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Financial Shenanigans: How To Detect Accounting Gimmicks & Fraud In Financial Reports by Howard M. Schilit

Financial Shenanigans

How To Detect Accounting Gimmicks & Fraud In Financial Reports

By Howard M. Schilit

Financial Shenanigans: How To Detect Accounting Gimmicks & Fraud In Financial Reports by Howard M. Schilit should be read by all serious, long-term, stock investors.

Schilit writes: "Financial shenanigans are actions or omissions intended to hide or distort the real financial performance or financial condition of an entity. They range from minor deceptions (such as failing to clearly segregate operating from nonoperating gains and losses) to more serious misapplications of accounting principles (such as failing to write off worthless assets; they also include fraudulent behavior, such as the recording of fictitious revenue to overstate the real financial performance). Since management is clever about hiding its tricks, investors and others must be alert for signs of shenanigans."

Schilit goes on to discuss a wide range of financial shenanigans which devalue the investment worth of a company. The shenanigans range from "recording revenue when important uncertainties exist" to "failing to accrue expected or contingent liabilities."

Each financial shenanigan is discussed in detail, and a real-world example of a public company affected by the shenanigan is given. Stock-versus-price charts are also given to show the stock-price behavior of the company's stock following the disclosure of the shenanigan (usually the stock price drops like a rock after accounting trickery is discovered).

For example, Tie Communications stock fell from a high of $40.38 per share in 1983 (five years after going IPO) to a low of $0.31 per share by 1990. The 1983 stated profits of the company were "given a shot in the arm by the sale of some investments at a substantial gain...." Schilit goes on to explain that some companies use the sale of appreciated assets to hide losses from normal business operations and make the company appear more profitable than it really is.

Financial Shenanigans: How To Detect Accounting Gimmicks & Fraud In Financial Reports is very easy to read, unlike many books which deal with the topic of accounting. Investors will read through this book rather quickly and that is a tribute to Schilit's writing. Yet, most investors will learn a great deal about financial reporting. Most importantly, readers will learn how to protect themselves as investors.

In addition to shenanigan busting, Schilit gives an excellent tutorial to help readers understand the basics of financial reporting and accounting. Plus, he does an excellent job of pointing out the logic of sound financial reporting.

For example, Schilit writes various "guiding principles" throughout the book to help the reader, such as "Guiding Principle: An enterprise should capitalize costs incurred that produce a future benefit and expense those that produce no such benefit."

Schilit explains that capitalizing costs which have no future benefit is one way to enhance current earnings at the expense of future earnings. Shilit discusses De Laurentiis Entertainment, a producer and distributor of motion pictures, as an example. In 1987, the SEC charged Laurentiis Entertainment with improperly capitalizing expenses which should have been charged against current earnings. Schilit's stock chart shows that shares of DEG fell from a high of $19.25 in 1986 to a low of $0.06 in 1989.

Serious, long-term investors don't want to hold stock in companies such as De Laurentiis Entertainment in 1987 and Tie Communications in 1983. Schilit gives a list of fifty-two techniques to help the investor spot financial shenanigans in advance when evaluating a company for investment.

These techniques range from looking for management incentives which encourage false reporting, to not being fooled by profits enhanced by retiring debt, to watching for worthless investments the company is making. Examining these factors together should help the investor evaluate the overall honesty and viability of the company long-term. The investor will gain insight as to whether the company is being conservative in its accounting or being too aggressive in its accounting.

I highly recommend Financial Shenanigans: How To Detect Accounting Gimmicks & Fraud In Financial Reports to all investors who buy individual stocks and who focus upon buying solid businesses. The book will help weed out the businesses which are only reporting "accounting" profits for the temporary benefit of management.

Financial Shenanigans: How To Detect Accounting Gimmicks & Fraud In Financial Reports
Financial Shenanigans:
How To Detect Accounting Gimmicks & Fraud In Financial Reports

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