A Financial Sleuth Finds a World of Abuses

Howard Schilit is back! The author of my favourite guide to detecting fraudulent accounting, Financial Shenanigans: How to Detect Accounting Gimmicks & Fraud in Financial Reports (see my in-depth review here), has emerged from retirement:

The list of companies that Schilit was either first or among the first to criticize is a rogue’s gallery: WorldCom, Sunbeam, Cendant, New Century Financial, among others.

Given the growth of capital markets outside the U.S., Schilit has spent the last two years acquainting himself with non-U.S accounting practices, focusing his gimlet eye on Chinese, Japanese and other foreign companies in which a lot of Americans have begun to invest.

At FSD Group, Schilit takes on specific projects for clients, and offers lectures and training in his sleuthing methods.

In a Barron’s interview, Schilit discusses his new endeavours in the same no BS fashion in which he wrote Financial Shenanigans:

Who is sitting there reading footnotes? People are making their decisions on a press release or a database. In general, the auditors’ focus is on a legalistic interpretation. So, if you tied up your neighbor and robbed his house, but you disclosed it in footnote No. 23, it’s okay.a

It shouldn’t be surprising that the bulk of shenanigans he is finding today are related to Chinese and Japanese companies, but he does discuss some domestic companies, including one already accused of shady accounting, Green Mountain Coffee Roasters (NASDAQ: GMCR)

In past quarterly statements, such as the third quarter of fiscal 2010, the company made a point of things like 11 consecutive quarters of 40% net sales growth and 24 quarters of double-digit growth. If you do some compounding, the numbers start to get enormous.

There were two important changes in the footnotes describing its accounting policies over the past five years or so. In 2007, Green Mountain recorded revenue when the product was delivered to the customer. Then, it gave rebates; For example, if you buy 1,000 of those little K-Cups, they may give you a 5% rebate. They accounted for rebates as a reduction from gross sales. Fine. Then, when they started having difficulty getting to that magical 40%—this is my interpretation—the revenue-recognition wording in the footnotes became longer; in some cases, revenue was recognized upon shipment. That’s not the same thing. Then, instead of treating the rebates as a reduction to sales, in some cases it was treated as an operating expense. Now, my friendly auditor will say: ‘They disclosed it all.’ But investors would say: ‘That stinks.’

It is well worth your time to read the full interview here. If you like what you see, pick up a copy of Financial Shenanigans: How to Detect Accounting Gimmicks & Fraud in Financial Reports.


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Talk to Frank about Howard Schilit