Asian Financial Statement Analysis: Detecting Financial Irregularities

CHAPTER 7

SUMMARY AND GUIDANCE

This chapter pulls together the concepts presented in prior chapters and summarizes analysis techniques and warnings signs to look out for when evaluating the financial statements of Asian companies.

Accounting scandals have been around for as long as capital markets. Whenever you have a separation of ownership and control—where the individuals running a company are not the same as those providing the capital for its operations—there is an opportunity for the managers to obscure the true economic picture of what is going on in the business. Sometimes it starts innocently enough. Perhaps there has been a tough quarter and management makes some adjustments to avoid triggering the violation of a debt covenant with the intent of reversing the manipulation in the subsequent period. However, if the economics do not improve in the subsequent period, the company may have to make bigger adjustments to continue to hide the prior manipulation, resulting in a snowball effect where the manipulations get increasingly larger over time. In other circumstances, the managers may have incentives, such as bonus arrangements, to make the reported results look better than reality. In more extreme cases, managers may have set out to commit fraud and loot as much as they can from the company and other shareholders.

These scandals have been global, such as the fraud of Ivar Kruger, the so-called Swedish match king, or the more recent cases of Parmalat in Italy or WorldCom ...