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Accounting Red Alerts Warning Signs Notes

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Accounting Red Alerts- Warning Signs

Definition Red flags mean those alarming signs which identifies that something is wrong.


In other words These are the indicator which tells that a company is facing problems and also hints some manipulation with the earnings and assets of the business. Red flags include: Large swings year-over-year, signifying some sort of event of change in accounting methods. A change in auditors, especially if the previous auditor was on board for an extended period of time. Inclusion of a qualified opinion from auditors No audit committee, or audit committee comprises mostly of related parties Pending lawsuits or other contingent liabilities, special compensation plans or perks for officers and directors Off-balance-sheet transactions Abnormalities found in the accounting-policy descriptions and unbilled receivables Why is it important?
The above items are crucial for analysts to recognize in order to avoid consulting poor investments to their clients. Top examples of cheating and fraud from the last decade were Enron and WorldCom. Lecture Notes Major Types of Earnings Manipulation

1. Classification of positive and negative news Since investors tend to focus on income from continuing operations, a reporting company will tend to include good news in this category and keep bad news out (report it below the netincome-from-operations line). If a company sells a division for a gain, it will likely be included in the net income from continuing operations. If the company sells the division for a loss, the company wants to classify it as a discontinued operation.

2. Income Smoothing During the good years some companies will create accounting reserves so when they are no longer doing well, they can increase their net income and effectively smooth out their reported net income over time. One example is choosing to capitalize or expense R&D expenditures. Another example is the selling of a subsidiary or asset as if it were a gain or loss from continuing operations or not.

3. Accounting Modifications


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