Warning Signs.docx

Warning Signs.docx

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WarningSigns

WarningSigns:

RecordingRevenueTooSoon（EMShenaniganNo.1）

●Recordingrevenuebeforecompletinganyobligationsundercontract

●Recordingrevenuefarinexcessofworkcompletedonacontract

●Up-frontrevenuerecognitiononlong-termcontracts

●Useofaggressiveassumptionsonlong-termleasesorpercentage-of–completionaccounting

●Recordingrevenuebeforethebuyer’sfinalacceptanceoftheproduct

●Recordingrevenuewhenthebuyer’spaymentremainsuncertainorunnecessary

●Cashflowfromoperationslaggingbehindnetincome

●Receivables（especiallylong-termandunbilled）growingfasterthansales

●acceleratingsalesbychangingtherevenuerecognitionpolicy

●Usinganappropriateaccountingmethodforanunintendedpurpose

●Inappropriateuseofmark-to-marketorbill-and–holdaccounting

●Changesinrevenuerecognitionassumptionsorliberalizingcustomercollectionterms

●sellerofferingextremelygenerousextendedpaymentterms

WarningSigns:

RecordingBogusRevenue（EMShenaniganNo.2）

●Recordingrevenuefromtransactionsthatlackeconomicsubstance

●Recordingrevenueformtransactionsthatlackareasonablearm’s-lengthprocess

●Lackofrisktransferfromsellertobuyer

●Transactionsinvolvingsalestoarelatedparty,affiliatedparty,orjointventurepartner

●Boomerang（two-way）transactionstonontraditionalbuyers

●Recordingrevenueonreceiptsfromnon-revenue-producingtransactions

●Recordingcashreceivedfromalender,businesspartner,orvendorasrevenue

●Useofaninappropriateorunusualrevenuerecognitionapproach

●Inappropriatelyusingthegrossratherthanthenetmethodofrevenuerecognition

●Receivables（especiallylong-termandunbilled）growingmuchfasterthansales

●Revenuegrowingmuchfasterthanaccountsreceivable

●Unusualincreasesordecreasesinliabilityreserveaccounts

WarningSigns:

BoostingIncomeUsingOne-TimeorUnsustainableActivities（EMShenaniganNo.3）

●Boostingincomeusingone-timeevents

●Turningproceedsfromthesaleofabusinessintoarecurringrevenuestream

●Cominglingfutureproductsaleswithbuyingabusiness

●Shiftingnormaloperatingexpensesbelowtheline

●Routinelyrecordingrestructuringcharges

●Shiftinglossestodiscontinuedoperations

●Includingproceedsreceivedfromsellingasubsidiaryasrevenue

●Operatingincomegrowingmuchfasterthansales

●Suspiciousorfrequentuseofjointventureswhenunwarranted

●Misclassificationofincomefromjointventures

●UsingdiscretionregardingBalanceSheetclassificationtoboostoperatingincome

WarningSigns:

ShiftingCurrentExpensestoaLaterPeriod（EMShenaniganNo.4）

●Improperlycapitalizingnormaloperatingexpenses

●Changesincapitalizationpolicyoracceleratedcapitalizationofcosts

●Neworunusualassetaccounts

●Jumpinsoftassetsrelativetosales

●Unexpectedincreaseincapitalexpenditures

●Amortizingordepreciatingcoststooslowly

●Stretchingoutdepreciableassetlife

●Improperamortizationofcostsassociatedwithloans

●Failingtorecordexpensesforimpairedassets

●Jumpininventoryrelativetocostofgoodssold

●Failurebylenderstoadequatelyreserveforcreditlosses

●Decreaseinloanlossreserverelativetobadloans

●Declineinbaddebtexpenseorobsolescenceexpense

●Decreaseinreservesrelatedtobaddebtsorinventoryobsolescence

WarningSigns:

EmployingOtherTechniquestoHideExpensesorLosses（EMShenaniganNo.5）

●Failingtorecordanexpensefromacurrenttransaction

●Unusuallylargevendorcreditsorrebates

●Unusualtransactionsinwhichvendorssendoutcash

●Failingtorecordanexpenseforanecessaryaccrualorreversingapastexpense

●Unusualdeclinesinreserveforwarrantyorwarrantyorwarrantyexpense

●Decliningaccruals,reserves,or“softliability”accounts

●Unexpectedandunwarrantedmarginexpansion

●Unusually“lucky”timingontheissuanceofstockoptions

●Failingtoaccruelossreserves

●Failingtohighlightoff-balance-sheetobligations

●Changingpension,lease,orself-insuranceassumptionstoreduceexpenses

●Outsizedpensionincome

WarningSigns:

ShiftingCurrentIncometoaLaterPeriod（EMShenaniganNo.6）

●Creatingreservesandreleasingthemintoincomeinalaterperiod

●Stretchingoutwindfallgainsoverseveralyears

●Improperlyaccountingforderivativesinordertosmoothincome

●Holdingbackrevenuejustbeforeanacquisitioncloses

●Creatingacquisition-relatedreservesandreleasingthemintoincomeinalaterperiod

●Recordingcurrent-periodsalesinalaterperiod

●Suddenandunexplaineddeclinesindeferredrevenue

●Changesinrevenuerecognitionpolicy

●Unexpectedlyconsistentearningsduringavolatiletime

●Signsofrevenuebeingheldbackbythetargetjustbeforeanacquisitioncloses

WarningSigns:

ShiftingFutureExpensestoanEarlierPeriod（EMS-henaniganNo.7）

●Improperlywritingoffassetsinthecurrentperiodtoavoidexpensesinafutureperiod

●Improperlyrecordingchargestoestablishreservesusedtoreducefutureexpenses

●Largewrite-offsaccompanyingthearrivalofanewCEO

●Restructuringchargesjustbeforeanacquisitioncloses

●Grossmarginexpansionshortlyafteraninventorywrite-off

●Repeatedrestructuringchargesthatservetoconvertordinaryexpensestoaone-timeexpense

●Unusuallysmoothearningsduringvolatiletimes

CashFlowShenanigans

Part3.part3expandsthediscussiontotheStatementofCashFlows.Sinceinvestorshavestartedplacingmoreemphasisoncashflowfromoperations（CFFO）,notsurprisingly,managementhastriedtoperfectanewclassofshenanigans—thosethatinflatetheCFFO.FourgeneralCashFlow（CF）ShenanigansareusedtoinflateCFFO,andtheyarereflectedintheaccompanyingboxes.

WarningSigns:

ShiftingFinancingCashInflowstotheOperatingSection（CFShenaniganNo.1）

●RecordingbogusCFFOfromanormalbankborrowing

●BoostingCFFObysellingreceivablesbeforethecollectiondate

●Disclosuresaboutsellingreceivableswithrecourse

●InflatingCFFObyfakingthesaleofreceivables

●Changesinthewordingofkeydisclosureitemsinthefinancialreports

●Providinglessdisclosurethaninthepriorperiod

●Bigmarginexpansionshortlyafteraninventorywrite-off

WarningSigns:

ShiftingNormalOperatingCashOutflowstotheInvestingSection（CFShenaniganNo.2）

●Inflatingoperatingcashflowwithboomerangtransactions

●Improperlycapitalizingnormaloperatingcosts

●Neworunusualassetaccounts

●Jumpinsoftassetsrelativetosales

●Unexpectedincreaseincapitalexpenditures

●Recordingpurchaseofinventoryasaninvestingoutflow

●Investingoutflowsthatsoundlikeanormalcostofbusiness

●Purchasingpatents,contracts,anddevelopment-stagetechnologies

WarningSigns:

InflatingOperatingCashFlowUsingAcquisitionsorDisposals（CFShenaniganNo.3）

●InheritingOperatingcashinflowsinanormalbusinessacquisition

●Companiesthatmakenumerousacquisitions

●DecliningfreecashflowwhileCFFOappearstobestrong

●Acquiringcontractsorcustomersratherthandevelopingtheminternally

●BoostingCFFObycreativelystructuringthesaleofabusiness

●NewcategoriesappearingontheStatementofCashFlows

●Sellingabusiness,butkeepingtherelatedreceivables

WarningSigns:

BoostingOperatingCashFlowUsingUnsustainableActivities（CFShenaniganNo.4）

●BoostingCFFObypayingvendorsmoreslowly

●Accountspayableincreasingfasterthancostofgoodssold

●Increasesinotherpayablesaccounts

●LargepositiveswingsontheStatementofCashFlows

●Evidenceofaccountspayablefinancing

●Newdisclosureaboutprepayments

●Offeringcustomersincentivestopayinvoicesearly

●BoostingCFFObypurchasinglessinventory

●Disclosureaboutthetimingofinventorypurchases

●DramaticimprovementsinCFFO

●CFFObenefitfromone-timeitems

KeyMetricsShenanigans

Part4.Part4introducesreaderstoagroupofshenanigansthatstretchesmanagement’screativityindeceptiontothelimit.ThissectionofthebookshowsKeyMetrics（KM）Shenanigansusedtodistortaninvestor’sunderstandingoftheeconomicperformanceandhealthofthatcompany.Theaccompanyingboxessummarizeexactlyhowitisdoneandhowinvestorscanspotthesedevices.

WarningSigns:

ShowcasingMisleadingMetricsThatOverstatePerformance（KMShenaniganNo.1）

●Changingthedefinitionofakeymetric

●Highlightingamisleadingmetricasasurrogateforrevenue

●Unusualdefinitionoforganicgrowth

●Divergenceintrendbetweensame-storesalesandrevenueperstore

●Inconsistenciesbetweentheearningsreleaseandthe10-Q

●Highlightingamisleadingmetricasasurrogateforearnings

●Pretendingthatrecurringchargesarenonrecurringinnature

●Pretendingthatone-timegainsarerecurringinnature

●Highlightingamisleadingmetricasasurrogateforcashflow

●Highlightingamisleadingmetricontheearningsrelease

WarningSigns:

DistortingBalanceSheetMetricstoAvoidShowingDeterioration（KMShenaniganNo.2）

●Distortingaccountsreceivablemetricstohiderevenueproblems

●Failingtoprominentlydisclosethesaleofaccountsreceivable

●Convertingaccountsreceivableintonotes

●Increasesinreceivablesotherthanaccountsreceivable

●AhugedeclineinDSOfollowingseveralquartersofgrowingreceivables

●InappropriateofchangingmethodsofcalculatingDSO

●Distortinginventorymetricstohideprofitabilityproblems

●MovinginventorytoanotherpartoftheBalanceSheet

●Distortingfinancialassetmetricstohideimpairmentproblems

●Stoppingthereportingofcertainkeymetrics

●Distortingdebtmetricstohideliquidityproblems