Inexact science of accounting lays it open to manipulation

Unscrupulous companies have a number of ways in which they can manipulate their financial returns and fool investors, according to a critical report into accounting practices by Deutsche Bank.

Accounting is such an inexact science, the report suggests, it is misleading to even provide one figure for a company's profits. It would be more realistic to announce estimated profits of, for example, between £90 and £100m than to arrive at an exact figure of say £95.3m Deutsche says.

The report, called the Art of Accounting, says "accounting will never been a precise science, company profits are always presented as exact numbers but the apparent precision is illusory."

Written before thefraud at WorldCom was revealed, Deutsche says a favourite way for directors to disguise problems is to do exactly what WorldCom did:treat operating expenses as investment.

Investment costs can be fed through the balance sheet and depreciated over time, which means they do not affect the profit and loss account. In the WorldCom case, the company appeared to be in profit when in fact it made $3.8bn of losses.

Acquisitions – another favourite activity of WorldCom – are also an area which creates opportunities for questionable accounting. Deutsche says some companies write down excessive amounts on the value of assets of businesses they buy in an effort to flatter profits from organic growth in the future.

Manipulating provision is identified as another way to boost profit. Some companies use one-off provision as a way to keep costs away from the profit and loss account.

A similar tactic is used with exceptional items. Deutsche says: "Virtually every company we follow has declared some form of exceptional charge in recent years. Sceptical investors can be forgiven for asking whether all these charges are really exceptional in nature or whether they are just operating costs moved to another part of the income statement."

One tactic Deutsche cites is when companies categorise restructuring costs as exceptional items. Deutsche suggest that unless the restructuring is fundamental the cost is really an operating one. Similarly with the profit and loss on the sale of a factory or machinery it can appear as an exceptional item but should under UK accounting regulations be described as an operating issue.