TABLE OF CONTENTS As the old saying goes, "Figures don't lie, but liars figure." And the figures on the income statement are the ones would-be liars play with most often and most enthusiastically. The income statement attracts manipulators for the same reasons it attracts investors: It seems to offer the most detailed and revealing information about what's really happening in a company, so it offers the biggest payoff both to those who want to twist it and to those who want to be able to rely on it.
Even though financial statement preparation rules are changing in an effort to try to prevent future scandals like the crop of 2002, the fact remains that income statements will still be tempting to manipulate. Why? Here's a look behind the scenes:
Even strong companies have problems and all companies are under the intense scrutiny of investors. It is very tempting for senior management to make choices that dress up the figures. At first, it will be harmless. The theory is things will get better. But they don't, and management continues to get more and more aggressive. It is a common trap.
Employee options have value if the stock price increases, and this usually happens if earnings increase. Senior managers will continue to get nice options packages and thus will be encouraged to ramp up earnings, even if it takes accounting that is on the aggressive side.
GAAP requirements are fairly flexible and will continue to be so. For example, certain things are at the...
