Devin Kelly

Dr, Janet Massey

ACT-580-A

12/11/17

Financial Shenanigans: How to Detect Accounting Gimmicks & Fraud in Financial Reports

Howard M. Schilit & Jeremy Perler

McGraw Hill, 2010

 Unfortunately, fraud is a crime that is only going to continuously grow in the coming

years. Society can hide from it, run from it, but in the end it is a reality that will have to be met

head on. What is done at that point is up to those who have the power to enact and enable

change. Dr. Howard M. Schilit is the founder and chief executive officer of Schilit Forensics LLC

where clients are alerted of accounting chicanery. Jeremy Perier is both a certified public

accountant and a charted financial analyst who has served as an auditor for

PriceWaterhouseCoopers and now operates as a managing director of research at Schilit

Forensics LLC. Together these men have comprised a book that serves as an insightful and

detailed guide to help executives, accountants, auditors, and investors unearth deceptive

financial reporting. Schilit and Perier dive deep into the world of fraud and the endless magic

hat of tricks that corporations use in order to “meet the numbers”. Along the way, the reader

is brought up to date on all of the accounting trickery used in the business world and how to

use these tool presented by the author in a real world situation.

Financial Shenanigans is broken down into five parts. The first being an introduction

into the world of financial fraud and mischiefs. In order to grasp the ideas of the topics being

discussed in later chapters, Schilit and Perier summarize numerous high profile fraud cases.

Enron, WorldCom, Tyco, and Symbol Technologies are just some of the examples used in the

book. The authors break down what happened in each case, the shenanigans used by the

fraudsters, and the warning signs that something was very wrong with the financial statements.

For example, Symbol Technologies used bogus adjustment entries in order to meet the Wall

Street expectations. Warning signs of this would be the accounts receivable account surged

exponentially within 3 years and the cash flow from operations routinely lagged behind net
income, a sign of poor earnings quality. The second part of section one includes a breakdown

of the methods of financial manipulation that are covered in the book. Those ways are

earnings manipulation, cash flow manipulation, and key metrics manipulation. Also, Schilit and

Perier discuss what kind of business environments breed such behavior. Whether it is a

management team devoid of checks and balances or an auditor lacking objectivity and the

appearance of independence, there are many telltale signs that something may be wrong with

the company financials. Part two, three, and four go in depth with the different types of

shenanigans the authors chose to cover.

Earnings manipulation is broken down into seven different section detailing the various

ways that such fraud can happen within a company. Recording revenue too soon is the first

variation and is something that occurs quite frequently in terms of fraud. This can be done by

recording sales before completing any obligations under contract or in excess of work

completed just to name a few. Recording bogus or fake revenue is something that has been

occurring in business ever since GAAP was put in place. Businesses can inflate the amounts of

normal transactions or simply put down a transaction that lacks any economic substance.

Another variation of earnings manipulation would be boosting income using one-time or

unsustainable transactions. An example that Schilit and Perier provide is turning the sale of a

business into a reoccurring revenue stream. A situation such as this includes buy-back

transactions where a company will enter into an agreement to sell then buy back products but

mark down the purchases as actual sales. The fourth type or revenue falsification would be

untrue capitalization or shifting current expenses to a later period. According to Schilit and

Perier this can be done by improperly capitalizing normal operating expenses, amortizing costs
too slowly, failing to write down assets with an impaired value, or failing to record expenses for

uncollectable receivables. Following improper capitalization and shifting current expenses

around would be other techniques to hide expenses or losses. Failing to put down an expense

from a current transaction seems to be a favorite among companies that practice fraudulent

behavior since auditors will probably miss if one small expense was not recorded during a

transaction. The sixth variant to earnings tweaking is shifting income to a later period. Despite

many people thinking that management would want to move income into the current period

(falsely or not), the authors explain that some businesses may have to meet unrealistically high

investor expectations and in order to accomplish this the entity may create reserves then

release the earnings on record at a later date that way everyone is satisfied. That is just one

example of how shifting income can illegally work in a company’s favor. Finally, the last scheme

is shifting future expenses to an earlier period. Unlike shenanigan four, shifting expenses to an

earlier period makes these costs to the company go away quicker and reduces the expense

account. As the scribes explain, this can be done by improperly writing off assets in the current

period to avoid expenses in a future period or improperly recording charges to establish

reserves used to reduce future expenses. Schilit and Perier go into much more depth with this

topics but that would be a general summation of the lengthy and detailed part of the book.

In the third part of the book Schilit and Perier go over cash flow manipulations and how

companies can use the inflow or outflow of money to their advantage when it comes to

fraudulent activity. The first method cash flow shenanigans would be shifting financing cash

inflows to the operating section. This all could be done multiple ways such as recording fake

cash flow from operations from a normal bank borrowing, boosting cash flow by selling
receivables before the collection date, or inflating cash flow by faking the sale of receivables. A

perfect example of this would be the case of Delphi Corporation which the authors explain how

the corporation entered into an elaborate buy back deal with a bank to record bogus cash flow

from operating activities. Cash flow shenanigan number two is shifting normal operating cash

outflows to the investing section. In efforts to eliminate normal operating cash outflows

forever, companies will enact boomerang transactions, capitalize on operating costs, and

record inventory purchases as an investing outflow. Using Tyco and WorldCom as great

examples, Schilit and Perier describe how corporations use the third technique of cash flow

manipulation which is inflating operating cash flow using acquisitions or disposals. During their

hay day, Tyco and WorldCom boosted cash flow by creatively structuring the sale of businesses

and acquiring contracts or customers rather than developing them internally. The final

shenanigan in this section is boosting operating cash flow using unsustainable activities. Many

companies are guilty of paying vendors slowly, collecting from customers quickly, or purchasing

less inventory than required all in an attempt to boost cash flow from operating activities.

Home Depot is a prime example. Back in 2000, instead of paying their vendors properly, the

company slowed down payments just to increase the quality of the cash flow statement.

Unlike the previous two section of the book, in part four, the authors explore other key

metrics that should be used to evaluate a company’s performance and economic health.

Metrics being key measurements or tools. Something that happens quite often with fraudulent

companies is that they will showcase misleading metrics that overstate performance. An

example used in the book was how AOL inflated the subscriber count on bulk sales to

companies. When sales were decreasing, the company decided to fictitiously add new
subscribers to add to the subscription revenue account. Another misleading activity that

companies will partake in order to hide revealing metrics is to distort the balance sheet so

deterioration is not shown. This can be done by distorting accounts receivable to hide revenue

problems. A case of this would be Symbol technologies turning receivables into notes in an

attempt to hide the fraud. Other methods include messing with inventory measurements to

hide profitability problems, and distorting debt metric to hide liquidity issues. Closing out the

book, Schilit and Perier’s final section gives a recap of the entirety of the discussions as well as

recommendations for those who come across a situation such as those mentioned.

Again, this was just a brief overview of what the book offered to those who decide to

read it. However, it essential for any person involved in any aspect of business. Fraud affects

everyone in a corporation no matter the position or amount of power that may be at an

employee’s disposal. Schilit and Perier do a stupendous job in detailing this financial statement

manipulations and possible avenues for fraud. Each method is thoroughly explained and the

authors provide a wealth of examples that make the concepts easier to understand. Having to

read things that can be about twenty layers deep and more complex than a maze is a daunting

thing to think about. Thankfully the book reads fluently without bogging down the reader with

an overload of information. Since, especially with those without any accounting experience,

may find these things hard to navigate, it is a testament to Schilit and Perier for crafting such an

enjoyable read. Whether the reader is a student learning about fraud, a person who just wants

to learn about finances, a company executive, or a potential investor, Financial Shenanigans

offers valuable knowledge that should be a part of any person’s library of business literature.