BOSTON (TheStreet) -- When he first wrote Financial Shenanigans: How to Detect Accounting Gimmicks & Fraud in Financial Reports almost two decades ago, forensic accountant Howard Schilit drew examples from companies that are now a distant memory.
Preparing the recently released third edition, Schilit added nearly 200 pages of new material. The shenanigans these days are just as plentiful and often more sophisticated, he lamented during a recent presentation at the CFA Institute's annual meeting in Boston.
In addition to the frauds perpetrated by
, Schilit says many other companies engage in what he calls financial trickery, including
Common tricks, he says, include recording revenue too soon or before a customer pays, the use of extended payment terms and pushing greater amounts to the front end of a deal. Expenses and losses are similarly manipulated, shifting them to an earlier or later time, he says.
Companies have been caught intentionally shipping the wrong product, recording the revenue even they knew it would be returned. Software companies have shipped software in one quarter and activation codes in another to record revenue sooner. Expected earnings from multi-year licensing deals have been crunched entirely into one quarter.
What should investors be on the lookout for?
Be wary of any investment in a company by, or joint partnership with, a company's existing customer. The line between sales and other cash flows can easily be blurred.
If it's too good to be true, it probably is. Enron's now-obvious manipulations included reporting that its sales grew from $40 billion to over $100 billion in 2000, a spike made all the more questionable by the fact that reported profits were just 1% of those sales and never grew proportionally.
There are also warning signs that go beyond what you could find scouring annual reports and financial filings.
Be leery when a single family dominates management and the board. Incompetent boards are also unlikely to serve as adequate watchdogs. Schilit points to O.J. Simpson's tenure on the audit committee of
, questioning why, aside from celebrity status, he was ever considered qualified to oversee the intricacies of balance sheets.
Auditors lacking independence or collecting large fees are a red flag. Enron paid its convicted and disbanded accounting firm Arthur Andersen $52 million the year 2000 alone.
Press releases can also offer important clues as to how the books may be cooked.
"When a company puts out a press release, always ask the question, 'What were they trying to sell,' " Schilit says, citing releases that tipped off skullduggery with boasts of an amazing improvement in leverage, unusual sales spikes or partnerships that factor into a current or future quarter.
"If you are going to find accounting tricks at a company, nine times out of 10 the company told you where the skeletons are buried," he says.
-- Reported by Joe Mont in Boston.
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