Wednesday, June 3, 2009

Financial Accounting Trainwrecks Coming

With the recession 18 months along and things still getting worse, it's as certain as the sun rising in the east that we'll see some corporate accounting and financial reporting failures. This would be in addition to the well-publicized mess on Wall Street. Even though the recession started because of Wall Street's recklessness and mismanagement, all of corporate America has been hit by falling sales, tightened (or turned off) credit, and difficulties raising capital. A lot of companies are in tight spots, and there surely is plenty of temptation to be overly optimistic in reporting financial results.

It was about at this point during the 2000-2002 stock market and economic downturn that WorldCom and Enron blew up. We'll probably soon see one or more similar trainwrecks. Accounting frauds have a life of their own. Once you cook the books, you usually have to keep cooking the books every subsequent quarter and year. That's because corporate books and records reflect a continuing process, where earlier profits or losses affect today's assets and liabilities. If the profits or losses were, say, freshened up the previous quarter, today's assets could be too large, today's liabilities could be too small, or both. Thus, the company has an ongoing problem that requires it to own up to fibbing (ha, ha, that would be funny if shareholders' money weren't involved), or bake today's financial reports so that there aren't segue problems with the preceding quarter. The longer the shenanigans continue, the greater the chances the fraud will fall apart and be exposed because it gets harder and harder to keep reheating the books. This far into the recession, some frauds could be nearing the breaking point.

Of course, there have been lots of public companies that have been reporting terrible results in the last year or so. Perhaps people are becoming more honest. Ha, ha, just another little joke. Moses lugged stone tablets down a mountain in part because people have long had a tendency to promise rose gardens.

Maybe the much criticized Sarbanes-Oxley Act is keeping more public companies in line. Ouch. A lot of corporate types and their lobbyists wouldn't like that thought. But Sarbox is probably an important reason why we haven't yet seen any large, brand name companies nabbed for accounting fraud.

However, with the economy doing so badly, it's surely just a matter of time before a big financial accounting scandal erupts. If we're lucky, it will involve high-maintenance mistresses, $5,000 umbrellas, $20,000 bidets, $5 million extreme executive office makeovers, senior executives sharing flights to posh destinations on the company jet with attractive younger subordinates for a corporate retreat (or something like that), and corporate coverage of all operating costs of the CEO's thoroughbred farm, along with enough additional cash to cover the CEO's income tax liabilities resulting from the company's purchases of hay, oats, and so forth. The real action in financial reporting frauds is in the manipulation of accounting reserves, overly generous interpretations of the definition of revenue, near mystical processes in the closing of the company's books where good numbers magically appear, so on and so forth. But that stuff is boring. And the thought of all the employees who lost their 401(k) accounts because their company stock proved worthless is depressing. The fun is finding out what all those hard charging, overbearing, disdainful executive types did with the moola after they picked the shareholders' pockets. After all, if you can't find a laugh in all this stuff, you might have to cry.

No comments: