Cook the Books

What Is 'Cook the Books'?

Cook the books is a shoptalk term for using accounting stunts to cause a company's financial outcomes to seem noticeably more appealing than they really are. Regularly, cooking the books involves manipulating financial data to inflate a company's revenue and empty its expenses in order to pump up its earnings or profit.

Understanding Cook the Books

Companies can control their financial records to further develop their financial outcomes using a large number of tactics. A few companies don't record each of their expenses that incurred in a period until the next period. By recording a portion of Q1's expenses in Q2, for instance, a company's Q1 earnings or profit will look better.

Many companies who sell their product, stretch out terms to their customers, which allows them to pay the company sometime in the not too distant future. These sales are recorded as accounts receivables (AR) since they address product that has been sold and shipped, however the customers still can't seem to pay. The terms can be 30, 60, 90 days, or more. Companies can distort their AR by claiming that they made a sale and record the accounts receivable on the balance sheet. In the event that the fake receivable is due in 90 days, the company can make one more fake receivable 90 days from this point to show that current assets remain stable. Just when a company falls behind collecting its receivables will it show that there's a problem. Sadly, banks frequently loan, in part, in light of the value of a company's accounts receivables and can fall casualty to lending off false receivables. During a definite audit, the bank auditors would match the AR invoices to customer payments into the company's bank accounts, which would show any sums not being collected.

During the principal years of the new thousand years, several large Fortune 500 companies, like Enron and WorldCom, were found to have utilized sophisticated accounting stunts to exaggerate their profitability. All in all, they cooked the books. When these enormous frauds became known, the ensuing outrages gave investors and regulators a stark illustration in how cunning a few companies had become at hiding the truth somewhere within their financial statements.

Even however the Sarbanes-Oxley Act of 2002 reined in numerous questionable accounting practices, companies that are inclined to cook their books actually have a lot of ways of doing so.

Regulations Against Cooking the Books

To assist with restoring investor confidence, Congress passed the Sarbanes-Oxley Act of 2002. In addition to other things, it required that the senior officers of corporations confirm in writing that their company's financial statements conform to SEC disclosure requirements and fairly present in all material angles the operations and financial condition of the issuer. The U.S. Securities and Exchange Commission (SEC) assists with maintaining a fair and orderly financial market, which includes various financial reporting requirements for public corporations.

Executives who knowingly approve false financial statements might face criminal punishments, including jail sentences. Yet, even with Sarbanes-Oxley in effect, there are as yet various ways that companies can cook the books assuming they're determined to do as such, as the following models represent.

Instances of Cooking the Books

Credit Sales and Inflated Revenue

Companies can utilize credit sales to overstate their revenue. That is on the grounds that the purchases customers make on credit can be booked as sales even in the event that the company allows the customer to postpone payments for a considerable length of time. As well as offering in-house financing, companies can broaden credit terms on current financing programs. Thus, a 20% leap in sales could just be due to another financing program with simpler terms as opposed to a real increase in customer purchases. These sales turn out to be reported as net income or profit, long before the company has actually seen that income — in the event that it at any point will.

Channel Stuffing

Manufacturers participated in "channel stuffing" ship unordered products to their wholesalers toward the finish of the quarter. These transactions are recorded as sales, even however the company completely anticipates that the merchants should send the products back. The appropriate technique is for manufacturers to book products shipped off wholesalers as inventory until the merchants record their sales.

Mischaracterized Expenses

Many companies have "nonrecurring expenses," one-time costs that are viewed as extraordinary events and far-fetched to reoccur. Companies can truly arrange those expenses as such on their financial statements. Notwithstanding, a companies exploit this practice to report expenses that they routinely incur as "nonrecurring," which causes their main concern and future possibilities to seem significantly more appealing than they are in reality.

Stock Buybacks

Stock buybacks can be a consistent move for companies with excess cash, particularly on the off chance that their stock is trading at a low valuation. A buyback is the point at which a company utilizes its cash to purchase a portion of the company's outstanding equity shares. Buybacks reduce the overall share count and regularly lead to a higher stock price. Be that as it may, a few companies buy back stock for an alternate explanation: to camouflage a decline in earnings for every share (EPS), and they frequently borrow money to do as such. By decreasing the number of shares outstanding, they can increase earnings per share even assuming the company's net income has declined.

• For instance, on the off chance that a company had a million outstanding equity shares and recorded net income or profit of $150,000, the company's EPS would be .15 pennies for every share ($150,000/a million).
• Nonetheless, in the event that the company bought back 200,000 shares and recorded a similar profit in the next quarter, the EPS would increase to .19 pennies for every share ($150,000/800,000).

Since company executives forecast their earnings per share for each upcoming quarter, beating that forecast can assist with creating a positive picture for the company and lead to a leap in the stock price. Share buybacks as a method to help EPS have been a disputable theme for a long time. Tragically, a few companies abuse the measurement by repurchasing shares to show that EPS has developed and surpassed their quarterly EPS forecast regardless of earning practically zero extra profit.

Features

• Commonly, cooking the books involves manipulating financial data to inflate a company's revenue, collapse expenses, and pump up profit.
• Cook the books is a shoptalk term for using accounting stunts to cause a company's financial outcomes to seem more appealing than they really are.
• Companies can utilize credit sales to overstate their revenue while others buy back stock to camouflage a decline in their earnings per share (EPS).