This case involves a west coast corporation that was a consumer electronics company formed by a merger. Eventually, the company had grown into the ninth largest U.S. company and the largest U.S. distributor of consumer electronics. The company began having problems when it announced a massive second-quarter loss of over $400 million. The company used accounting practices that enabled it to reduce the company’s tax payments, inflate the company’s income and profits, inflate the company’s stock price and credit rating, and hide losses in off-balance-sheet subsidiaries. The company’s rapid growth early on involved large capital investments that did not generate significant cash flow in the short term. The company’s accountants (CPA) hid losses in off-balance-sheet partnerships by using deals with special purpose entities (SPE’s) that were not arm’s length transactions. The deals would hurt the SPEs financially, but dramatically increase the company’s financial position.
Question(s) For Expert Witness
- 1. Can a company use accounting practices such as special purpose entities and loopholes in the way the company recognizes revenue?
Expert Witness Response
The first thing to look at in a case like this is auditing. Auditing is always key in a company’s financial situation. There is always increasing pressure on a company to meet earnings goals and this means that the CEO and the CFO may be required to sign off on the fairness and accuracy of financial statements. In many cases like these, if company executives have carefully considered the possible consequences of manipulating numbers to meet earnings forecasts, there is less likelihood of fraud. In cases like this, Generally Accepted Accounting Principles (GAAP) are very difficult to interpret and apply because of the standards are written in highly technical ways. The GAAP standards can be difficult for accountants to apply because are rule-based and have to be applied in many types of transactions in varying business situations. In general, the quality of financial reporting within most large companies is very high. Most CFO’s are very concerned with fair and accurate reporting because of high pressure and penalties from the SEC. Since the company generally has to pay the fines when a CEO is charged with failing to abide by SEC rulings, more and more CEO’s are vouching for the financial statements of their companies. Also, more and more of these companies are trying to improve the transparency of their financial reporting by internal controls that focus on longer-run profit performance rather than focusing just on short-run profits.