Financial statements manipulation by directors

What is financial statement manipulation?

Financial statement manipulation is the fraudulent practice of altering the financial records of a company to paint a false picture of its financial health. Despite the many steps taken by legislative and regulatory bodies, financial statement manipulation continues to spread especially in publicly traded companies.

How does financial statement manipulation occur?

Financial statement manipulation is the act of intentionally altering financial statements to make a company look more profitable than it is. It can occur in several ways but typically involves either overstating or understating income, expenses, or assets.

1. Cooking the books: This is when a company doctors the numbers on their financial statements to make it look like they are doing better than they are. This can be done by inflating revenue numbers, understating expenses, or anything else that would make the company looks more profitable than it actually is.

2. Creative accounting: This is when a company uses accounting methods that are not in line with generally accepted accounting principles (GAAP) in order to make their financial statements look better. This can be done by using creative accounting methods to inflate revenue or using off-balance-sheet financing to hide debt.

3. Improper disclosures: This is when a company withholds information from its financial statements that would make them look less profitable. This can be done by hiding expenses, failing to disclose loans or anything else that would make the company look more financially healthy than they actually are. Financial statement manipulation involves two things: inflating apparent revenues or manipulating them to show reduced liabilities or expenses.

Other common tricks used by directors to create a false picture of a company’s financial status include:

? Recording revenues before the supply of goods or services

? Reporting as a business revenue income obtained from capital or investments from loans

? Posting inaccurate liabilities – or failing to report them altogether

? Shifting business expenses from the income statement to the balance sheet.

One surprisingly simple way of financial statement manipulation involves inflating a company’s assets using fake inventory count values. Your directors may perform an inventory count and add more items to each category. For example, they may decide to add 100 items to each category inflating your assets by hundreds or even millions of dollars

Why Do Directors Manipulate Financial Statements?

There are several reasons why directors might manipulate their financial statements. Some do it to make their companies look more profitable than they actually are in order to attract investors. Others do it to artificially inflate their stock's value so they can sell it at a higher price. Still, others do it to hide financial problems from creditors or regulators.

Red flags

If you’re keen, you can spot financial statements manipulation by looking out for the following red flags:

• Accounting anomalies, such as growth in revenues but without a corresponding growth in cash flows.
• Trajectory sales growth when competitors are struggling.
• The sudden replacement of an auditor led to the mysterious disappearance of crucial records.
• Weak internal corporate governance increases the possibility of fraudulent financial statement reporting
• A surge in your company’s performance when the last reporting period of a financial year.

What shareholders can do

If you detect red flags, you need to investigate further. There are plenty of options to help shareholders against possible fraud. These tips can help you detect financial statements fraud:

• Vertical analysis: Take every item in the income statement as a percentage of revenue and compare its year-to-year trends. Do the same to the balance sheet and use total assets as the benchmark to monitor significant deviations over time.
• Comparative ratio analysis: Compare a day’s sales in leverage multiples, receivables, and other metrics to spot inconsistencies.
• Use the Beneish model: Helps you to evaluate up eight ratios to determine the chances of financial statement manipulations. The ratios include asset quality gross margin deprecation and leverage.

Laws are in place to ensure companies report their financial status truthfully to protect the interests of shareholders and investors. But these protections may not be enough to curb financial statement fraud. Shareholders need to review a company’s financial statements regularly and earn how to spot the red flags. This can go a long way to stop bad actors from trying to conceal fraudulent practices such as covering losses or laundering money.

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