Massaging the Numbers and Cooking the Books
Beyond choosing between alternative accounting methods, business managers can go two steps further in manipulating recorded profit. The first technique is called massaging the numbers or income smoothing. Business managers can control the timing of some expenses and sales revenue to some extent and therefore boost or dampen recorded profit for the year. In this way managers ''put a thumb on the scale," the scale being net income for the year. When managers cross the line and go too far it's called cooking the books. Cooking the books constitutes fraud and is probably illegal.
The most common way of massaging the numbers involves the discretionary expenses of a business. Consider repair and maintenance expenses, for instance. Until the work is done, no expense is recorded. A manager can simply move back or move up the work orders for these expenditures, and thus either avoid recording some expense in this period or record more expense in the period. In this way the manager controls the timing of these expenses. There are other discretionary expenses of a business. Two come quickly to mind—employee training and development costs, and advertising expenditures.
Managers control the timing of discretionary expenses, it is thought, to smooth profit from period to period. Instead of permitting the profit numbers to pop out of the process of the accounting system, and letting the chips fall where they may, managers ask the company's controller to let them know in advance how profit for the period is shaping up, to get a preview of the final profit number for the year.
The profit lookout for the year may be below or above expectations. The look ahead at profit may indicate a unacceptable swing from last year. In these situations the manager may decide to nudge the profit number up or down, and the best way of doing this is to manipulate discretionary expenses. Or, the manager can control the timing for recording revenues. Sales can be accelerated, for example, by shipping more products to the company's captive dealers even though they didn't order the products. The business is taking away sales from next year to put the sales on the books this year.
The second technique, cooking the books, is very serious stuff, and goes beyond massaging the numbers or doing some profit smoothing. It's fundamentally different from taking advantage of discretionary expenses to give profit a boost up or a shove down. Cooking the books is not just "fluffing the pillows" to make profit look a little better or worse for the period. Cooking the books means that sales revenue is recorded when in fact no sales were made, or that actual expenses or losses during the period were not recorded.
Cooking the books requires falsification of the accounting records. To put it as bluntly as I can, cooking the books constitutes fraud—the deliberate design of deceptive financial statements. CPA auditors search for any evidence fraud, as Chapter 17 explains. But they may not find it when managers are adept at concealing the fraud.
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