The Allure of Aggressive Accounting Can Lead to All Sorts of Pain

The siren song of an overly aggressive accounting scheme can be hauntingly alluring. At first.

That is until, as it often does, a plan that runs afoul of the law or accounting rules collapses in a blaze of financial damage or ruin, negative publicity, and personal wreckage. Aggressive accounting has other names, such as creative accounting or inventive accounting, which can be used to describe situations both legal – and otherwise.

On the not-so-legal side, less formal monikers include “fudging the numbers,” and “cooking the books.” Again, that’s not to say that all aggressive accounting is wrong. But whenever it’s used, there’s an associated risk. Otherwise it wouldn’t be identified as aggressive.

Aggressive accounting, by definition, makes numbers look better than they otherwise might to investors and anyone else with a stake or interest in a company. Typical aggressive accounting techniques involve what’s termed “earnings management.” That is, it makes assumptions (not unusual in financial statement preparation) that accrue to the company’s reporting benefit. In reality, it’s not a rare situation, as CNBC reported in Oct. 2012: “In an anonymous survey of CFOs last year, the study found that at least 20% of companies are "managing" earnings and using aggressive accounting methods to legally alter the outcome of their earnings reports.”

The emphasis is on “legally.” There’s a price to pay for skirting that issue.

In 2009, GE agreed to pay $50 million in a settlement with the federal government stemming from Securities and Exchange Commission charges that GE over a two-year period committed fraud through the use of aggressive accounting.

As the Washington Post reported, "‘GE bent the accounting rules beyond the breaking point,’ Robert Khuzami, director of the SEC's Division of Enforcement, said in a statement. ‘Overly aggressive accounting can distort a company's true financial condition and mislead investors.’"

Aggressive accounting can take different forms for different processes. For example, in 2013 the IRS served notice that it would not look approvingly on aggressive measures taken to employ cost segregation, an accounting tool used to depreciate structures for tax benefit purposes.

A March, 2013 Accounting Today column by Gian Pazzia was headlined, “IRS will Penalize Overly Aggressive Positions in Cost Segregation Studies.” The column focused on an overly aggressive cost segregation study submitted by a firm hired by a property owner that didn’t contain the proper justification for the claimed depreciation of a parking structure, and it was disallowed by the IRS.

So, how do you guard against the bad effects of aggressive accounting?

First, if there’s any question about an accounting transaction, don’t close your eyes and go forward hoping for the best. Seek top-notch accounting and legal advice, and follow it.

If at any point there’s a doubt, question, or uncertainty about whether the SEC, the IRS, or other regulators will approve the action, ask them. It’s much better for regulators to be up on something than down on you for it. You may not get a quick answer, or any answer at all, but you’ll never be faulted for asking the question and it shows you were trying to do the right thing.

If at any point a real number is substituted for a number anyone on the team knows isn’t accurate, don’t do it.

The prospect of bigger or faster return is alluring.

But succumbing to the siren song isn’t worth the pain.

Tagged Accounting, Featured, IRS