1. Analyzing Financial Statements
Financial Information
Balance Sheet
Income Statement
Cash Flow Statement
Financial Ratios
Trends
Industry Norms
Industry/Competitive Analysis

2. Cooking the Books Aggressive application of accounting rules Estimates
Fraud

3. Overstating Revenues Selling to Related Entities Stuffing the Channels
The party must be an “arms length”
Stuffing the Channels
Excessive quantities to distributors/retailers
Extended credit terms
Installment sales at Low Interest Rates
Artificially low interest rate to calculated time-adjusted cash flows = higher recognized Revenues

4. Overstating Revenues Using funds from Over-funded Reserves
Reserves obligation will fluctuate
Using over-funded Reserves can result in under-funding at later accounting periods.
Treat Nonrecurring Dispositions as Ordinary Income
“Below-the-line” gains are nonrecurring
Can over-state Income from normal business operations

5. Overstating Revenues Record Income for Future Services
“Bundled price” includes deferred expenses
May underestimate value of future services to over-state current Revenues

6. Understating Expenses
Unrealistic Depreciation/Amortization
Allowable to use a different method for public financial reports from Tax (IRS) reporting
Capitalize Questionable Expenses
Capitalization or Expense?
Capitalization = deferred expenses
Match Expenses to Revenues

7. Understating Expenses
Ignore the cost of Stock Options
When exercised
Increases outstanding shares and affects EPS
Loss of value to company if strike price below market price
How to value?
Must have some value to have meaning to recipient
Valuation methods require making assumptions

8. Overstate Assets or Understate Liabilities
Delay Recognizing Declining Asset Value
Dressing up the Balance Sheet
Accounts Receivable and Allowance for Doubtful Accounts
Loans Receivable and Allowance for Bad Debt
Inventory and Allowance for Obsolete Inventory
Fixed Assets and writing off obsolete assets
Investments and unrealistic market valuation
Conservatism requires the Accountant to understate assets

9. Failure to Disclose Liabilities
Must disclose all liabilities
Pending lawsuits
Pension costs
Toxic cleanup
Deferred Executive compensation
Use Unconsolidated Debt
Offload debt from one affiliated to another
Dresses up Balance Sheet
Relationships must be reported in footnotes