such a comprehensive, digestible, easy-to-understand overview of all the ways companies try to pull the wool over our eyes when it comes to their finances.
July 17, 2018
Extra one star for the style of presenting the cases and real life situation! Accounting gimmicks and ethical business always been my favourite research area and I never found such an interesing book in this area before! I think the newest edition will also cover changing situation under IFRS vs GAAP in details!
April 8, 2018
For investing, think Warren Buffett. For detecting accounting gimmicks, think Howard Schilit.
"Accounting is the language of business, and you have to learn it like a language… To be successful at business, you have to understand the underlying financial values of the business," said Warren Buffett. To understand the language of business, read Financial Shenanigans.
Financial Shenanigans is the best book about accounting gimmicks that I have ever read. I read it like watching a detective horror movie with my heart pounding along the way. This book is a real page-turner and hard to put it down. I immersed myself in the book all day while my wife and kid were doing their things around me over the weekend.
Warren Buffett explains businesses and investing in such a way that laypeople could understand, so do Schilit, Perler, and Engelhart for detective accounting. This book should be the required reading for all investors and used in basic accounting or finance classes. It will benefit financial world tremendously.
I am a fan of Schilit. I read all four editions of his books and use them as a reference from time to time. The book is very easy to follow. Schilit, Perler, and Engelhart make creative accounting fun and easy to detect. They explain gimmicks after gimmicks in plain English. It is a rare gem. Investors may also want to check out the second and third editions which have the wonderful checklists at the end of the books.
"Accounting is the language of business, and you have to learn it like a language… To be successful at business, you have to understand the underlying financial values of the business," said Warren Buffett. To understand the language of business, read Financial Shenanigans.
Financial Shenanigans is the best book about accounting gimmicks that I have ever read. I read it like watching a detective horror movie with my heart pounding along the way. This book is a real page-turner and hard to put it down. I immersed myself in the book all day while my wife and kid were doing their things around me over the weekend.
Warren Buffett explains businesses and investing in such a way that laypeople could understand, so do Schilit, Perler, and Engelhart for detective accounting. This book should be the required reading for all investors and used in basic accounting or finance classes. It will benefit financial world tremendously.
I am a fan of Schilit. I read all four editions of his books and use them as a reference from time to time. The book is very easy to follow. Schilit, Perler, and Engelhart make creative accounting fun and easy to detect. They explain gimmicks after gimmicks in plain English. It is a rare gem. Investors may also want to check out the second and third editions which have the wonderful checklists at the end of the books.
July 1, 2014
Read this book for my audit 2 class. Really amazing how many sneaky ways companies have of trying to show improved performance. No wonder so much fraud is never caught - it's got to be hard to find a lot of this stuff! Another thing that really surprised me was the number of example companies used in the book (other than the big obvious ones). There were companies who had gotten in trouble with the SEC for all kinds of things that I hadn't even heard about. No wonder everyone always talks about corruption in the big companies (and small ones too, apparently!). It's actually a little disheartening, though I am sure there are many honest companies and CEOs out there, as well. Just makes me glad I'm not going into audit as a profession.
July 7, 2020
very good and insightful. Explained in a very simple way.
With accounting background most of it is common sense but is very good to have the cases layed out and explained.
With accounting background most of it is common sense but is very good to have the cases layed out and explained.
August 21, 2018
Greed is as old as mankind. Unscrupulous people will try to trick others out of their money. One arena for this is the business sector and especially after the IT-crash there was a number of high profile accounting scandals. Financial Shenanigans has become the de-facto standard work on detecting “accounting gimmicks and fraud in financial reports.” Howard Schilit is a former accounting professor who left academia and founded two consultancy firms specializing in so-called forensic accounting. Having sold the prior Centre for Financial Research and Analytics, the author is today the CEO of Schilit Forensics, helping clients research companies of interest. Schilit is, as Barron’s puts it, a financial sleuth and this book will provide the reader plenty of advice on how not to be taken advantage of.
The second edition of this book contains five parts. After an introduction the meatiest part of the book is the second where The Seven Shenanigans are presented, i.e. the most common ways to intentionally distort a company’s financials to make the current profits and the financial strength look stronger (or weaker) than is warranted by actual performance. In order the shenanigans are 1) Recording revenue too soon or of questionable quality, such as recording revenue before a service has been provided, before a shipment has been made or before the customer’s full acceptance or recording sales to an affiliated party and much more; 2) Recording bogus revenues, as when recording cash from lending transactions as revenue or any recording of sales without economic substance; 3) Boosting income with one- time gain, which includes increasing profits by selling undervalued assets or creating income by reclassification of balance sheet items; 4) Shifting current expenses to a later or earlier period, for example capitalizing normal operating costs, amortizing costs too slowly, unduly reducing asset reserves etc.; 5) Failing to record or improperly reducing liabilities, such as failure to record expenses and related liabilities when future obligations remain or recording revenue when cash is received even though future obligations remain; 6) Shifting current revenue to a later period by for example creating reserves and releasing them into income in a later period or improperly holding back revenue before an acquisition closes and; 7) Shifting future expenses to the current period as a special charge - that could include improperly inflating the amount of a special charge or accelerating expenses into the current period.
The first five of those shenanigans aim to inflate the current period and to make it look better than it is. The last two instead deflate the current period to be able to look better than merited in the future. The creative accounting that tweaks the revenues is in a way worse than that which misrepresents costs as the revenues form the basis for the entire profit and loss-statement. The topics discussed are all relevant but to some extent I feel that the book is too profit and loss-centric. The balance sheet get’s very little attention. The chapters include a number of guiding accounting principles and there is an appendix tutorial describing the basics of financial reporting. Despite this, it is a clear benefit for the reader to have some basic understanding of accounting principles and concepts.
The much shorter parts three through five handle areas such as how to search for signs of improper accounting by using databases and analysing company reports, trickier areas such as acquisition accounting and financial reporting in companies that due to their business model don’t fit into standard accounting models, and finally there is a short historical review of financial tricksters with special attention given to Enron. Especially the history part is so short that it becomes close to unnecessary. However, the part on analysing financial reports does its job. To sum up, this book should be mandatory complementary reading in every accounting class. Apart from learning how accounting ought to work, everybody should know how some people come to misuse accounting.
The second edition of this book contains five parts. After an introduction the meatiest part of the book is the second where The Seven Shenanigans are presented, i.e. the most common ways to intentionally distort a company’s financials to make the current profits and the financial strength look stronger (or weaker) than is warranted by actual performance. In order the shenanigans are 1) Recording revenue too soon or of questionable quality, such as recording revenue before a service has been provided, before a shipment has been made or before the customer’s full acceptance or recording sales to an affiliated party and much more; 2) Recording bogus revenues, as when recording cash from lending transactions as revenue or any recording of sales without economic substance; 3) Boosting income with one- time gain, which includes increasing profits by selling undervalued assets or creating income by reclassification of balance sheet items; 4) Shifting current expenses to a later or earlier period, for example capitalizing normal operating costs, amortizing costs too slowly, unduly reducing asset reserves etc.; 5) Failing to record or improperly reducing liabilities, such as failure to record expenses and related liabilities when future obligations remain or recording revenue when cash is received even though future obligations remain; 6) Shifting current revenue to a later period by for example creating reserves and releasing them into income in a later period or improperly holding back revenue before an acquisition closes and; 7) Shifting future expenses to the current period as a special charge - that could include improperly inflating the amount of a special charge or accelerating expenses into the current period.
The first five of those shenanigans aim to inflate the current period and to make it look better than it is. The last two instead deflate the current period to be able to look better than merited in the future. The creative accounting that tweaks the revenues is in a way worse than that which misrepresents costs as the revenues form the basis for the entire profit and loss-statement. The topics discussed are all relevant but to some extent I feel that the book is too profit and loss-centric. The balance sheet get’s very little attention. The chapters include a number of guiding accounting principles and there is an appendix tutorial describing the basics of financial reporting. Despite this, it is a clear benefit for the reader to have some basic understanding of accounting principles and concepts.
The much shorter parts three through five handle areas such as how to search for signs of improper accounting by using databases and analysing company reports, trickier areas such as acquisition accounting and financial reporting in companies that due to their business model don’t fit into standard accounting models, and finally there is a short historical review of financial tricksters with special attention given to Enron. Especially the history part is so short that it becomes close to unnecessary. However, the part on analysing financial reports does its job. To sum up, this book should be mandatory complementary reading in every accounting class. Apart from learning how accounting ought to work, everybody should know how some people come to misuse accounting.
September 18, 2016
A solid basic book on what to look for when analyzing the shenanigans of a company. It gave me a few good ideas on adjusting my process. I woudl recommend to those that are learning to become skeptics of management teams and earnings releases.
June 25, 2023
A brilliantly written book outlining the methods used by corporates to do some crazy accounting gymnastics. A must-read.
### Part One Establishing The Foundation
In early 2001, Joe Nacchio, the CEO of Qwest Communications, stood onstage at a companywide meeting and delivered a rousing speech intended to energize his team and focus them on his priorities for the company. “The most important thing we do is meet our numbers,” Nacchio declared. “It’s more important than any individual product, it’s more important than any individual philosophy, it’s more important than any cultural change we’re making. We stop everything else when we don’t make the numbers.” Through his words and deeds, Joe Nacchio created a culture that resulted in $2.5 billion of phantom earnings, landing himself in federal prison and devastating investors who saw the stock price tumble by 97 percent in the 18 months following his speech.
Senior managers at all publicly traded companies yearn to report positive news and impressive financial results that will satisfy investors and drive the share price higher. While most companies act ethically and follow the rules when reporting their financial performance, some take advantage of gray areas in the rules (or worse, ignore the rules altogether) in order to “make the numbers.
Waste Management: Investors Cannot Always Rely upon the Auditors
Described by the SEC as “one of the most egregious frauds we have seen,” Chicago-based trash hauler Waste Management Inc. (WM) inflated its pretax earnings by $1.7 billion over a six-year period starting in 1992. At that time, it represented the biggest misstatement of income in U.S. corporate history.
Waste Management grew dramatically over the period from 1993 to 1995, spending billions acquiring an unfathomable 441 companies. With these acquisitions came the inevitable special charges against income. These “one-time” charges became so common that during the seven-year period from 1991 to 1997, WM took write-offs in six of those years, totaling $1.6 billion. Since investors typically ignore special charges in evaluating profitability, WM appeared to be in tip-top shape. Also, to keep investors in the dark about what was really happening, WM offset (or “netted”) numerous one-time investment gains from asset sales against these special charges.
Waste Management was also notorious for finding ways to inflate profits by deferring expenses to a later period. The company aggressively capitalized maintenance, repair, and interest costs to the Balance Sheet rather than expensing them, and minimized the depreciation expense on its garbage trucks by using inflated salvage values and lengthening their useful lives.
After the SEC sued Waste Management alleging fraud, we later learned in reviewing the legal documents that its auditor, Arthur Andersen, was aware of accounting problems much earlier but chose to “protect” its client. As far back as 1993, Arthur Andersen quantified misstatements totaling $128 million, which, if recorded, would have reduced net income before special items by 12 percent. The Andersen partners, however, determined that the misstatements were “immaterial,” and they blessed the 1993 financial reports with a clean opinion.
Indeed, each year when Andersen raised accounting concerns with WM, the proposed adjustments and restatements—not surprisingly—were ignored by management. During the 1995 audit, Andersen clearly disagreed with WM’s approach to netting one-time gains against special charges and the choice not to disclose the practice. Here are excerpts from the auditor’s 1995 internal memorandum:
The Company has been insensitive to not use special charges [to eliminate Balance Sheet errors and misstatements that had accumulated in prior years] and instead has used “other gains” to bury charges for Balance Sheet clean-ups.
onsider CUC International, a darling stock for much of the 1980s–1990s, run by Walter Forbes. By the mid-1990s, CUC started making acquisitions that should have given investors a wake-up call. In April 1996 the company acquired Ideon Group for nearly $400 million. Through the merger, CUC inherited substantial litigation obligations, and booked a reserve for these costs totaling $137 million. Shortly after Ideon closed, CUC bought Davidson and Sierra On-Line for around $2 billion. These businesses produced educational software games, completely unrelated to CUC’s core business, and also came with significant merger-related reserves.
Cendant was created in December 1997, through the merger of Henry Silverman’s HFS and Walter Forbes’s CUC International. This practice of creating merger-related reserves continued in late 1997 (when CUC was about to merge with HFS to form Cendant), as CUC set up a reserve to write off a staggering $556 million associated with this deal.
The stock eventually collapsed in March 1998 when accounting problems at CUC were revealed to investors. When the subsequent investigations and litigation concluded, the total costs of the fraud were staggering. Consider that in 1996 and 1997 alone, investigators found more than $500 million of bogus operating income. Walter Forbes was sentenced to 12 years in prison and assessed $3.25 billion in restitution for his crime. And CUC’s auditor, Ernst & Young, which failed to perform the appropriate tests to spot the fraud, paid $300 million to settle class-action litigation.
Enron: Numbers That Seem Unbelievable Should Not Be Believed
Unlike acquisition-fueled frauds like Waste Management and CUC, Enron’s trickery was entirely organic: it simply changed its business model (and accounting policies) in a dramatic way. Enron, perhaps the most recognizable accounting fraud of the past generation, was a largely unknown producer of natural gas that within a few years morphed into an enormous commodities trading company. This dramatic change in business model was accompanied by a meteoric rise in revenues through the late 1990s. In just five short years, Enron’s revenue had increased by an astounding factor of 10, growing from $9.2 billion in 1995 to $100.8 billion in 2000. In 2000 alone, Enron’s sales grew a staggering 151 percent, from $40.1 billion to $100.8 billion.
Curious investors might question how often other companies have managed to grow their revenue from under $10 billion to over $100 billion in just five years. The answer: never. Enron’s staggering increase in revenue was unprecedented, and the company achieved this growth without any large acquisitions along the way. Impossible! Underlying the reported revenue growth was the company’s unusual treatment of trading activities as sales. These transactions resulted in modest profits, but because the notional values of trades were accounted for as part of revenue (and cost of goods sold), it gave the appearance that the business was in a period of hypergrowth.
WorldCom: Focus on Free Cash Flow in Addition to Earnings
Throughout WorldCom’s history, its growth came largely from making acquisitions. (As we will explain later in Part Five, acquisition-driven companies offer investors some of the greatest challenges and risks.) WorldCom’s largest deal closed in 1998 with its $40 billion acquisition of MCI Communications.
Almost from the beginning, WorldCom used aggressive accounting practices to inflate its earnings and operating cash flows. Much like CUC, one of its principal shenanigans involved making acquisitions, writing off much of the costs immediately, creating reserves, and then releasing those reserves into income as needed. With more than 70 deals over the company’s short life, WorldCom continued to “reload” its reserves so that they were available for future releases into earnings.
By early 2000, with its stock price declining and intense pressure from Wall Street to hit earnings targets, WorldCom embarked on a new and far more aggressive shenanigan—moving ordinary business expenses from its Income Statement to its Balance Sheet. One of WorldCom’s major operating expenses was its so-called line costs. These costs represented fees that WorldCom paid to third-party telecommunication network providers for the right to access their networks. Accounting rules clearly required that such fees be expensed and not capitalized. Nevertheless, WorldCom removed hundreds of millions of dollars of its line costs from its Income Statement to please Wall Street. In so doing, WorldCom dramatically understated its expenses and inflated its earnings, duping investors.
As earnings were being overstated, investors would have found some clear warning signs in evaluating WorldCom’s Statement of Cash Flows, specifically, its rapidly deteriorating free cash flow. WorldCom had manipulated both its net earnings and its operating cash flow. By treating line costs as an asset instead of an expense, WorldCom improperly inflated its profits. In addition, since it improperly placed those expenditures in the Investing section rather than the Operating section of the Statement of Cash Flows, WorldCom similarly inflated operating cash flow. While reported operating cash flow appeared consistent with reported earnings, the company’s free cash flow told the real story.
In early 2002, a small team of internal auditors at WorldCom, working on a hunch, were secretly investigating what they thought could be fraud. After finding $3.8 billion in inappropriate accounting entries, they immediately notified the company’s board of directors, and events progressed swiftly from there. The CFO was fired, the controller resigned, Arthur Andersen withdrew its audit opinion for 2001, and the SEC launched its investigation.
WorldCom’s days were numbered. On July 21, 2002, the company filed for Chapter 11 bankruptcy protection, the largest such filing in U.S. history at the time (a record that has since been overtaken by the collapse of Lehman Brothers in September 2008). Under the bankruptcy reorganization agreement, the company paid a $750 million fine to the SEC and restated its earnings in an amount that defies belief. In total, the company reported an accounting restatement that exceeded $70 billion, including adjusting the 2000 and 2001 numbers from the originally reported gain of nearly $10 billion to an astounding loss of over $64 billion. The directors also felt the pain, having to pay almost $25 million to settle class-action litigation.
In a report commissioned by the bankruptcy court judge to investigate the Lehman collapse, attorney Anton Valukas alleged that the company had cleverly misled investors and creditors by hiding $50 billion of debt from its Balance Sheet. This deception related to Lehman’s aggressive interpretation of an arcane (and since changed) accounting rule known as “Repo 105.”
When borrowing cash through very short-term collateralized loans, say for payroll, the cash received should be reflected on the Balance Sheet as a liability, and the assets given in collateral should remain on the borrower’s Balance Sheet. The “Repo 105” rule allowed for an exception when the value of the assets given as collateral represented at least 105 percent of the loan value. In these cases, the transaction was no longer accounted for as a loan, rather it was considered a sale and subsequent repurchase of the collateral assets. Lehman seized upon this loophole and in doing so recorded its collateralized borrowings as asset sales. As such, instead of recording a short-term liability for the cash received, Lehman would record a temporary reduction to its assets.
The bankruptcy examiner’s report highlighted a suspicious spike in Lehman’s Repo 105 transaction balance at the month-ends corresponding with either a quarterly or year-end filing. Since the need for overnight borrowings should remain fairly consistent throughout a quarter, the jump in Repo 105 transactions only on dates corresponding to financial filings may suggests that Lehman artificially depressed its liability balance in order to mislead investors into believing that the company’s leverage was lower. Table 1-2 shows the monthly trend in Lehman’s Repo 105 balance. Note that in May 2008, the Repo 105 balance jumped to $50.8 billion from $24.6 billion in March and $24.7 billion in April 2008. This same suspicious phenomenon is found in the earlier period, as well.
We classify financial shenanigans into four broad groups (discussed in Parts Two to Five in the book): Earnings Manipulation Shenanigans (Part Two), Cash Flow Shenanigans (Part Three), Key Metric Shenanigans (Part Four), and Acquisition Accounting Shenanigans (Part Five).
We have identified the following seven categories of Earnings Manipulation (EM) Shenanigans that result in misrepresentations of a company’s sustainable earnings.
EM Shenanigan No. 1: Recording revenue too soon
EM Shenanigan No. 2: Recording bogus revenue
EM Shenanigan No. 3: Boosting income using one-time or unsustainable activities
EM Shenanigan No. 4: Shifting current expenses to a later period
EM Shenanigan No. 5: Employing other techniques to hide expenses or losses
EM Shenanigan No. 6: Shifting current income to a later period
EM Shenanigan No. 7: Shifting future expenses to the current period
CF Shenanigan No. 1: Shifting financing cash inflows to the Operating section
CF Shenanigan No. 2: Moving cash outflows from the Operating section to other sections
CF Shenanigan No. 3: Boosting operating cash flow using unsustainable activities Shenanigans
Key Metric Shenanigans (Part Four)
So far, we have addressed shenanigans in the traditional financial statements. Increasingly however, business results are presented outside of this format in order to cater to a wider range of company-specific and industry-specific metrics. These include measures such Same-Store-Sales, Bookings, Average Revenue per User (ARPU), Return on Invested Capital (ROIC), Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA) and many others. Since they are outside the realm of GAAP, companies have much more latitude in calculating and reporting key metrics. Naturally this creates an opportunity for shenanigans. Part Four introduces two categories of Key Metric (KM) Shenanigans.
KM Shenanigan No. 1: Showcasing misleading metrics that overstate performance
KM Shenanigan No. 2: Distorting Balance Sheet metrics to avoid showing deterioration
Acquisition Accounting Shenanigans (Part Five)
Over the last quarter century, we have found some of the most disturbing shenanigans hidden through the complicated acquisition accounting process. We have therefore added this section to this new edition of Financial Shenanigans to highlight the complexities inherent in evaluating M&A-driven companies and to identify the common shenanigans that often trip up investors.
AA Shenanigan No. 1: Artificially boosting revenue and earnings
AA Shenanigan No. 2: Inflating reported cash flow
AA Shenanigan No. 3: Manipulating key metrics
Whether the goal is preserving a democracy or upholding the integrity of financial reporting, a system of checks and balances is paramount for preventing, uncovering, and punishing improper behavior. And much like the U.S. government, financial reporting has three distinct “branches,” an Income Statement, a Balance Sheet, and a Statement of Cash Flows. When one of these financial statements contains shenanigans, warning signs generally appear on the other ones. Thus, Earnings Manipulation Shenanigans can often be detected indirectly through unusual patterns on the Balance Sheet and the Statement of Cash Flows. Similarly, deciphering certain changes on the Income Statement and the Balance Sheet often can help investors sniff out Cash Flow Shenanigans.
What Environment Breeds Shenanigans?
Companies with structural weaknesses or inadequate oversight provide a fertile breeding ground for shenanigans. Investors should probe a company’s governance and oversight by asking these basic questions: (1) Do appropriate checks and balances exist among senior executives to snuff out corporate misdeeds? (2) Do outside members of the board play a meaningful role in protecting investors from greedy, misguided, or incompetent management? (3) Do the auditors possess the independence, knowledge, and determination to protect investors when management acts inappropriately? And (4) has the company improperly taken circuitous steps to avoid regulatory scrutiny?
In 2008 executives at India’s information technology giant Satyam decided to acquire a company, Maytas, in a transaction that required board approval. The board met and acquiesced to management’s request, even though the CEO’s sons controlled the target company. Specifically, Satyam’s board approved the recommendation to invest $1.6 billion for 100 percent of Maytas Properties and 51 percent of Maytas Infrastructure. (The word Maytas is Satyam spelled backward—another clue for all you Sherlock Holmeses about the related-party nature of the deal.)
The board should have objected to the acquisition not only because the CEO’s sons controlled the target company but also because it made little sense. Any Satyam director should have been puzzled that the company was proposing to invest $1.6 billion in related-party real estate ventures (certainly not its core business) at a time when its core business was under pressure and additional investments would have likely been better directed toward staving off the competition.
While the board agreed to the acquisition, it was aborted the next day after an investor uproar. Satyam’s CEO later told authorities that the deal was the last attempt to replace Satyam’s fictitious assets with real ones. A sign of a healthy and effective board is when a dissenting view overturns a management-driven consensus. That clearly did not happen at Satyam.
The fraud and collapse of Parmalat, the Italian dairy behemoth, has been referred to as the “Enron of Europe.” While the business and accounting issues differ, both Enron and Parmalat had one obvious similarity: independent auditors missed the fraud.
One intriguing fact in this case concerns Parmalat’s change in its primary auditor from Grant Thornton to Deloitte & Touche. Indeed, Parmalat’s chicanery might have continued longer had it not been for an Italian law that requires companies to switch audit firms every nine years. Deloitte & Touche replaced auditor Grant Thornton in 1999 and may have been the first to scrutinize certain offshore accounts, which turned out not to exist (many of which were still audited by Grant Thornton at the time, as they were not subject to Italian law). As a result, fraudulent offshore entities were exposed, including Bonlat, a Cayman Islands subsidiary of Parmalat and one of the primary vehicles used to hide fake assets.
### Part One Establishing The Foundation
In early 2001, Joe Nacchio, the CEO of Qwest Communications, stood onstage at a companywide meeting and delivered a rousing speech intended to energize his team and focus them on his priorities for the company. “The most important thing we do is meet our numbers,” Nacchio declared. “It’s more important than any individual product, it’s more important than any individual philosophy, it’s more important than any cultural change we’re making. We stop everything else when we don’t make the numbers.” Through his words and deeds, Joe Nacchio created a culture that resulted in $2.5 billion of phantom earnings, landing himself in federal prison and devastating investors who saw the stock price tumble by 97 percent in the 18 months following his speech.
Senior managers at all publicly traded companies yearn to report positive news and impressive financial results that will satisfy investors and drive the share price higher. While most companies act ethically and follow the rules when reporting their financial performance, some take advantage of gray areas in the rules (or worse, ignore the rules altogether) in order to “make the numbers.
Waste Management: Investors Cannot Always Rely upon the Auditors
Described by the SEC as “one of the most egregious frauds we have seen,” Chicago-based trash hauler Waste Management Inc. (WM) inflated its pretax earnings by $1.7 billion over a six-year period starting in 1992. At that time, it represented the biggest misstatement of income in U.S. corporate history.
Waste Management grew dramatically over the period from 1993 to 1995, spending billions acquiring an unfathomable 441 companies. With these acquisitions came the inevitable special charges against income. These “one-time” charges became so common that during the seven-year period from 1991 to 1997, WM took write-offs in six of those years, totaling $1.6 billion. Since investors typically ignore special charges in evaluating profitability, WM appeared to be in tip-top shape. Also, to keep investors in the dark about what was really happening, WM offset (or “netted”) numerous one-time investment gains from asset sales against these special charges.
Waste Management was also notorious for finding ways to inflate profits by deferring expenses to a later period. The company aggressively capitalized maintenance, repair, and interest costs to the Balance Sheet rather than expensing them, and minimized the depreciation expense on its garbage trucks by using inflated salvage values and lengthening their useful lives.
After the SEC sued Waste Management alleging fraud, we later learned in reviewing the legal documents that its auditor, Arthur Andersen, was aware of accounting problems much earlier but chose to “protect” its client. As far back as 1993, Arthur Andersen quantified misstatements totaling $128 million, which, if recorded, would have reduced net income before special items by 12 percent. The Andersen partners, however, determined that the misstatements were “immaterial,” and they blessed the 1993 financial reports with a clean opinion.
Indeed, each year when Andersen raised accounting concerns with WM, the proposed adjustments and restatements—not surprisingly—were ignored by management. During the 1995 audit, Andersen clearly disagreed with WM’s approach to netting one-time gains against special charges and the choice not to disclose the practice. Here are excerpts from the auditor’s 1995 internal memorandum:
The Company has been insensitive to not use special charges [to eliminate Balance Sheet errors and misstatements that had accumulated in prior years] and instead has used “other gains” to bury charges for Balance Sheet clean-ups.
onsider CUC International, a darling stock for much of the 1980s–1990s, run by Walter Forbes. By the mid-1990s, CUC started making acquisitions that should have given investors a wake-up call. In April 1996 the company acquired Ideon Group for nearly $400 million. Through the merger, CUC inherited substantial litigation obligations, and booked a reserve for these costs totaling $137 million. Shortly after Ideon closed, CUC bought Davidson and Sierra On-Line for around $2 billion. These businesses produced educational software games, completely unrelated to CUC’s core business, and also came with significant merger-related reserves.
Cendant was created in December 1997, through the merger of Henry Silverman’s HFS and Walter Forbes’s CUC International. This practice of creating merger-related reserves continued in late 1997 (when CUC was about to merge with HFS to form Cendant), as CUC set up a reserve to write off a staggering $556 million associated with this deal.
The stock eventually collapsed in March 1998 when accounting problems at CUC were revealed to investors. When the subsequent investigations and litigation concluded, the total costs of the fraud were staggering. Consider that in 1996 and 1997 alone, investigators found more than $500 million of bogus operating income. Walter Forbes was sentenced to 12 years in prison and assessed $3.25 billion in restitution for his crime. And CUC’s auditor, Ernst & Young, which failed to perform the appropriate tests to spot the fraud, paid $300 million to settle class-action litigation.
Enron: Numbers That Seem Unbelievable Should Not Be Believed
Unlike acquisition-fueled frauds like Waste Management and CUC, Enron’s trickery was entirely organic: it simply changed its business model (and accounting policies) in a dramatic way. Enron, perhaps the most recognizable accounting fraud of the past generation, was a largely unknown producer of natural gas that within a few years morphed into an enormous commodities trading company. This dramatic change in business model was accompanied by a meteoric rise in revenues through the late 1990s. In just five short years, Enron’s revenue had increased by an astounding factor of 10, growing from $9.2 billion in 1995 to $100.8 billion in 2000. In 2000 alone, Enron’s sales grew a staggering 151 percent, from $40.1 billion to $100.8 billion.
Curious investors might question how often other companies have managed to grow their revenue from under $10 billion to over $100 billion in just five years. The answer: never. Enron’s staggering increase in revenue was unprecedented, and the company achieved this growth without any large acquisitions along the way. Impossible! Underlying the reported revenue growth was the company’s unusual treatment of trading activities as sales. These transactions resulted in modest profits, but because the notional values of trades were accounted for as part of revenue (and cost of goods sold), it gave the appearance that the business was in a period of hypergrowth.
WorldCom: Focus on Free Cash Flow in Addition to Earnings
Throughout WorldCom’s history, its growth came largely from making acquisitions. (As we will explain later in Part Five, acquisition-driven companies offer investors some of the greatest challenges and risks.) WorldCom’s largest deal closed in 1998 with its $40 billion acquisition of MCI Communications.
Almost from the beginning, WorldCom used aggressive accounting practices to inflate its earnings and operating cash flows. Much like CUC, one of its principal shenanigans involved making acquisitions, writing off much of the costs immediately, creating reserves, and then releasing those reserves into income as needed. With more than 70 deals over the company’s short life, WorldCom continued to “reload” its reserves so that they were available for future releases into earnings.
By early 2000, with its stock price declining and intense pressure from Wall Street to hit earnings targets, WorldCom embarked on a new and far more aggressive shenanigan—moving ordinary business expenses from its Income Statement to its Balance Sheet. One of WorldCom’s major operating expenses was its so-called line costs. These costs represented fees that WorldCom paid to third-party telecommunication network providers for the right to access their networks. Accounting rules clearly required that such fees be expensed and not capitalized. Nevertheless, WorldCom removed hundreds of millions of dollars of its line costs from its Income Statement to please Wall Street. In so doing, WorldCom dramatically understated its expenses and inflated its earnings, duping investors.
As earnings were being overstated, investors would have found some clear warning signs in evaluating WorldCom’s Statement of Cash Flows, specifically, its rapidly deteriorating free cash flow. WorldCom had manipulated both its net earnings and its operating cash flow. By treating line costs as an asset instead of an expense, WorldCom improperly inflated its profits. In addition, since it improperly placed those expenditures in the Investing section rather than the Operating section of the Statement of Cash Flows, WorldCom similarly inflated operating cash flow. While reported operating cash flow appeared consistent with reported earnings, the company’s free cash flow told the real story.
In early 2002, a small team of internal auditors at WorldCom, working on a hunch, were secretly investigating what they thought could be fraud. After finding $3.8 billion in inappropriate accounting entries, they immediately notified the company’s board of directors, and events progressed swiftly from there. The CFO was fired, the controller resigned, Arthur Andersen withdrew its audit opinion for 2001, and the SEC launched its investigation.
WorldCom’s days were numbered. On July 21, 2002, the company filed for Chapter 11 bankruptcy protection, the largest such filing in U.S. history at the time (a record that has since been overtaken by the collapse of Lehman Brothers in September 2008). Under the bankruptcy reorganization agreement, the company paid a $750 million fine to the SEC and restated its earnings in an amount that defies belief. In total, the company reported an accounting restatement that exceeded $70 billion, including adjusting the 2000 and 2001 numbers from the originally reported gain of nearly $10 billion to an astounding loss of over $64 billion. The directors also felt the pain, having to pay almost $25 million to settle class-action litigation.
In a report commissioned by the bankruptcy court judge to investigate the Lehman collapse, attorney Anton Valukas alleged that the company had cleverly misled investors and creditors by hiding $50 billion of debt from its Balance Sheet. This deception related to Lehman’s aggressive interpretation of an arcane (and since changed) accounting rule known as “Repo 105.”
When borrowing cash through very short-term collateralized loans, say for payroll, the cash received should be reflected on the Balance Sheet as a liability, and the assets given in collateral should remain on the borrower’s Balance Sheet. The “Repo 105” rule allowed for an exception when the value of the assets given as collateral represented at least 105 percent of the loan value. In these cases, the transaction was no longer accounted for as a loan, rather it was considered a sale and subsequent repurchase of the collateral assets. Lehman seized upon this loophole and in doing so recorded its collateralized borrowings as asset sales. As such, instead of recording a short-term liability for the cash received, Lehman would record a temporary reduction to its assets.
The bankruptcy examiner’s report highlighted a suspicious spike in Lehman’s Repo 105 transaction balance at the month-ends corresponding with either a quarterly or year-end filing. Since the need for overnight borrowings should remain fairly consistent throughout a quarter, the jump in Repo 105 transactions only on dates corresponding to financial filings may suggests that Lehman artificially depressed its liability balance in order to mislead investors into believing that the company’s leverage was lower. Table 1-2 shows the monthly trend in Lehman’s Repo 105 balance. Note that in May 2008, the Repo 105 balance jumped to $50.8 billion from $24.6 billion in March and $24.7 billion in April 2008. This same suspicious phenomenon is found in the earlier period, as well.
We classify financial shenanigans into four broad groups (discussed in Parts Two to Five in the book): Earnings Manipulation Shenanigans (Part Two), Cash Flow Shenanigans (Part Three), Key Metric Shenanigans (Part Four), and Acquisition Accounting Shenanigans (Part Five).
We have identified the following seven categories of Earnings Manipulation (EM) Shenanigans that result in misrepresentations of a company’s sustainable earnings.
EM Shenanigan No. 1: Recording revenue too soon
EM Shenanigan No. 2: Recording bogus revenue
EM Shenanigan No. 3: Boosting income using one-time or unsustainable activities
EM Shenanigan No. 4: Shifting current expenses to a later period
EM Shenanigan No. 5: Employing other techniques to hide expenses or losses
EM Shenanigan No. 6: Shifting current income to a later period
EM Shenanigan No. 7: Shifting future expenses to the current period
CF Shenanigan No. 1: Shifting financing cash inflows to the Operating section
CF Shenanigan No. 2: Moving cash outflows from the Operating section to other sections
CF Shenanigan No. 3: Boosting operating cash flow using unsustainable activities Shenanigans
Key Metric Shenanigans (Part Four)
So far, we have addressed shenanigans in the traditional financial statements. Increasingly however, business results are presented outside of this format in order to cater to a wider range of company-specific and industry-specific metrics. These include measures such Same-Store-Sales, Bookings, Average Revenue per User (ARPU), Return on Invested Capital (ROIC), Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA) and many others. Since they are outside the realm of GAAP, companies have much more latitude in calculating and reporting key metrics. Naturally this creates an opportunity for shenanigans. Part Four introduces two categories of Key Metric (KM) Shenanigans.
KM Shenanigan No. 1: Showcasing misleading metrics that overstate performance
KM Shenanigan No. 2: Distorting Balance Sheet metrics to avoid showing deterioration
Acquisition Accounting Shenanigans (Part Five)
Over the last quarter century, we have found some of the most disturbing shenanigans hidden through the complicated acquisition accounting process. We have therefore added this section to this new edition of Financial Shenanigans to highlight the complexities inherent in evaluating M&A-driven companies and to identify the common shenanigans that often trip up investors.
AA Shenanigan No. 1: Artificially boosting revenue and earnings
AA Shenanigan No. 2: Inflating reported cash flow
AA Shenanigan No. 3: Manipulating key metrics
Whether the goal is preserving a democracy or upholding the integrity of financial reporting, a system of checks and balances is paramount for preventing, uncovering, and punishing improper behavior. And much like the U.S. government, financial reporting has three distinct “branches,” an Income Statement, a Balance Sheet, and a Statement of Cash Flows. When one of these financial statements contains shenanigans, warning signs generally appear on the other ones. Thus, Earnings Manipulation Shenanigans can often be detected indirectly through unusual patterns on the Balance Sheet and the Statement of Cash Flows. Similarly, deciphering certain changes on the Income Statement and the Balance Sheet often can help investors sniff out Cash Flow Shenanigans.
What Environment Breeds Shenanigans?
Companies with structural weaknesses or inadequate oversight provide a fertile breeding ground for shenanigans. Investors should probe a company’s governance and oversight by asking these basic questions: (1) Do appropriate checks and balances exist among senior executives to snuff out corporate misdeeds? (2) Do outside members of the board play a meaningful role in protecting investors from greedy, misguided, or incompetent management? (3) Do the auditors possess the independence, knowledge, and determination to protect investors when management acts inappropriately? And (4) has the company improperly taken circuitous steps to avoid regulatory scrutiny?
In 2008 executives at India’s information technology giant Satyam decided to acquire a company, Maytas, in a transaction that required board approval. The board met and acquiesced to management’s request, even though the CEO’s sons controlled the target company. Specifically, Satyam’s board approved the recommendation to invest $1.6 billion for 100 percent of Maytas Properties and 51 percent of Maytas Infrastructure. (The word Maytas is Satyam spelled backward—another clue for all you Sherlock Holmeses about the related-party nature of the deal.)
The board should have objected to the acquisition not only because the CEO’s sons controlled the target company but also because it made little sense. Any Satyam director should have been puzzled that the company was proposing to invest $1.6 billion in related-party real estate ventures (certainly not its core business) at a time when its core business was under pressure and additional investments would have likely been better directed toward staving off the competition.
While the board agreed to the acquisition, it was aborted the next day after an investor uproar. Satyam’s CEO later told authorities that the deal was the last attempt to replace Satyam’s fictitious assets with real ones. A sign of a healthy and effective board is when a dissenting view overturns a management-driven consensus. That clearly did not happen at Satyam.
The fraud and collapse of Parmalat, the Italian dairy behemoth, has been referred to as the “Enron of Europe.” While the business and accounting issues differ, both Enron and Parmalat had one obvious similarity: independent auditors missed the fraud.
One intriguing fact in this case concerns Parmalat’s change in its primary auditor from Grant Thornton to Deloitte & Touche. Indeed, Parmalat’s chicanery might have continued longer had it not been for an Italian law that requires companies to switch audit firms every nine years. Deloitte & Touche replaced auditor Grant Thornton in 1999 and may have been the first to scrutinize certain offshore accounts, which turned out not to exist (many of which were still audited by Grant Thornton at the time, as they were not subject to Italian law). As a result, fraudulent offshore entities were exposed, including Bonlat, a Cayman Islands subsidiary of Parmalat and one of the primary vehicles used to hide fake assets.
April 28, 2024
I would read this book over and over again!
It will make you a better investor and even potentially spot divergence in the market!
It will make you a better investor and even potentially spot divergence in the market!
February 15, 2024
The title makes this book sound dry, but it’s loaded with fantastic anecdotes about most of the major accounting scandals from the last fifty years. Yes, it’s got the big ones you’ve heard of like Enron and WorldCom, but lots of more obscure ones too: crazy, audacious, how-did-they-ever-think-they’d-get-away-with-it scams. Maybe I’m weird, but I found it highly entertaining.
May 4, 2022
Understanding financial scams and gimmicks can be fairly straightforward by simply understanding where the numbers come from rather than taking them for granted in the context of an audited financial statement.
This book points out the shenanigans used to "put lipstick on a pig."
This book points out the shenanigans used to "put lipstick on a pig."
August 5, 2016
best book ive read all year
December 22, 2016
Reads like a novel with the content of a textbook.
October 9, 2019
The best of it's kind, a case study approach to forensic accounting, similar to "What's Behind the Numbers?", published by Wiley competitor McGraw Hill. "Financial Shenanigans" has a simple theme -there are all kinds of ways to obfuscate business activities when non-GAAP accounting practices are reported to the public, and many of these tricks center on a range of things from simply allocations of liabilities to profits, to more sophisticated measures like coordinating with vendor/supplier/buyers to quicken/slow down/exaggerate purchases often manifesting themselves as channel stuffing, double counting, or mis-attributing profits from serial acquisitions to name a few.
The later is probably the best known trick as the lack of strict government oversight in this case led to several M&A booms (and busts) over the past few decades. As a personal aside, I found it especially funny that one of the small-fry cases the text reviews was one from Kevin O'Leary, currently a co-host of "Shark Tank", the so-called "Donald Trump of Canada". Specifically, his potentially underhanded sale of his company "The Learning Company", a sort of shell firm that was able to portray itself as a profitable company by rapid acquisitions of other companies and listing those as assets for the black in their books, to Mattel, who themselves were doing the same thing.
Unfortunately for Mattel, their accountants failed to do their due diligence and dramatically overpaid for a company made up of smaller entities, many of which were bleeding capital quarter-over-quarter. Mattel's CEO resigned shortly after reporting multi-billion dollar losses, and in hindsight, we've seen Mattel in general declining in relative to terms since that deal with other main competitors, like Hasbro. The book outlines this trick several times in many different cases, and it never. One case of this that is briefly mentioned at the beginning of the text, but not actually cases was that of CUC, who's acquisition of Sierra Online destroyed that company, a story that has still not been properly written on but any text in the market.
What makes many of these tricks hard to stop is they often deal with activities that are not outright fraud, i.e. writing bogus numbers to the book, but instead deal with manipulating business operations in sales and supply chains to shift regular institutional activity to meet or exceed quarterly reports. In recent time, company's like IBM have been accused of this sort of thing in the business press.
The book is a good intro to this field and combined with either a formal course in accounting and/or forensic accounting, especially focused on fraud analytics, could probably serve one well in a plethora of applications from traditional corporate finance and audit/accounting, to informing valuation of companies for investment and/or IPO purposes. For the later use-case, it's especially good that so many case-studies of accounting trickery are outlined, to provide historical context in ways the recently (or imminently public) company could be portraying themselves more desirable than they really are, especially since many of these newer firms will be engaging in high-volume sales in their first few quarters at least, an activity that is definitely rife with potential manipulation. Highly recommended
The later is probably the best known trick as the lack of strict government oversight in this case led to several M&A booms (and busts) over the past few decades. As a personal aside, I found it especially funny that one of the small-fry cases the text reviews was one from Kevin O'Leary, currently a co-host of "Shark Tank", the so-called "Donald Trump of Canada". Specifically, his potentially underhanded sale of his company "The Learning Company", a sort of shell firm that was able to portray itself as a profitable company by rapid acquisitions of other companies and listing those as assets for the black in their books, to Mattel, who themselves were doing the same thing.
Unfortunately for Mattel, their accountants failed to do their due diligence and dramatically overpaid for a company made up of smaller entities, many of which were bleeding capital quarter-over-quarter. Mattel's CEO resigned shortly after reporting multi-billion dollar losses, and in hindsight, we've seen Mattel in general declining in relative to terms since that deal with other main competitors, like Hasbro. The book outlines this trick several times in many different cases, and it never. One case of this that is briefly mentioned at the beginning of the text, but not actually cases was that of CUC, who's acquisition of Sierra Online destroyed that company, a story that has still not been properly written on but any text in the market.
What makes many of these tricks hard to stop is they often deal with activities that are not outright fraud, i.e. writing bogus numbers to the book, but instead deal with manipulating business operations in sales and supply chains to shift regular institutional activity to meet or exceed quarterly reports. In recent time, company's like IBM have been accused of this sort of thing in the business press.
The book is a good intro to this field and combined with either a formal course in accounting and/or forensic accounting, especially focused on fraud analytics, could probably serve one well in a plethora of applications from traditional corporate finance and audit/accounting, to informing valuation of companies for investment and/or IPO purposes. For the later use-case, it's especially good that so many case-studies of accounting trickery are outlined, to provide historical context in ways the recently (or imminently public) company could be portraying themselves more desirable than they really are, especially since many of these newer firms will be engaging in high-volume sales in their first few quarters at least, an activity that is definitely rife with potential manipulation. Highly recommended
February 28, 2020
I started this book around 1 year ago and have had hard time to finish it due to my lack of knowledge in accounting and my lose of interests while reading the book. I expected the books to be more like a seminar documents with more detailed examples / problems rather than broad claims and general examples (Who don't know Enron, Worldcom, Toshiba were a fraud?). However, the book does provide useful accounting knowledge, especially for accounting beginners so I rate it 4 stars.
## Pros ##
This book teaches you how to read through the line and connect accounting items in the finance reports to understand the health of beneath business. In presents various ways accounting items can be manipulated and methods to detect those manipulations. Each chapter also includes various real life use cases of businesses, whose managers intentionally manipulated their businesses' earnings, cash flows, key financial metrics, to deceive investors.
## Cons ##
The examples in this book is not detailed enough and you might need to actually dig into the company's IR report to find the gimmicks. Some companies were requested by law enforcement at the time the gimmicks were detected, so you might not able to find the problematic report. Some points in the books to me don't sound like a gimmicks to me as they are not 100 percent illegal, so you were left with uncertainties whether the fraud was there.
## Pros ##
This book teaches you how to read through the line and connect accounting items in the finance reports to understand the health of beneath business. In presents various ways accounting items can be manipulated and methods to detect those manipulations. Each chapter also includes various real life use cases of businesses, whose managers intentionally manipulated their businesses' earnings, cash flows, key financial metrics, to deceive investors.
## Cons ##
The examples in this book is not detailed enough and you might need to actually dig into the company's IR report to find the gimmicks. Some companies were requested by law enforcement at the time the gimmicks were detected, so you might not able to find the problematic report. Some points in the books to me don't sound like a gimmicks to me as they are not 100 percent illegal, so you were left with uncertainties whether the fraud was there.
April 8, 2021
This was an entertaining and accessible book that should be a required read for anyone looking to invest in listed equities or who is looking to do balance sheet analysis.
The book aims to show different ways companies can account for different transactions to help you better understand their financial reports and what they are trying to tell investors. It also highlights red flags, or things that should be considered aggressive or looked at more closely. Companies are able to manipulated their reported cash flows, revenues, expenses, assets and liabilities to hide the real story, depending on their situation. It's important to not only look at numbers presented, but also read notes to financial statements to uncover any irregularities on inconsistences. This is work that not a lot of analysts do and is why a lot of fraud can and does go undetected. The book is light hearted, easy to read and shows a range of real life examples that explain their reasoning.
This book would be good to re read at different points of time as a refresher. Red flags include aggressive revenue recognition, cash flows that don't reflect earnings, swelling intangible assets, significant write offs when new management joins, insider sell downs, swelling inventories, reclassification of cash flows from investing to operating, auditor changes and many others.
The book aims to show different ways companies can account for different transactions to help you better understand their financial reports and what they are trying to tell investors. It also highlights red flags, or things that should be considered aggressive or looked at more closely. Companies are able to manipulated their reported cash flows, revenues, expenses, assets and liabilities to hide the real story, depending on their situation. It's important to not only look at numbers presented, but also read notes to financial statements to uncover any irregularities on inconsistences. This is work that not a lot of analysts do and is why a lot of fraud can and does go undetected. The book is light hearted, easy to read and shows a range of real life examples that explain their reasoning.
This book would be good to re read at different points of time as a refresher. Red flags include aggressive revenue recognition, cash flows that don't reflect earnings, swelling intangible assets, significant write offs when new management joins, insider sell downs, swelling inventories, reclassification of cash flows from investing to operating, auditor changes and many others.
October 20, 2022
Written by Howard M. Shilit, Jeremy Parker, and Yoni Englehart
I listened to the audiobook narrated by Scott Pollak. For my personal listening preference, I listened at 1.3 speed.
Even though some of the concepts presented were new to me, the authors explain things simply, and the entire book wasn’t full of complicated jargon. Many of the cases of financial shenanigans presented are fairly simply stated, and I found myself able to keep up with my limited knowledge of financial dealings.
I’m not even a big financial guru, but the stories about corporate, financial trickery were gripping to listen to. Some of these book cooking schemes were downright ridiculous, and I don’t want to use the phrase “enjoyable to listen to” because of how messed up some of the actions described were, but….
I liked that the authors repeated definitions of acronyms, and with my not being familiar with the terms, this helped solidify the terms in my mind as I listened.
Scott Pollak’s narration is generally crisp and clean. At one point, Pollak pronounces “scourge” as “scoowerge,” but the rest of the narration was very well done.
Overall, I highly recommend this audiobook if you are someone with a moderate base of knowledge in finance. The stories, delivery, and explanation of the situations surrounding the events are all done very well.
I listened to the audiobook narrated by Scott Pollak. For my personal listening preference, I listened at 1.3 speed.
Even though some of the concepts presented were new to me, the authors explain things simply, and the entire book wasn’t full of complicated jargon. Many of the cases of financial shenanigans presented are fairly simply stated, and I found myself able to keep up with my limited knowledge of financial dealings.
I’m not even a big financial guru, but the stories about corporate, financial trickery were gripping to listen to. Some of these book cooking schemes were downright ridiculous, and I don’t want to use the phrase “enjoyable to listen to” because of how messed up some of the actions described were, but….
I liked that the authors repeated definitions of acronyms, and with my not being familiar with the terms, this helped solidify the terms in my mind as I listened.
Scott Pollak’s narration is generally crisp and clean. At one point, Pollak pronounces “scourge” as “scoowerge,” but the rest of the narration was very well done.
Overall, I highly recommend this audiobook if you are someone with a moderate base of knowledge in finance. The stories, delivery, and explanation of the situations surrounding the events are all done very well.
January 12, 2023
The book is a guide to detecting financial irregularities and fraud in companies.
The authors provide a comprehensive overview of the various types of financial shenanigans that companies use to manipulate their financial statements, such as revenue recognition, channel stuffing, and big bath accounting. They also provide detailed examples of real-world cases of financial shenanigans and explain how investors can detect and avoid these practices.
The book also provides a step-by-step guide for investors to use in analyzing a company's financial statements, including tips on where to look for red flags and how to use financial ratios and other tools to uncover potential fraud.
The book also explains the role of auditors, rating agencies, and regulators in detecting and preventing financial shenanigans, and highlights the importance of corporate governance in preventing financial fraud.
In summary, "Financial Shenanigans" is a valuable resource for investors, financial professionals, and anyone interested in understanding the various types of financial fraud that companies use to manipulate their financial statements and how to detect and avoid them.
The authors provide a comprehensive overview of the various types of financial shenanigans that companies use to manipulate their financial statements, such as revenue recognition, channel stuffing, and big bath accounting. They also provide detailed examples of real-world cases of financial shenanigans and explain how investors can detect and avoid these practices.
The book also provides a step-by-step guide for investors to use in analyzing a company's financial statements, including tips on where to look for red flags and how to use financial ratios and other tools to uncover potential fraud.
The book also explains the role of auditors, rating agencies, and regulators in detecting and preventing financial shenanigans, and highlights the importance of corporate governance in preventing financial fraud.
In summary, "Financial Shenanigans" is a valuable resource for investors, financial professionals, and anyone interested in understanding the various types of financial fraud that companies use to manipulate their financial statements and how to detect and avoid them.
September 4, 2023
Pleaaassseeeeeeeee seriously guys please do not read this book! — fraudsters, probably.
Just kidding, that’s a quote from me to you. This book is so insanely boring for non-accountants. AND for accountants!! So what’s the point, then? KNOWLEDGE is the point. I will NOT allow fraud to slip through my fingertips as an incoming auditor. Not on my watch. Think of the most narc person you know then combine it with like the most boring subject in the history of human academia, and you get this book. And I absolutely love it. This book is gleaming with that good stuff. And by “that good stuff” I of course am referring to methodologies and tips to detect financial shenanigans. I am a literal master of Accounting who graduated with flying colors (flex) (albeit with 0 real life or professional experience) and there is information on almost every page that made me visit Investopedia and read the same definition 6 times in a row. How can accounting get so complicated? Isn’t it just like using tally marks to count things? You would think that would be the case. You’d be surprised. Thanks, Luca Pacioli and the Italian Renaissance.
Just kidding, that’s a quote from me to you. This book is so insanely boring for non-accountants. AND for accountants!! So what’s the point, then? KNOWLEDGE is the point. I will NOT allow fraud to slip through my fingertips as an incoming auditor. Not on my watch. Think of the most narc person you know then combine it with like the most boring subject in the history of human academia, and you get this book. And I absolutely love it. This book is gleaming with that good stuff. And by “that good stuff” I of course am referring to methodologies and tips to detect financial shenanigans. I am a literal master of Accounting who graduated with flying colors (flex) (albeit with 0 real life or professional experience) and there is information on almost every page that made me visit Investopedia and read the same definition 6 times in a row. How can accounting get so complicated? Isn’t it just like using tally marks to count things? You would think that would be the case. You’d be surprised. Thanks, Luca Pacioli and the Italian Renaissance.
July 16, 2020
With a title that includes the word "Shenanigans" you might be led to believe this will be a wild an wacky adventure through financial history. While this is somewhat true you'll be disappointed if you're looking for a laugh a minute. As a financial analyst and investor I found this book most helpful. Much of what is discussed is common sense, but perhaps mostly only in hindsight. I found myself scrambling to take notes the whole way through as the content is so applicable to financial analysis and so logically laid out that I wanted to be able to recall each individual tenet described.
The book masterfully gave examples of each shenanigan described with a company they discovered were using accounting trickery to mislead investors, which was good because without it the book would have been seriously lacking.
Probably not a book I'd recommend to people with only a passing interest in finance, but if you're serious about investing and financial analyst it's an absolute must read.
The book masterfully gave examples of each shenanigan described with a company they discovered were using accounting trickery to mislead investors, which was good because without it the book would have been seriously lacking.
Probably not a book I'd recommend to people with only a passing interest in finance, but if you're serious about investing and financial analyst it's an absolute must read.
March 24, 2019
While none of the ideas in this book are mind-blowing. I really liked the framework. Im sure the framework will help asking the right questions when evaluating the financial performance of potential acquisition targets.
I gave the book four rather than five stars because it didn't give me a feeling of having learnes something new. Rather, most people with flair for accounting or finance would probably be able to come up with similar explanations after the fact when fraud has been detected, but the book will probably be a solid starting point as a checklist for the most common things to look out for - it will save time in terms of researching on how companies historically have fitted the numbers to look in a particular way.
I gave the book four rather than five stars because it didn't give me a feeling of having learnes something new. Rather, most people with flair for accounting or finance would probably be able to come up with similar explanations after the fact when fraud has been detected, but the book will probably be a solid starting point as a checklist for the most common things to look out for - it will save time in terms of researching on how companies historically have fitted the numbers to look in a particular way.
July 16, 2020
If you already know the basics on accounting and financial statement analysis as well as you work in the investments industry, this is your book. There are more books about forensic accounting aimed at accountants, yet this book is aimed at investing practitioners looking forward to hone their forensic accounting skills in order to avoid avoid fraudulent long picks or screen good shorts ideas from an accounting and fundamental standpoint.
Some examples about what you will learn are how to identify bogus revenue, detect when the management is using one-time or unsustainable activities to boost profits, spot a shift in current expenses to a later period, confirm if a company is inflating operating cash flow using M&A or asset disposals, and many others.
Some examples about what you will learn are how to identify bogus revenue, detect when the management is using one-time or unsustainable activities to boost profits, spot a shift in current expenses to a later period, confirm if a company is inflating operating cash flow using M&A or asset disposals, and many others.
April 27, 2023
Fantastic.
Total roadmap to getting past smoke and mirrors created by the institutional imperative.
Perfect for operators and investors. Doesn't read like a book, reads like a manual– and rightly so. Gives great case examples too.
- Boomerang transactions
- Recording transactions too late/early
- financial disclosure changes
- capitalization shenanigans
- Supplemental cashflows info
- Actual Economic change vs Cosmetic Financial change
- Unsustainable cash flow growth
- Tobashi
- Boosting CFFO
- Stickiness and slippery slope of shenanigans
- Pro forma variations and false "one time presentations" that actually reoccur
I could go on
Perfect for M&A
lotta juice to squeeze
Total roadmap to getting past smoke and mirrors created by the institutional imperative.
Perfect for operators and investors. Doesn't read like a book, reads like a manual– and rightly so. Gives great case examples too.
- Boomerang transactions
- Recording transactions too late/early
- financial disclosure changes
- capitalization shenanigans
- Supplemental cashflows info
- Actual Economic change vs Cosmetic Financial change
- Unsustainable cash flow growth
- Tobashi
- Boosting CFFO
- Stickiness and slippery slope of shenanigans
- Pro forma variations and false "one time presentations" that actually reoccur
I could go on
Perfect for M&A
lotta juice to squeeze
December 21, 2020
This book is a well presented, systematic approach of pulling back the curtain on the murky hidden world that is concealed by at best meaningful figures, at worst fraudulent misrepresentations, clearly outlining the deficiencies found within the grey area of accounting, a grey area which manifests due to an incessant reliance of self-conflicting policing practices.
This book is nothing short of eye opening, obviously recommended reading for all interested in finance & accounting, but I would not hesitate to suggest recommended reading for all, to provide a greater understanding of the reality of 'money management'.
This book is nothing short of eye opening, obviously recommended reading for all interested in finance & accounting, but I would not hesitate to suggest recommended reading for all, to provide a greater understanding of the reality of 'money management'.
August 17, 2023
Read the report thoroughly.
Scrutinize the narratives contained in Footnotes.
=================
Earnings Manipulation
- Recording revenue too soon
- Recording bogus revenue
- Boosting income using one-time or unsustainable activities
- Shifting current expenses to a later period
- Employing other techniques to hide expenses or losses
- Shifting current income to a later period
- Shifting future expenses to the current period
Cashflow Manipulation
- Shifting financing cash inflows to the Operating section
- Moving cash outflows from the Operating section to other sections
- Boosting operating cash flow using unsustainable activities Shenanigans
Scrutinize the narratives contained in Footnotes.
=================
Earnings Manipulation
- Recording revenue too soon
- Recording bogus revenue
- Boosting income using one-time or unsustainable activities
- Shifting current expenses to a later period
- Employing other techniques to hide expenses or losses
- Shifting current income to a later period
- Shifting future expenses to the current period
Cashflow Manipulation
- Shifting financing cash inflows to the Operating section
- Moving cash outflows from the Operating section to other sections
- Boosting operating cash flow using unsustainable activities Shenanigans
March 8, 2022
Very eye opening! I have to admit to be guilty of overlooking some of the shenanigans mentioned in this book, which are more common than I imagined. The book does a great job of providing relevant examples with each financial shenanigans and I was shocked to learn that some well known companies were also participating in the shenanigans.
In short I would recommend all investors to read this book because you will become a better investor if you apply the forensic mindset in this book and save yourself from bad companies.
In short I would recommend all investors to read this book because you will become a better investor if you apply the forensic mindset in this book and save yourself from bad companies.
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