Making(Up)Numbers 161to matter very much to the managers at our company or to other
owners of options on our stock.
To reconcile managerial needs with the requirements of financial
reporting, the board adopted a new rule of materiality. Under it, no
economic activity is material to the company unless it impacts our
earnings by at least 5%. This rule is more definitive and reliable than
the ol drule an dwill result in greater certainty in our bookkeeping
department. By applying this approach to materiality, we can ignore
a variety of burdensome reporting questions, thus saving (material)
basketfuls of money.
As satire, the report from E-America Dot.Com reveals how atro-
cious an d distorte daggressive accounting an dearnings management
can be. (Most of the examples are base don actual cases.) However,
you will never see the kin dof can dor expresse din this news release
coming out of corporations. That kin dof honesty is inconsistent with
the goals underlying the shenanigans.
Accordingly, you will not recognize financial disingenuousness,
recklessness, aggressiveness, deception, or fraud when you see it un-
less you know how to look. You will fin dthe following examples of
recent financial chicanery helpful an dwill benefit from constant pe-
rusal of the reports of financial deception chronicled virtually daily
in newspapers, newsletters, an dreputable Web sites.
In thinking about such charades, note that many frequently crit-
icize dtechniques are not always unlawful an d do not necessarily
violate generally accepte daccounting principles. Often, however,
they impair the integrity of financial reporting. Worse, a corporate
or financial reporting culture that condones aggressive practices cre-
ates the risk of degradation of financial reporting: What starts as
merely aggressive can create pressure that leads reporting over the
line an dinto the frau dulent.
There is always pressure to engage in accounting shenanigans.
Many scandals suggest that irregular accounting is especially acute
at businesses with poor economic characteristics an dthose facing
tough competitive conditions. A company’s contractual profile may
increase pressure for aggressive or irregular accounting. Many loan
agreements, for example, contain promises by the borrower to main-
tain certain financial ratios, including debt-to-equity ratios and the
others discusse dearlier, an dcan lea dmanagers to meet those prom-
ises by finessing.
Incentive compensation agreements triggere dby meeting sales
or earnings targets may encourage accounting games. Similar pres-