In an ideal world, investors, board members, and executives are fully confident in the financial statements of companies. Unfortunately, this is not what happens in the real world; companies find ways to cheat the system. In the article SEC Digs Deeper Into Companies’ EPS Manipulation, provided by the Wall Street Journal, Mark Maurer brings the attention of the reader to the creative accounting of several companies, which alarmed the SEC.
According to the author, three companies have been suspected of manipulating the figures earnings per share. This number may seem insignificant; however, this was brought to the attention of the regulator. As a result, this situation can lead to multiple charges against those complicit in the crime. The biggest concern is not only the process of figure manipulation but the negative impact on the investors. Investors use the earnings per share ratio in order to “help gauge a stock’s value relative to earnings” (Maurer, 2021, para.5). In the situation of manipulating numbers, investors may be susceptible to significant losses.
The problem lies within the invisibility of the manipulations. According to Denis Usher, a partner in charge of audit and consulting services, auditors who perform high-quality analyses of companies’ quarterly financials usually don’t identify EPS manipulations. As a matter of fact, auditors examine a firm’s internal controls and review unusual transactions or book records during specific periods (Maurer, 2021, para.9). Thus, the executives have complete control of the books, and it is their responsibility to guarantee the integrity of financial and accounting information.
The EPS initiative entails investigating financial fraud, which is exceptionally intricate compared to other actions, such as those requiring investment advisers to disclose conflicts of interest related to their practices and those requiring investors to disclose short-selling practices. During the examination, witnesses and auditors will testify, and the SEC will analyze GAAP in detail. This kind of fraud investigation might take 18 to 24 months (Maurer, 2021, para.21). As a result, this much time might not prevent retail investors from buying the stocks of the firm.
Nevertheless, Mazars’ Mr. Usher asserts that the settlements of the SEC will prompt the auditors to examine more reports in order to eliminate any fraud. The situation with creative accounting might impose a threat not only on the firms and executives but on the auditors as well. As a result, auditors will pay more attention even to smaller entries on the books. I support this well-thought decision, and, in my opinion, that will help eliminate the number of frauds committed by dishonest companies. What is more, I believe more measures need to be taken since previous actions of the regulator do not seem to influence the dishonest executives.
I find this situation quite overwhelming since, in such circumstances, the executives are driven by various intents. The purpose of manipulating financial statements is to mislead people, who, in turn, will make the wrong decision based on false information. Accordingly, the methods of falsification of financial statements largely depend on the range of users of financial statements and the nature of their decisions.
There are two main reasons why management manipulates financial statements. Firstly, in many cases, managers’ reward is directly related to the company’s financial performance. As a result, they have a direct incentive to manipulate the figures to meet the established expectations regarding performance and increase their compensation. Secondly, it is relatively easy to do, which is proven in the article. Accounting principles provide a significant amount of latitude in accounting methods. As a result, these standards provide significant flexibility, allowing corporate management to create the desired financial conditions for the company. Therefore, it is hard not only for investors to find discrepancies in financial statements but also for auditing companies.
Investors and board members understand that manipulating operational decisions to report higher revenues in the short term carries a genuine risk of compromising the long-term competitiveness of the company. This is also clear that despite the fact that accounting rules continue to improve and prevent more accounting fraud, the incentives for managers to achieve short-term goals remain strong; companies will increasingly manipulate reporting through management decision-making.
Thus, investors and directors will have to demand more disclosure of those operational decisions that are most susceptible to manipulation in order to determine whether they are made for reasonable business reasons or with the aim of artificially inflating financial results. This procedure might prevent financial fraud and protect investors from malpractice.
Hence, creative accounting, which implies manipulating numbers in financial statements, is not a single occurrence. Executives in various companies look for ways to cheat the system and boost their revenues. With the slight possibility of unveiling these situations, there is still a chance to detect such frauds. With the help of the SEC commission, the auditors might pay more attention to the entries in the books, which will lead to more risks to the firms. Such an approach will help to eliminate financial fraud, as well as protect the investors.
Reference
Maurer, M. (2021). SEC Digs Deeper Into Companies’ EPS Manipulation. WSJ. Web.