Windows Dressing
Transcript of Windows Dressing
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Window Dressing
Accounting FraudsAuditing
Corporate Governance
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Limitations of Financial
Statements
Based on Historical Costs
Human Assets not recorded
Personal Judgment of Accountant
Deliberate Manipulations
Differences in Accounting PoliciesWindow Dressing
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Responsibility of CEO
Fair (Not false & misleading) presentation of Co’s Financial Statements
“Look” of the Co’s Financial Statements in thebest interests of the business
Use of permissible accounting methods (asper Accounting Standards) to measure Co’s profit
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Window Dressing
Massaging (manipulating) the accounting numbers to
make the short term solvency & liquidity of the businesslook better than what it really was at the end of the year.Examples:
(1) Accounting records of a company kept open for a few
days after the end of its accounting yearObjective: Record additional cash collection from Debtors.
(2) Accelerate sales at the fag end of the year by shippingmore products to the company’s captive dealers ( Dumping
of goods without orders or stuffing the channels of distribution)
(3) Deferring or reducing discretionary expenses e.g. R & MCosts, employee training & development Costs, advertising
expenses, etc. PIYOOSH BAJORIA
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Window Dressing
(4) End of year adjusting entries requiring estimates e.g.
Provision for expenses, provision for doubtful debts,decline in value of intangibles, etc.
Manager’s perception that net income numbersgenerated from accounting system may behave too
erratically year to year and hence, argue that some
manipulation required to ensure smooth reported
profit year to year.
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Cooking the Books / Accounting Frauds
Frauds in Financial Reporting
Deliberate Dishonesty Goes beyond window dressing
Falsification of accounting records
Fabrication of sales revenue & expenses
e.g. recording sales revenue when no sales were made or not recording actualexpenses or losses during the period. Reporting assets that don’t exist or not reportingliabilities that do exist. Withholding vital information from being disclosed in thefinancial report.
Massaging the numbers – recording legitimate sales revenue & expenses butmanagement takes action to nudge the numbers up or down for the year.
If manipulation is carried too far, it can end up being equivalent to accounting fraud.
Hence, Window Dressing is a slipping slope that can lead to accounting fraud.
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Fraud in Financial Statements
Committed in 5 ways
1. Fictitious Revenues
2. Fraudulent Timing Differences
3. Concealed Liabilities & Expenses
4. Improper or Fraudulent Disclosures or Omissions
5. Fraudulent Asset Valuations
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Restatement of Financial Reports
Company’s management retracting the originally
published financial report and replacing with the revised
version
In most of these cases, the new net income is
considerably lower than the one first reported by the
business
No of restatements exploded from only 90 in 1997 to
2,000+ by 2010 & most of them by private companies not
listed on a major stock exchange
Negative market reaction- Investors should be morecareful about investing in these companies
More skeptical in reading the financial statements of a
private company , unless they have been audited by a CPA
firm. Consider quality of earnings & not just the magnitude.PIYOOSH BAJORIA
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Audits of financial reports in the
Post- Enron Era
Few cases of Accounting Fraud:
-World .com
- Enron
-Tyco- Ahold
- Xerox
- Rite Aid
- Global Crossing-Health South
-Adelphia communications
-Satyam
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Types of Audits
• Statutory Audit
• Internal Audit/ Management Audit
• Tax Audit
• Special Audit/Investigation
• Forensic Accounting
• Concurrent Audit (Banks)
• Propriety Audit
• Environmental Audit
•
Energy Audit PIYOOSH BAJORIA
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Propriety Audit•
Loans and advances made by the company – whether secured properly and whether the terms
are not prejudicial to the interest of the company
or its members.
• Transactions represented merely by book entries
are not prejudicial to the interest of company.
• Personal expenses whether charged to Revenue
A/c.
• Non investment company – whether securities
were sold at a price less than the purchase price.
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Auditing & Corporate Governance
• Internal Controls
• Audit Committee
•
Compliance Report by CEO• Due Diligence Audit Report (M&A)
• Quarterly Financial Reporting
• Interim Review• Code of Ethics & conduct
• Auditing Practices (SSAP)
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Types of Audit Reports
• Clean Report
• Qualified Report
•
Disclaimer of opinion
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Corporate Governance Report
SEBI Code of Corporate Governance requires
listed companies to include a separate
section of ‘corporate governance’ in their
annual reports. This section should include adetailed compliance report on corporate
governance. The code provides the following
suggested list of items to be included in thereport:
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Corporate Governance
• Defining Good Corporate conduct
• Roles & Responsibilities of Directors
• Increasing expectations from Directors• Investors servicing & investors protection
measures
• Whistle Blowing policy
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Audit Committee• Sub Committee of the Board
•
Mandatory for every public company with a paid upcapital of not less than Rs.5 crore (Sec.292 A of
Company’s Act)
• Minimum 3 directors on the Audit Committee
• 2/3rds of such directors shall be directors other thanMD or WTD
• A chairman selected by the committee from these
directors• Composition to be disclosed in the Annual Report
• The statutory auditor, internal auditor and Director -
Finance may attend and participate at the meeting,
but have no right to vote.PIYOOSH BAJORIA
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Audit Committee
• Clause 49 of the Listing Agreement requires setting
up of an Audit Committee.• Minimum 3 members, all being non executive
Directors, with majority of them being independent
and with at least one having Financial & Accounting
knowledge.
• The chairman of the committee shall be an
independent Director. He must be present at the
AGM to answer share holders’ queries. • Invite executives, as felt necessary, to be present at
the committee meetings.
• The Company Secretary would act as the Secretary to
the committee.PIYOOSH BAJORIA
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Audit Committee• At least 3 meetings in a year – one meeting before
finalization of Annual Accounts and one each everysix months.
• Quorum – either two members or 1/3 of the
members, which ever is higher and minimum of two
independent Directors.
• Mechanism of Audit Committee as an overall part of
Corporate Governance is acquiring greater
significance.• Such self – governance structure would enhance the
auditor’s independence
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Functions of Audit Committee• Discuss quarterly Internal Audit (IA) reports submitted to the
management and the report on action taken on the suggestions –
appraising the effectiveness of the IA function in the organization.
• Review quarterly financial statements and disclosures before
submission to the Board for its completeness and reliability/
integrity.
• Ensure compliance with the internal control systems. Review of Statutory and Regulatory compliances.
• Examine fraud risk assessment and mitigation mechanism.
• Authority to investigate any matter, including items referred to it
by the Board. Access to all the information contained in thecompany records.
• Make recommendations relating to Appointment / Removal of
the external Auditor and approve his remuneration/ terms of
engagement PIYOOSH BAJORIA
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Non Standard Items on Audit
Committee Agenda
• Review of risk strategy
• Review of Forex transactions
•
Review of major investments or prospectiveacquisitions
• Review of related party transactions
•
Review of third party dealings – Interactionwith external consultants/ independent
council for forming up opinions, action plans
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Recommended Books of Reading /
Research Papers
1. “How to read a financial report for Managers,Entrepreneurs, Lenders, Lawyers & Investors” – John A
Tracy, Wiley Publication (2009)
2.Corporate Governance -Global concepts & Practices – Dr. S. Sinha, Excel Books
3.Corporate Governance – Machi Raju – Himalaya
Publication
4. The Role of Audit Committee Chair in a fast changing
global scenario – Governance Publication by BDO
Consulting, India, June 2010PIYOOSH BAJORIA
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Thank You
PIYOOSH BAJORIA