Financial Shenanigans by Howard Schilit

Financial Shenanigans by Howard Schilit

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Financial Shenanigans by Howard Schilit

Financial Shenanigans was written by Howard Schilit. The main objective of the book is to show ways companies can alter their financial accounting reports to reflect a much attractive appearance of their company’s health and growth when indeed that company is running into severe trouble. There are different ways the company can accomplish this and the author gives us “Seven Shenanigans” that companies can change the investor’s point of view towards the performance of the company. Basically, he breaks up each chapter to the particular shenanigan and discusses different techniques for achieving each shenanigan. For example, the author used Priceline.com, Cendant/CUC, AOL, and Xerox to illustrate each shenanigan. Chapter 11 and 12 of the book discusses the analyzing of financial reports and how to use financial databases to discover warning signs. Then there is another chapter on finding shenanigans in the company’s annual 10K report and how to find hints for financial shenanigans.
Financial shenanigan could be defined as actions that purposely distort a company’s financial condition and performance. The Seven Shenanigans are:
1. Recording revenue too soon.
2. Recording bogus revenue.
3. Boosting Income with one time gains.
4. Shifting current expenses to a later or earlier period.
5. Failing to disclose liabilities.
6. Shifting current income to a later period.
7. Shifting future expenses into the current period.

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I think the most common shenanigans would be Revenue Recognition as we have discussed in class. This seems to be a combination of two shenanigans: Recording revenue to soon and Failing to disclose liabilities. For example, if a company received advanced payments for services to be performed in the future and if they record this payment as revenue then it has used both shenanigans because they should have showed it as a liability under unearned revenue. There are two basic strategies that Schilit discusses and they are: To inflate current period earnings by inflating current period revenue and gains or by deflating current period expenses and to deflate current period earnings (and consequently, inflate future period results) by deflating current period revenue or by inflating current period expense.
In the other chapters, he breaks down into detail to explain each shenanigan, the technique companies use to perform the shenanigan, and gives examples of real companies that have used the shenanigan to change how their accounting books look. He also has given us the tools that corporate mangers use to cook the books. He also teaches us how to critically examine financial statements. His three major steps are: 1.) Create and analyze the common size balance sheet and income statement, 2.) Carefully read the footnotes and 3.) Compare the cash flow from operations to net income. Also he has to special chapters and those are acquisition accounting tricks and revenue recognition. I think acquisition tricks are pretty important because acquisitions and mergers allow for many areas to hide financial account shenanigans. Some of the topics he discussed were reserve releases, shifting losses to stub periods, and taking large write-offs. As I have mentioned earlier revenue recognition is very important as we have had several discussions in class.
Financial Shenanigans is very important in reference to what we have covered in this class this semester. We can see that not recognizing revenue, recording liabilities and not properly accruing expenses can really affect our final bottom line number or even our balance sheet. Also, it can give us misleading information on how a company is performing.
What have I really learned from Financial Shenanigans? I think the most important lesson I have learned is how managers have many ways that they can purposely misrepresent the account records of a company in order to make their company look rather attractive. An example of this is to reduce the earnings in one year and then they can transfer those earnings to a following year. They do this because the company could have had a pretty good year and perhaps exceed the expectations from investors or they may think that the following year might be a bad year due to the economy. This gives the investors false impression about the company performance. Another lesson, I learned was proper revenue recognition. You can do this by recognizing revenue too soon, or improperly leaving out revenue recognition by using the completed contract method, whereas, the revenue can be taken into the current period or taking it into later periods. This will not represent current period earnings or deflate the current earnings while inflating future earnings. Also, another important lesson I learned was as an investor, I can use what I have learn from this author to go into reports of companies and spot things like receivables being higher than sales which would tell me improper revenue recognition or prepaid expenses going up relative to total assets which would tell me that improper capitalization of operating expenses.
I was very quick to learn that one cannot judge a book by its cover. I say this because my initial reaction was that this book would be boring since it dealt with accounting and finance, but after I read a few pages, Howard Schilit proved me wrong. This book was interesting and easy to read and understand. The author style of writing this book made it really interesting. Some of the company’s CEO were creative in how they could improperly capitalize expenses such as AOL and its marketing, or even how companies would take big write-offs when acquiring other companies. We even had some companies write off more than what they paid to acquire them. This book helped me in this class because it has went over some of the things we have gone over in class and given me a better understanding of those terms and applications that we have learned in class. It gave me true life situations where they have applied these shenanigans such as revenue recognition, unearned service revenue, capitalization and depreciation. It also lets me know that financial reports of a company do not give me the whole story of the company. I need to go beyond what is given to get a true story of how they are really performing.
Howard Schilit, the author, did a great job to get his point across to the reader. He presents the reader with the tools CEO’s use to misrepresent financial reports and at the same time tools used to detect the tricks that they use. With the major accounting meltdowns of WorldCom and Enron, this book should be a “tool” that investors should utilize in detecting accounting gimmicks and fraud in financial reports.
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