Many companies routinely massage the numbers in their accounts either for a better looking presentation or because managers are under pressure to achieve the targets and earn their bonuses. However, because of greed for an urgent need to cover up, these practices can be pushed to the limit and end up as corporate fraud. You only need to look at companies like WorldCom or Enron where billions of dollars of assets seemingly evaporated into thin air when their fraudulent accounting practices were exposed. This is not to say that all companies are fraudulent otherwise there would be no stock markets. The majority of companies and their managers follow ethical and transparent practices. However, you need to learn some of the methods in which accounts can be manipulated because, like all of us, you rely heavily on the numbers reported by the companies to carry out your analysis.
Overstatement of revenues. One of the pillars of accrual accounting is for revenues to be related to that accounting period. However, one of the easiest ways to make your towline and hence your bottom line look good is to inflate the numbers. This can be achieved in several ways. If you have received a lump sum payment that covers several years of services, you can inflate your sales by booking the entire amount to the sales for the current year. If the contrast contract is for say five years, the correct accounting treatment is to apportion the sales over five years in the process called amortization.
A second and common way of inflating revenues is to make large shipments of products to distribution channels towards the end of the year. The entire shipment is booked as sales for the current year even though your distributors are free to return any unsold goods. The correct accounting would be to show the amount as inventory and only account for sales as and when the products are actually sold. For contracting companies, such as building contractors, it is easy to inflate revenue by booking excess profits on contracts that have not been completed
Deferring or understating expenses. This is the reverse side of the coin from revenues and your financial position can often be made to look better by showing lower expenses. For example, a company may regard marketing expenses or brand building expenses as long-term expenses and show them as a capital expenditure. This will result in the amount being shown in the balance sheet where it can be amortized over a number of years rather than in the profit loss account, where it should be shown, As a result, the profit for the year will be inflated by this figure. Another way of manipulating expenses is not to create provisions from profit is to cover payouts for legitimate claims against the company.
Off-balance-sheet items. You can avoid showing significant items of capital expenditure on your balance sheet by leasing them and arranging to buy them back at the end of the lease period. Only the lease rental that is payable at periodic intervals is shown as an expense. Once the asset has been taken off the balance sheet, neither the asset nor the buyback liability is disclosed on the accounts. Similarly you can create a network of subsidiaries and associate companies and, because these are separate legal entities, their financial position need not be incorporated into the financial position of the parent.
http://www.korpritzombie.com/tag/stock-market-investigation/