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What's in a number? A lot, if they happen to be earnings numbers. And, thanks to the Enron saga, even audited numbers look a bit colorful now. As more and more revelations about financial manipulations keep pouring in, it raises a serious concern: Is financial reporting at a risk of losing its credibility?
Recently the Securities and Exchange Commission of USA filed a civil action lawsuit against two former executives of Critical Path, a San Francisco-based IT Services Company. The charge: The executives and other employees recorded revenue from eight fictitious, contingent, or backdated transactions in the third and fourth quarters of fiscal 2000. As a result of this action, the company understated its net loss for the third quarter of the fiscal by over 50 percent while the net loss for the year was understated by over 27 percent. In the settlement later, one of the executives agreed to pay a fine of $ 110,000 and a five-year ban on taking a job as an officer or director of a public limited company.
Critical Path is not a lone example. Wall Street is inundated in recent times by cases of questionable practices by companies to inflate their accounting numbers. Somewhere along the way the auditors also got entangled in the financial re-engineering that companies indulge in. Given the growing number of civil action lawsuits against several companies and as the ill-fated Enron case suggests, one can safely say that the situation now has reached crisis proportions. The recent allegations of accounting violations by companies including some high profile names like Cisco, IBM, Lucent, and Qwest are a pointer to the fact that if appropriate actions are not taken, we are bound to witness many more emperors emerging in their new clothes.
Earnings management can be simply defined as a misrepresentation of a company's financial performance. In broader terms, earning manipulations are actions or omissions intended to hide or distort the real financial performance of a firm. Such actions range from minor deceptions such as failing to clearly segregate operating from non-operating gains and losses to more serious abuses of accounting principles such as failing to write-off worthless assets; they also include fraudulent behavior, such as the recording of fictitious revenue to overstate the real financial performance.
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