It is quite sad that many large multinational companies employ accounting tricks and gimmicks (also called shenanigans accounting) in order for their financial statements to become more attractive to venture capitalists and investors.
While the fraudulent accounting methods of both Enron and WorldCom were fortunately discovered, the usage of accounting tricks and gimmicks is still a widespread practice in business.
Accounting tricks are widely used to misinterpret a company’s assets, liabilities, equity, revenues and/or expenses. Needless to say, it is important that investors become aware of such tricks for them to safeguard their investments.
The following are just four of the most common accounting tricks investors should be aware of especially when analyzing possible investments.
Trick 1: Devaluation of plant, property and equipment.
A common accounting trick involves the devaluation of plant, property and equipment (PPE). The main reason for this is that it will lower the company’s deprecation charges, resulting in a smaller operating expense and ultimately higher income.
According to stockrip.com, the US Steel and Goodyear “wrote down their fixed assets from $1,338,522,858.98 to minus ($1,000,000,000.00.)” The accounting trick completely eradicated the company’s current and future depreciation expenses.
Trick 2: Belligerent recognition of gains and revenues.
Companies that want to look good to potential investors usually employ an aggressive method of revenue recognition. A good example of this accounting trick is the classification of cash received for future services (unearned revenue) as part of the accounting period’s revenue.
The revenue recognition employed in the example above is contrary to the concept of accrual basis accounting. Under the accrual basis accounting, revenue is recognized when earned and not when cash is received.
Trick 3: Short-term cost (operating expenses) being capitalized.
Another common accounting trick employed by some companies is the misrepresentation of short-term costs. Short-term costs particularly operating expenses such as office supplies expenses, utility expenses and research and development should be expensed as incurred.
However, in order to report smaller expenses and larger assets, some companies capitalized short-term costs.
Trick 4: Recording bogus and/or questionable revenue.
Another way to misrepresent financial data is by recording bogus and/or questionable revenue. This is quite different from belligerent recognition of income in a way that bogus and/or questionable revenue are basically nonexistent or unlikely to exist.
This accounting trick involves the recording of revenue despite the lack of economic substance and the classification of loans received as part of revenue.