Chapter 13 Liability Asset and Inadequate Disclosure Frauds
Waste Management
p. 446 Uniform Limited Partnership Act
 General partners used the assets of the limited partnership as collateral for personal
loans
 Note that the bank participated in the scam --- April 12, 1996
Liabilities are difficult to audit
bullets on p. 447
 Collusion by insiders and outsiders
 Forged documents
 A complex audit trail
 Off-book nature of the fraud, meaning that the records on the company’s books are not
fraudulent.
Excessive reserves can be used to manage future earnings
 Cookie jar
 Big bath
Sunbeam /. Grumley Nano Tech
Failing to record an inventory purchase understated Cost of Goods Sold & Accounts Payable
p. 449 Table 13.1
record payables in subsequent period
don’t record purchases
overstate purchase returns or purchase discounts
record payments on payables in earlier period than they were actually made
don’t accrue liabilities
don’t record warranty expenses
record deposits as revenue
don’t record repurchase agreements and commitments
don’t record contingent liabilities
lowball contingent liability estimates
Record unearned revenue as revenue
Under estimate future obligations
Warranty
Money-back gauantee
Pension liabilities
p. 451 Debt
GEC General Electrodynamic Corp.
Omit or lowball contingent liabilities
Pfizer heart valce
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p. 452 Analytical Symptoms Lehman Bros.
usually reported liabilities are too low
purchase returns or discounts are too high
premature recognition of unearned revenue
Accounting or Documentary Symptoms
Large purchases or payments recorded after year-end
Interest expense deducted on tax return but not on financial statements
Discrepancies between accounting records and bank confirmations
Discrepancies between accounting records and vendor confirmations
Large journal entries near end of period that increase revenues or reduce liabilities
Payments to defense attorneys without acknowledged litigation
Proactive
Liabilities with large declines year on year
Trend analysis
Statement of cash flows
Horizontal analysis
Ratios
Table 13.3 on page 455
Vertical analysis
Industry comparisons
Table 13.3
discuss ratios
Table 13.4
discuss items in the table
Board of Directors minutes
Letters from attorneys
Confirm vendors
Assets
typically overstatement
NJR
Waste Management
failed to record impairment
capitalized expenses
Computer Science
capitalized development costs even after it was apparent that
commercial success was unlikely
Small earnings management can grow into fraud
Earnings management creates a history of using accounting methods to meet targets
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WorldCom
reduced operating expenses by capitalizing expenses as assets.
Converted periodic line costs into assets.
Merger and Acquisition
Malibu Capital
Chester Holdings (p. 460)
AFCO
reverse merger to write up assets, the acquiring firm can write
assets of the acquired firm up to market value
what is the FMV of a private company’s stock?
The Syllabus said to stop at page 460
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Lincoln S&L
land flipping & sales where Lincoln provided the down pay
PNC Financial
Adelphis
Lehman Bros.
transferred losses to SPEs
Repo 105 -- sale or debt the other investment banks treated all
of their repurchase agreements as debt
Analytical Symptoms
Changes and trends in account balances
Compare changes and trends in financial statement relationships
Compare account balances to non-financial information
compare policies with similar companies
Accounting or Documentary symptoms
Merger & Acquisition
Kimberly Clark
excessive reserves
Is it OK for the acquiring firm to write up assets of the acquired?
Compare asset ratios of individual companies to the merged entity
Life expectancy of PPE for depreciation before and after the merger
Related Parties
Related parties
Were appraisals obtained
Were transactions near year-end
Did transactions involve an exchange of similar assets
Are the assets normal for this business
Fixed Assets
Insufficient depreciation expense or write down
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