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Satyam-indicative of a larger issue?

If anything, the outsource company Satyam bears testimony to two things. One, that account doctoring isn’t specifically an Indian problem, and second, that auditors, often collude with managements in fudging financial, a practice that compromises the interests of gullible shareholders.

Here’s a look at all the accounting scandals that have rocked the corporate world in India and abroad, in recent years. The list bears testimony that all companies indulge in some sort of financial jugglery; a few more than the others.

Hall of Shame
General Motors: GM accelerated the booking of income from 2002 to 2006. They did this by improperly accounting for supplier credits, cash flows and two one-time transactions based on product recalls. The carmaker also failed to disclose legacy benefits to former GM workers, who left in 1999 to become employees of Delphi Corp., an auto parts company that was spun off from GM that year. After being sent to mediation, GM agreed to pay $277 million.
Their accountants at that time were Deloitte and Touche, which served as independent auditor for the auto company. The accounting form was accused of falsely certifying that GM’s financials adhered to GAAP. Deloitte agreed to foot an additional $26 million to settle the charges.

Enron:Enron delivered smoothly growing earnings (but not cash flows). Wall Street took Enron on its word but didn’t understand its financial statements. It was all about the price of the stock .In its last 5 years, Enron reported 20 straight quarters of increasing income. Enron, that had once made its money from hard assets like pipelines, generated more than 80% of its earnings from a more vague business known as “wholesale energy operations and services. The company avoided hundreds of millions of dollars in taxes by its use of stock options. Corporate executives received large quantities of stock options. When they exercised these options, the company claimed compensation expense on their tax returns. Accounting rules let them omit that same expense from the earnings statement. The options only needed to be disclosed in a footnote. Options allowed them to pay less tax and report higher earnings while, at the same time, motivating them to manipulate earnings and stock price.

Their accountants, Arthur Andersen LLP, which then made up the big 5, was convicted of obstruction of justice for shredding documents related to its audit of Enron, resulting in the Enron scandal. Nancy Temple (Andersen legal department) and David Duncan (lead partner for the Enron account) were cited as the responsible managers in this scandal, as they had given the order to shred relevant documents. Since the US Securities and Exchange Commission does not allow convicted felons to audit public companies, the firm agreed to surrender its CPA licenses and its right to practice before the SEC on August 31, 2002 – effectively putting the firm out of business in the US. Meanwhile, Anderson’s non-US practices ceased to be viable due to reputational collateral damage. Most of them were taken over by local firms of other major international accounting firms.

WorldCom:WorldCom, US’s second largest long distance telecommunications company, announced that it had overstated earnings in 2001 and the first quarter of 2002 by more than $3.8 billion. The accounting maneuver responsible for the overstatement was classifying payments for using other companies’ communications networks as capital expenditures. WorldCom filed for bankruptcy protection on July 21, 2002. On August 8, the company announced that it had also manipulated its reserve accounts in recent years, affecting an additional $3.8 billion. They admitted that the company had classified over $3.8 billion in payments for line costs as capital expenditures rather than current expenses. Line costs are what WorldCom pays other companies for using their communications networks; they consist principally of access fees and transport charges for messages for WorldCom customers. Reportedly, $3.055 billion was misclassified in 2001 and $797 million in the first quarter of 2002. According to the company, another $14.7 billion in 2001 line costs was treated as a current expense. By transferring part of a current expense to a capital account, WorldCom increased both its net income (since expenses were understated) and its assets (since capitalized costs are treated as an investment). Had it not been detected, the maneuver would have resulted in lower net income in subsequent years, as the capitalized asset was depreciated.

Essentially, capitalizing line costs would have enabled the company to spread its current expenses into the future, perhaps for 10 years or even longer. WorldCom also announced that it was also investigating possible irregularities in its reserve accounts. Companies establish these accounts to provide a cushion for predictable events, such as future tax liabilities, but they are not supposed to manipulate them to change reported earnings. On August 8, WorldCom admitted that it had improperly used its reserves in recent years. The indictments issued August 28 charged that reserve accounts were reduced in order to provide credits against line expenses. WorldCom’s 12 outside directors have agreed to a $60.75 million settlement in the case, agreeing to pay $24.75 million out of their own pockets. Insurance will cover the rest.

In this case also, the accounting company (Incidentally, it was none other than Arthur Andersen LLP) got implicated. A lawyer for a group of WorldCom Inc stockholders and bondholders has gone on record saying that the auditors were more concerned with “lining its own pockets” than catching a massive accounting fraud at the telecommunications company. Instead of asking tough questions of WorldCom’s top executives or continuing to demand access to company records, Andersen shrugged its shoulders and acquiesced to a client that paid the firm more than $40 million in auditing and consulting fees in a three-year span is what he was accused of.

Xerox:In 2002, Xerox revealed that over the past five years it has improperly classified over $6 billion in revenue, leading to an overstatement of earnings by nearly $2 billion. The effect of the manipulation was that Xerox could count as earnings what essentially was future revenue.

This boosted short-term profits and allowed the company to meet profit expectations in 1997, 1998 and 1999, though it had the effect of reducing earnings during the past two years. In 1998, Xerox reported a pretax income of $579 million, while it should have reported a loss of $13 million. On the other hand, the $137 million loss for 2001 will become a $365 million gain after the manipulation is reversed. The $1.9 billion total that will now be subtracted from revenue reported from 1997-2001 will be added to future reports. Xerox has not been accused of falsely creating unearned income. Rather, it spread its income out in a fraudulent manner. To the same end, WorldCom improperly capitalized about $4 billion in ordinary expenses in order to allow the company to deduct the expense over a period of decades rather than writing it off all at once. Both these methods serve to boost short-term profits.

SEC settled its securities fraud case with the four remaining defendants, all of who were partners at the company’s outside auditor at the time, KPMG. The four were: Ronald Safran, engagement partner on the Xerox audit for 1998 and 1999; Michael Conway, senior engagement partner for 2000; Anthony Dolanski, engagement partner for 1997; and Thomas Yoho, the SEC concurring review partner for KPMG on the Xerox engagement from 1997-2000. Safran, Conway, and Dolanski agreed to the entry of an injunction, with Safran and Conway paying civil penalties of $150,000 and Dolanski paying a $100,000 penalty. Yoho settled a separate administrative proceeding brought by the Commission and was censured. According to the SEC’s Litigation Release, the audit fraud allowed Xerox to manipulate its earnings by over a billion dollars during the relevant period. The settled SEC order against Yoho finds that he engaged in improper professional conduct by failing to exercise appropriate due care and professional skepticism when he conducted an “indepth” review during the 2000 audit.

Indian scams
DSQ Software:In March 2006, Indian authorities arrested Dinesh Dalmia, chief executive of DSQ Software, for fraud and inducing US investors to part with $100 million for investment in substandard equipment for operating a back-office firm out of India. This was five years after DSQ Software collapsed in the 2001 stock market scandal, following charges of insider trading by Dalmia. He is currently facing trial and is lodged in a Kolkata jail.

Pentasoft and Pentamedia Graphics:Both the animation companies collapsed after their promoters in 1999 diversified from the software and animation services business into new ventures such as resorts and multiplexes.

SSI Technologies Inc.:SSI Technologies Ltd figured in the K-10 stocks of broker Ketan Parekh, who led the 2002 market collapse and was arrested later for alleged share price manipulation. Kalpathi Suresh, the chief executive of SSI, eventually sold the software services and software education businesses to PVP group.

Videocom International :In the year ended 31.3.1999, the company changed its accounting policy of deferring preliminary and capital raising expenses, and started charging the entire amount in the year the expense was incurred. The resulting write-off to the tune of Rs 49.97 crore was withdrawn from the general reserve and the impact on profit for the year was concealed. During the year, the company charged a premium on redemption of debentures, Rs 40 lakh, to the P&L account and withdrew the amount from general reserve, which resulted in zero impact on the declared profits.

NOCIL:In 2001, the company declared a profit after tax of Rs 11.61 crore and adjusted a loss of Rs 12.37 crore towards diminution in value of investments directly against contingency reserve. The same routed through the profit and loss would have shown a loss of Rs 11.29 crore.

Zee Telefilms :In its March 2001 accounts, the company has provided for tax related to earlier years to the extent of Rs 56.95 crore. The company had earlier been claiming 100 per cent exemption under section 80 HHC of the IT Act on exported programmes but the same had been disallowed by the Income Tax Department.

Hindustan Motors :In 2001, HM reversed a provision for taxes made in earlier years to the tune of Rs 4.47 crore. In the 2000 accounts, the company wrote off Rs 9.46 crore as debenture issue expenses/premium on redemption against share premium reserve. If this had been routed through the profit and loss account, the loss for the year would have increased from Rs 62.27 crore to Rs 71.74 crore.

Bombay Dyeing :Over the years Bombay Dyeing has been overstating its profits by routing some of its expenses directly through its reserves, for example, gratuity expenses of Rs 1.88 crore were written off against the general reserve, and loss on sale of long-term investments worth Rs 22.89 crore were written off against the investment reserve. The recomputed figures show a loss after tax of Rs 6.64 crore against a stated profit after tax of Rs 18.13 crore.

TISCO :The company wrote off expenses directly from its reserves. These were related to premium on redemption of secured premium notes and non-convertible debentures. The expenses amounted to Rs 24.86 crore in 1998-99 and Rs 6.71 crore in 1999-00. The expenses were directly deducted from share premium reserve as the Companies Act permits the same. In actual fact, the redemption premium is cumulative interest.

Century Textiles & Industries:In its March 2001 results, Century provided for prior period adjustments of Rs 1.84 crore, expenses on account of depreciation arrears of Rs 6.87 crore, and leave encashment liability of Rs 5.57 crore, all after PAT. These adjustments reduce the declared profits from Rs 68.23 crore to Rs 53.95 crore

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