CHAPTER 3 Adjusting the Accounts


What Was Your Profit?

The accuracy of the financial reporting system depends on answers to a few fundamental questions: At what point has revenue been recognized? When have expenses really been incurred?

Unfortunately, all too often companies overstate their revenues. For example, during the dot-com boom, most dot-coms earned a large percentage of their revenue from selling advertising space on their websites. To boost reported revenue, some dot-coms began swapping website ad space. Company A would put an ad for its website on company B’s website, and company B would put an ad for its website on company A’s website. No money changed hands, but each company recorded revenue (for the value of the space that it gave the other company on its site). This practice did little to boost net income, and it resulted in no additional cash flow—but it did boost reported revenue. Regulators eventually put an end to this misleading practice.

Another type of transgression results from companies recording revenues or expenses in the wrong year. In fact, shifting revenues and expenses is one of the most common abuses of financial accounting. For example, here is a sample of British companies that have recently disclosed issues regarding revenue recognition: the Nigerian unit of candy company Cadbury (GBR); vehicle and accident management company Helphire (GBR), which appeared to overstate the amount it was due in reimbursement from insurance companies; ...

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