Table of Contents
- Premature Recognition of Revenue
- Recognition of Bogus Revenue
- Onetime Items Masked as Recurring Items
- Deferral of Expense
- Hiding Expenses
- Shifting Revenue into the Future
- Shifting Expenses into the Present
- Unsustainable Generation of Cash Flow
- Overstating Performance Metrics
- Related Business essays
According to Dr. Howard M. Schilit (2002), shenanigans are untrustworthy activities aimed at distorting the accurate financial status of a business. Several factors influence the occurrence of shenanigans. They include helping a company avoid negative market perceptions and attracting investors. Shenanigans are easy to carry out and complete especially when the stock prices are high, and no one bothers investigating a company. One of the notable companies that do not escape the hammer of financial shenanigans is WorldCom. Below are some financial shenanigans and how WorldCom relates to some of them.
Premature Recognition of Revenue
Premature recognition of revenue is a situation whereby a company records revenue before it is lawfully eligible to be entered into books. It involves the conveyance of goods to a consumer before all transactions are finalized. In addition, a business records a sale when significant risks are imminent. This shenanigan is observed when a firm records revenues before offering services or delivering goods.
Recognition of Bogus Revenue
In this shenanigan, businesses record an increase in income even when it has not conducted any transaction. A business also records refunds as incomes and makes fraudulent estimates on provisional financials reports.
Onetime Items Masked as Recurring Items
Under this shenanigan, profits are boosted by selling undervalued assets and retiring debts. Failure to segregate non-recurring activities is also noted.
Deferral of Expense
Deferral of expenses is a situation whereby a company forwards expenses to future financial periods or quarters. Companies involved in this shenanigan capitalize costs improperly. They also depreciate or amortize costs slowly and fail to write off worthless assets. WorldCom was notorious for improper capitalization of line costs. Although line costs were leased from other telecommunications carriers and were supposed to be recorded as expenses, WorldCom capitalized these costs as assets. This vice resulted in the company reporting few expenses through statements of income while still paying out money.
In some transactions, payments are made before services are offered. In this case, a business conceals its obligations to the buyer and omits financial liabilities associated with prepayments. WorldCom used contingencies and transacted to conceal financial obligations from its books. The vice of capitalizing line costs and consequently removing the line cost from statement of income greatly reduced expenses and increased the company’s earnings.
Shifting Revenue into the Future
Shifting revenue into the future involves the creation and disbursement of reserves into income in a later financial period. For instance, if a company makes excess profits in the financial quarter, it may choose to release incorrect information to its investors indicating a slightly lower profit than the actual value. This practice creates excess revenue, which is used to boost future revenues in case they get below the expected earnings. The excess revenue gives the investors an illusion of a steady growth in the business. A good example is WorldCom, who used the “revenue” realized from capitalization of expenses as a reserve for their winter season.
Shifting Expenses into the Present
This shenanigan could involve recording future expenses in the current financial period. A business reduces its current earnings and charges them as expenses to cover future obligations. For example, WorldCom shifted $ 3.8 billion in expenses to capital accounts from operating accounts.
Unsustainable Generation of Cash Flow
Under this financial shenanigan, the main culprits are companies that have insufficient cash flow to operate their activities. Some of the techniques used include paying vendors at a slow rate. For example, payments that should be done within one month can be stretched out to one and a half months. At the end of three months, only two months worth of payment will have been made to the vendors. Thus, a quick brush on the books will reveal that the company has enough cash flow. Other techniques include collecting money from the customers faster than a set period. The influx in the collected cash only serves the purpose at the moment since the customers will have paid money long before due; when the right time for use of that money comes, the customer will not be in debt; the company will.
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Overstating Performance Metrics
Most companies overstate their financial metrics to investors by comparing their performance with the set targets. In case a company’s performance is below the set standards, it may fool the investors by changing the definition of a key metric to suit its present financial situation. Additionally, if a company wanted to show an increase in revenue, it may either unusually define its organic growth or diverge the trend between same-store sales (SSS) and revenue per store. To mislead investors on the company’s status of earnings, it might pretend that recurring charges are nonrecurring in nature, which leaves an influx of cash in their financial statements.