Financial

Chapter 4 Summary

1) Focus of chapter is on fabricated earnings manipulation

a) Recording revenue from transactions that lack economic substance.

i) Customer is under no obligation to keep or pay for the product; there is no transfer of risk.

(1) AIG sold “finite insurance” that insured against a business downturn. This insurance was retroactive and Brightpoint Inc. was guaranteed a settlement. The companies recorded these transactions as revenue producing transactions, not financing.

(2) To increase AIG’s insurance liability reserve, AIG received $500 mil. in insurance premiums and paid the same out to reinsure a risk. AIG used this round trip of cash to inflate reserves that could be used to create bogus revenue.

(a) Auditors need to watch for unusual increases in decreases in reserves.

(3) Peregrine induced bogus sales by making secret arrangements where the customer did not have to pay; DSO would jump.

(4) Symbol instructed their distributer to place phony PO’s. Symbol then shipped them to their own warehouse. The distributor would then “exchange” these goods when need be.

b) Recording revenue from transactions that lack a reasonable arm’s length process.

ii) In this case it is possible that the transaction was not at fair market value or there are other undisclosed arrangements involved in the “sale”.

(5) Syntax-Brillian sold $100 mil. of TV’s to SCHOT (related party) on extended credit terms. Later that year SCHOT announced to “buy back” the TV’s.

(6) When Krispy Kreme was acquiring one of its franchises it sold $700,000 of equipment to them and paid the same to acquire the franchise.

(b) Auditors should watch out for these boomerang arrangments.

c) Recording revenue from receipts from non-revenue producing transactions.

iii) Not all cash is from operations and should be recorded as revenue. Some...