There are several ways in which you could forge the profit of the company and they are accompanied with some examples of the most scandalous cases ever to be discovered. One of them is Enron Corporation which by overstating profit and hiding huge amounts of debt allowed them to expand and get even higher loans. Investors and managers made billions of dollars by selling their stocks after they achieved high prices in the stock market. For the period of 1996 to 2000 they have increased revenue with more than 700% which was unheard before that.
No other company has ever achieved such a high increase in any industry what so ever. In 1996 the Enron revenue was just 13. 3 billion but in 2000 it was already 100. 8 billion dollars, and until the 3rd quarter in 2001 Enron reported 138. 7 billion dollars. After it was discovered that the company had hidden enormous amounts of debts and overstated its profit for the past several years investors and creditors backed away which led to incredible drop in the Enron's stock price from highest $90. 75 to $0.
68 and after the huge drop Enron was finished and declared bankruptcy. Other reason why this scandal happened with Enron is not only because of manipulating the balance sheets but also because external auditors failed to recognize what was going on. The firm that was engaged with the audit of Enron was Arthur Anderson LLP which was one of the "Big Five" auditing firms. It is uncertain whether the accounts of Arthur Anderson knew what was going on or had no clue but after the collapse of Enron the big auditing firm suffered greatly which eventually led it to its collapse.
(Scandal at-a-glance, August 22, 2002) This is a clear case of fraud and it has no connection to caveat emptor what so ever. The fault of Enron's collapse is because of its managers and the poor auditing team. Everything that happened to Enron was done deliberately and no one could plead a case that every shareholder who got damaged was aware of the situation. The guilty should of course be penalized and should compensate all the people they have hurt. (Called to Account, Thomas, B. C. , June 18, 2002) Another great scandal took place a year after in 2001 when WorldCom went bankrupt.
One of the reasons why it happened is because the CFO Scott Sullivan took billions of dollars in operating costs and put them in types of capital expense accounts, which mean that all those money would not be properly expensed in the balance sheet at the end of the year. He did that over the course of five quarters and managed to hide 3. 8 billion dollars of operating costs. (World-Class scandal at WorldCom, Hancock, D. June 26, 2002) Also he did boast the revenues of the company again to maximize the profit and again to increase the price of the stock.
But a team of auditors worked during the night in secret managed to discover the truth and after that inevitably it led to the end of WorldCom bringing down the price of stock to a mere 20 cents. After the complete audit in 2003 it came to light that the managers boasted up the total assets of the company to amazing 11 billion dollars. (Worldcom's Magic Trick, Schmidt, R. January 31, 2005) This again shows us the perfect example of aggressive earnings management which went horribly wrong.
Everything again is done with the full awareness of those who committed the crime. The Latin term caveat emptor cannot be connected to that situation under no circumstances. (The earnings management crackdown, Ward, R. ,January 2001) As I mentioned before Generally Accepted Accounting Principles or GAAP are used both in US and UK as a guideline framework for all accounting procedures. US GAAP and UK GAAP are pretty much similar to each other but the legislation that they are under is different.
For example the UK GAAP as a result in recent changes in European law all Companies should report under International Financial Reporting Standards and as a result it differs from its American cousin the US GAAP. In America all companies should report to Financial Accounting Standards Board because currently they are establishing all the accounting principles in US. Also in the states they have many other external and internal regulators who allow them to keep track of all the companies. Nevertheless GAAP is slightly different on each continent because of the difference of each Legal environment.
I do believe that most of the times the generally accepted accounting principles fail to recognize the big schemes involving aggressive earnings management because it is easy to hide and also GAAP does not have so strict limits to what you can do. It often judges by the different situation meaning that it is not always the same for each company. This means that firms can be very flexible in order to avoid any suspicions if they do something wrong and even if they get caught the uncertainty of GAAP can rule in their favor. (Uk Accounting standards: A quick reference guide.
Kirk, R. J. 2005) (Financial Accounting Standards, n. d) In a nutshell I believe that there is a fine line between earnings management and fraud and the problem with this is that not many people can tell when the boundary is crossed. I know that managers try to keep the shareholders happy and because of that I believe there is almost always a case of caveat emptor. The new investors should take care of themselves before they decide to take any action. They should do their homework in order to be certain that everything is fine with the company they intend to invest.
But then again there are some cases in which ridiculous amounts of money have been hidden or overstated as a profit intentionally by some individuals in order to attract more "prey". This is a clear case of fraud and investors cannot be blamed for their misfortunes. Reading all this information I honestly believe that a drastic change in the behavior and thinking of managers of big corporation is to follow. People cannot go on losing money because of some deliberate acts of some fools or otherwise the authorities should keep a strict watch for everybody.