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How Far These Top 3 Accounting Scandals Cooked The Books?

A well-known airline has accounted for USD 11.58 million as an exceptional item on its balance sheet for the June quarter. This accounting change increased a net profit of USD 1.81 million to show a healthier picture of their business operations. 

The finance manager cooked its books by changing the depreciation policy from the Written Down Method (WDM) to the Straight-line Method (SLM) while writing back a lot of money to its profit and loss account. The primary reason for changing their books was to exceed their market expectations and convert the operating expense into capital expenditure.

What is cooking the books? 

The term "cooking the books" is associated with financial statements falsified to make a business seem better than reality. Companies globally need to follow specific accounting rules and principles. If these rules are bent or broken, the "cooking of books" can occur.

Cooking the books typically means manipulating the financial data to inflate an organization's revenue and deflate expenses to pump up its profit and earnings.

The top 3 common ways to cook the book include:

1. Off-balance-sheet Items

Companies separate their subsidiaries as legal entities to transfer liabilities or incur undisclosed expenses. Their parent companies do not wholly own these subsidiaries, so they are hidden from investors.

2. Accelerating Pre-Merger Expenses

It might seem irrational; however, the acquired company will pay—preferably prepay—all the expenses that would be prudent before a merger is complete. Then, after the consolidation, the combined entity's earnings per share (EPS) and development rate will seem higher than in past quarters. Moreover, the organization will effectively reserve the expenses incurred in the past period.

3. Inflating Revenues

One approach to restrict inflating income is to book lump-sum amounts in a single year when service or product revenues are distributed over several years. For instance, a specialist software organization may get a forthright installment for a four-year administration solution contract yet record the full installment as a deal for the period that brought the installment. The right and correct way is to amortize the income over the existence of the contract.

Top 3 Accounting Scandals in the Past Decades

Each organization controls its monetary numbers somewhat to ensure financial plans balance, executives score rewards, and financial investors continue to offer up funding. Although such creative accounting is nothing new, greed, desperation, immorality, and impaired judgment can cause some executives to cross the line into outright corporate fraud.

Few organizations like Enron, Adelphia Communications, and Worldcom—fell titans whose corporate wrongdoings crushed lives, sent executives to jail, caused far-reaching monetary ruin for financial investors, and made the actual organizations collapse.

Listed here are a few notable companies who notoriously cooked the books, claiming billions in assets that didn't exist:

1. Enron Scandal (2001)

Industries: Energy

What was the Enron Scandal of 2001 about? 

The Enron corporation and its management resorted to an unethical scheme and malpractice of the off-balance-sheet mechanism. The executives created certain economic entities to hide the massive debt from its external stakeholders, namely creditors and investors. The special purpose entities ( SPEs) were utilized to conceal accounting realities rather than focus on the operating results.

  • The board of directors and the leadership team at Enron manipulated regulators and investors regarding the fake holdings and unrecorded accounting methods.
  • Enron created special-purpose entities (SPEs) or special-purpose vehicles (SPVs) to conceal huge debt and toxic assets from investors and creditors.
  • Enron's shares went from $90.75 at their peak to $0.26 at bankruptcy.
  • The company paid its creditors more than $21.7 billion from 2004 to 2011.

Impact of Scandal

Due to the bankruptcy of Enron, employees lost several perks and pension benefits. As a result, many arrived on the verge of a financial crisis. The crisis was so deep that the shareholders of the business lost an estimated value of $74 billion.

2. The WorldCom Scandal of 2002 

Industries: Telecommunications

What was the WorldCom Scandal of 2002 about? 

WorldCom, to make illegal and illicit profits in the business, used strategies in the accounting system. They recorded USD 3.8 billion worth of capital expenditure. This strategy disguised the profits earned and the company's five-quarter net losses. The books of accounts showed that the company grew each quarter and was in a strong financial position.

The WorldCom Scandal was a major accounting scandal that came to light in the summer of 2002.

  • From 1999 to 2002, senior executives and the founder orchestrated a scheme to inflate earnings to maintain WorldCom's stock price.
  • The fraud was uncovered in June 2002 when the company's internal audit unit discovered over $3.8 billion of fraudulent balance sheet entries.
  • Eventually, WorldCom was forced to admit that it had overstated its assets by over $11 billion. At the time, it was the largest accounting fraud in American history.

Impact of Scandal

The most significant effect was on the company's investors. After this scandal:

  • Congress quickly passed the Sarbanes-Oxley Act on July 30th, 2002
  • Strengthened the principles of corporate governance to prevent such fraud
  • Shuffled the Board of Directors and let go of 17,500 employees 
  • Implemented a new ethical program and appointed a new independent auditor

3. The Lehman Brothers Scandal 2008 

Industries: Investment Banking

What was the Lehman Brothers Scandal 2008 about? 

Lehman Brothers had deeply invested in mortgage-backed securities (MBSs) by the time the mid-2000s rolled around. The housing boom led to an overabundance of MBSs and collateral debt obligations (CDOs) being created, and by 2007, Lehman was the largest holder of MBS. Their vast investments in MBSs, many of which were teeming with subprime mortgage loans, led to the end of Lehman Brothers.

  • In January 2008, Lehman Brothers were the fourth-largest investment bank in the U.S.
  • By the end of 2008, Lehman Brothers Holdings Inc. had vanished from the investment banking landscape, the largest corporate bankruptcy filing (with $619 billion in debt) in U.S. history.
  • The key players were Lehman executives and auditors, Ernst & Young.
  • They allegedly sold toxic assets to Cayman Island banks, understanding that they would eventually repurchase them.
  • Thus, it created an impression that Lehman had $50 million more cash and $50 million less in toxic assets than it did.

Impact of Scandal

In the wake of Lehman Brothers' bankruptcy, approximately 26,000 of the firm's employees worldwide lost their jobs, and investors suffered immense losses. It fueled the country's most significant economic downturn since 1929.

Keeping Your Books Compliant, Not Cooked

Keeping corporate fraud and other creative accounting problems at bay can be challenging, especially if your current business processes are too opaque and manual to spot the warning signs. But with thorough checking of financial records, most companies can detect anomalies through proper auditing processes, risk models, and AI-based technology solutions.

As a solution, one must invest in a comprehensive plan like a Source-to-Pay solution. Connecting procurement and finance and centralizing the invoice collection, and management, besides analysis of all financial records makes it much easier to notice potential issues before they become disasters.

Organizations must create a secure environment where all purchases are routed through a centralized solution using process automation and restricted access to data. For example, use a solution wherein the entire vendor payments are recorded and tracked in real-time. 

Dashboards that provide on-demand financial reporting help in making better analysis.

Built-in compliance controls include automated 2/3 invoice matching, limiting account access to critical financial data, and audit trails. Advanced invoice approval workflow management ensures that your invoices are comprehensive, compliant, and accurate.

How Can Aavenir Invoiceflow Help Ensure Transparent Accounting for Your Organization?

Manual accounting processes and stacks of paperwork ultimately lead to data silos. These silos break up transparency in the organization, making it harder to analyze company spending and maintain vendor relationships thoroughly. As a result, you are opening yourself up to risk, fraud, and inefficiencies without a clear view of your accounting process.

Aavenir Invoiceflow can help your organization establish clear channels of vendor communication, increasing the visibility and transparency of the entire accounting process. With the help of this solution, the AP team can gain complete visibility of the status of invoices, payments, and purchase orders. Greater visibility would also ensure that the AP team would make better and more informed decisions.

Efficiency and transparency are achieved using touchless invoice processing use cases such as:

  • Cognitive Invoice Data Capture
  • Intelligent Data Validation for 2-way and 3-way Match
  • Invoice Payment Approval Workflow on ServiceNow

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