Now that you’ve been accepted to b-school you’re probably thinking about things like getting a decent apartment and which exotic locale to visit before school starts, but you might also want to put some thought into your academic preparation. Will you have pre-term classes? Without them you might be jumping right into the deep end of the pool. Even with pre-term, you may often learn the mechanics without the context, especially when it comes to quantitative classes.
For example, when you take introductory accounting in business school you’ll learn how to do accounting, but it’s unlikely that you’ll get the bigger picture. Here’s a topic that gives you good insight into how accounting is applied: accounting fraud. There have been an unprecedented number of cases of accounting fraud in the last decade, with surprisingly few people actually understanding what went wrong. Understanding how fraud works will help you avoid committing it, avoid falling for it, and perhaps most importantly, will provide an even better understanding of how what you learn in class applies to the real world.
Here’s a little insight into a few recent cases of accounting fraud:
The top pursuit of almost any company is profit. We generally think of profit as what’s left over when we subtract costs from revenue. In accounting, though, profit is generally measured with more nuance than that (and rightly so, by the way). For example, a credit sale, in which a sale is agreed upon and a product (or service) may be delivered but payment has not yet been received, counts as revenue even though the company’s cash has not increased. So we might see a “profit” even though we actually have less cash than we did before. This may seem strange, but in the long run, doing things this way provides the best way to track a company’s performance, though it is important to pay attention to cash flow as well as profit.
So as you might expect, manipulating profit is a common theme in accounting fraud. Some very creative people have come up with a myriad of ways to falsely report revenue, thereby increasing profit, without the possibility of ever generating cash. Let’s start with something simple that Informix tried in the mid-nineties. In order to continue to show healthy revenue and profitability in the wake of competition from Oracle, they decided to offer extremely liberal return policies to their customers. So liberal, in fact, that it would be silly for anyone to say no, given that they would never have to pay if they were unsatisfied for the slightest reason. However, Informix counted virtually every dollar of those sales as revenue.
Another creative method for creating revenue where none actually exists is the bandwidth swap, used by companies such as Global Crossing, Qwest, and 360Networks in the late nineties and early 2000s, in which two companies set up sales of electronic bandwidth contracts to each other. Each company immediately booked the revenue from their sale, but considers their bandwidth purchase to be a cost that they can pay for over the life of the contract, which could be as long as 20 or 30 years. Lots of revenue now, a little cost on into the future, and no actual cash changing hands!
Lastly, there’s Enron. Among the many ways that Enron found to hide debt and costs and otherwise defraud investors was the way they handled futures contracts, which are basically rights to future energy at a predetermined price. Under the guise of “mark-to-market accounting,” they were able to “value” those rights based on Enron’s own estimate of their future value and book the difference between what Enron paid for those futures and Enron’s own estimates of their value as current revenue.
If you’d like to know more about good and evil in the application of accounting, and at the same prepare yourself for some of b-school’s most rigorous courses, you might be interested in checking out Telestrat’s Pre-MBA Prep Course in early June. The first of these four 2-hour online courses explains financial statements, and the second discusses accounting fraud and tools that you can use to quickly and easily evaluate a company’s performance. (SPECIAL NOTE: The company is running a special introductory offer and has reduced the cost of the courses for a limited time only.)
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