Study session 6, LOS 19-20: Financial Reporting and Analysis

Limitations of the Beneish Model

The Beneish model relies on accounting data, which may not reflect economic reality. Deeper analysis of underlying relationships may be warranted to get a clearer picture. Additionally, as managers become aware of the use of specific quantitative tools, they may begin to game the measures used. This concern is supported by evidence indicating that the predictive power of the Beneish model is decreasing over time.

LOS 20 - Integration of Financial Statement Analysis Techniques

This is a key topic review in Study Session 6, and perhaps as important as any of the financial statement analysis material. Here, you are required to use material presented earlier to make appropriate adjustments to the balance sheet and income statement using a common framework. Make sure you can determine and interpret the effects of management's choice of accounting methods and assumptions on the reported financial results and ratios.

LOS 19.h: Evaluate the earnings quality of a company.

Two major contributors to earnings manipulation are: 1.Revenue recognition issues and; 2.Expense recognition issues (capitalization).

One way to overstate persistent earnings

is to mis-classify normal operating expenses as expenses from discontinued operations. Analysts should be wary of large special items or when the company is reporting unusually large operating income for a period. Companies may include non-GAAP metrics such as proforma income which excludes non-recurring elements. Analysts should review the disclosures reconciling proforma income to reported income to evaluate whether the items that are labeled as non-recurring are truly non-recurring. Classification of items as non-recurring is highly subjective and, hence, is open for gaming. Classification shifting does not affect the total net income but rather is an attempt to mislead the user of the financial statements into believing that the "core" or "recurring" portion of earnings is higher than it actually is.

It is important to recognize that some accruals occur as part of normal business, called non-discretionary accruals. Discretionary accruals result from ---

non-normal transactions or non-normal accounting choices, and are sometimes used to manipulate earnings. One mechanism to separate discretionary and non-discretionary accruals is to model (using regression) total accruals as a function of a set of factors that typically give rise to normal accruals (e.g., growth of credit sales, amount of depreciable assets). The residuals from such a model would be an indicator of discretionary accruals.

"Take-or-pay" contractual provisions

obligate a party to either take delivery of goods or pay a specified amount (i.e., a penalty).

High-quality cash flow is characterized by

positive OCF that is derived from sustainable sources and is adequate to cover capital expenditures, dividends, and debt repayments. Furthermore, high-quality OCF is characterized by lower volatility than that of the firm's peers. Significant differences between OCF and earnings, or differences that widen over time, can be an indicator of earnings manipulation.

Biased Accounting: Warnings signs of misstated assets/liabilities:

•Inconsistency in model inputs for valuation of assets versus valuation of liabilities .•Typical current assets (e.g., inventory, receivables) being classified as non-current. •Allowances and reserves differ from those of peers and fluctuate over time. •High goodwill relative to total assets. •Use of special purpose entities. •Large fluctuations in deferred tax assets/liabilities. •Large off-balance-sheet liabilities.

Biased Accounting: Warnings signs of overstated operating cash flows:

•Increase in payables combined with decreases in inventory and receivables. •Capitalized expenditures (which flow through investing activities). •Increases in bank overdraft.

Biased Accounting: Mechanisms to overstate operating cash flows:

•Managing activities to affect cash flow from operations (e.g., stretching payables). •Misclassifying investing cash flow as cash flow from operations.

Biased Accounting: Warnings signs of misstated profitability

•Revenue growth higher than peers'. •Receivables growth higher than revenue growth. •High rate of customer returns. •High proportion of revenue is received in final quarter. •Unexplained boost to operating margin. •Operating cash flow lower than operating income. •Inconsistency in operating versus non-operating classification over time. •Aggressive accounting assumptions (e.g., high estimated useful lives). •Executive compensation largely tied to financial results.

Of course, which data are processed and analyzed will depend on the specific objectives of the analysis. In the example we present here, the objective is an analysis of a purchase decision for a long-term equity investment. The analysis focuses on the following:

•Sources of earnings and return on equity. •Asset base. •Capital structure. •Capital allocation decisions. •Earnings quality and cash flow analysis. •Market value decomposition. •Off-balance-sheet financing. •Anticipating changes in accounting standards. Professor's Note: A detailed example of financial statement adjustments and analysis is the best way to address the LOS in this topic review. To make the example easier to follow, we provide the financial statement data necessary to conduct our analysis as needed, rather than all at once

We must also consider the firm's sources of income and whether the income is generated internally from operations or externally. As discussed in the topic review on Intercorporate Investments, the equity method is used to account for influential investments (generally an ownership interest of 20% to 50%).

Under the equity method, the investor recognizes its pro-rata share of the investee's earnings on the income statement. Eliminating the equity income from the investor's earnings permits analysis of the investor's performance resulting exclusively from its own asset base. Assuming the investee is profitable, this adjustment will decrease both the investor firm's earnings and net profit margin. Since, under the equity method, the firm's investment is reported as a balance sheet asset, total assets should be reduced by the carrying value of investment. This will increase total asset turnover (smaller denominator). We can use the extended Dupont equation to determine the overall effect on ROE.

Cash flow statement approach to accruals

We can also derive the aggregate accruals by subtracting cash flow from operating activities (CFO) and cash flow from investing activities (CFI) from reported earnings as follows: Like the balance sheet accrual measure, the cash flow measure must be scaled for comparison purposes. Recall that IFRS allows some flexibility in the classifications of certain cash flows, primarily interest and dividends paid. Thus, for firms following U.S. GAAP, it may be necessary to reclassify these cash flows from operating activities to financing activities for comparison purposes.

Market Value Decomposition

When a parent company has an ownership interest in an associate (subsidiary or affiliate), it may be beneficial to determine the standalone value of the parent; that is, the implied value of the parent without regard to the value of the associate. The implied value is equal to the parent's market value less the parent's pro-rata share of the associate's market value. If the associate's stock is traded on a foreign stock exchange, it may be necessary to convert the market value of the associate to the parent's reporting currency.

Clear Presentation

While accounting standards specify which items should be included in the balance sheet, they do not typically specify how such items must be presented. Companies have discretion regarding which items they present as a single-line item versus those that are grouped together. Clarity of presentation allows an analyst to gather relevant information as well as to make comparisons across companies. Clarity should be evaluated in conjunction with information found in the notes to financial statements and supplementary disclosures.

The quality of financial reports can be viewed along two highly related dimensions:

earnings quality and reporting quality

One way to gauge earnings persistence is to use a regression model such as:

earnings(t+1) = α + β1 earnings(t) + ε In this model, a higher value of β1 indicates higher persistence of earnings.

Finally, a major red flag about earnings quality

is raised when a company reports positive net income while reporting negative operating cash flow.

tax burden

(net income - equity income) / EBT

Unbiased Measurement - the balance sheet reflects subjectivity in the measurement of several assets and liabilities:

.•Value of investment in debt or equity of other companies for which a market value is not readily available. •Goodwill value (subjectivity in impairment testing). •Inventory valuation (subjectivity in testing for impairment). •Impairment of PP&E and other assets.

cash generated from operations (CGO)

CGO = EBIT + non-cash charges - increase in working capital Because of the potential for earnings manipulation by increasing accruals, we decide to compare Thunderbird's cash flow to its operating income. Our interest is in determining whether operating income is confirmed by cash flow. In order to compare the two measures, it is necessary to eliminate cash paid for interest and taxes from operating cash flow by adding them back. (Interest and taxes are deducted for operating cash flow but not for operating income.)

Classification Issues

Classification issues refer to how an individual financial statement element is categorized within a particular financial statement (e.g., classification of expenses as operating vs. non-operating in the income statement). While timing/measurement issues affect multiple financial statement elements, classification issues typically affect one element

Completeness of a balance sheet

Completeness of a balance sheet is compromised by the existence of off-balance-sheet liabilities such as incorrect use of the operating lease classification, or purchase agreements structured as take-or-pay contracts. Analysts should restate the reported balance sheet by capitalizing operating leases and recording purchase contract obligations, if significant.

4. Capital Allocation Decisions

Consolidated financial statements can hide the individual characteristics of dissimilar subsidiaries. As a result, firms are required to disaggregate financial information by segments to assist users. Recall that a business segment is a portion of a larger company that accounts for more than 10% of the company's revenues or assets, and is distinguishable from the company's other line(s) of business in terms of risk and return characteristics. Geographic segments are also identified based on the same criteria. Although required disclosure under U.S. GAAP and IFRS is limited, the disclosures are valuable in identifying each segment's contribution to revenue and profit, the relationship between capital expenditures and rates of return, and which segments should be de-emphasized or eliminated.

Earnings Quality and Cash Flow Analysis

Earnings quality refers to the persistence and sustainability of a firm's earnings. Earnings that are closer to operating cash flow are considered higher quality. Of course, earnings are subject to accrual accounting events that require numerous judgments and estimates. As a result, earnings are more easily manipulated than cash flow. We can disaggregate earnings into their cash flow and accruals components using either a balance sheet approach or a cash flow statement approach. With either approach, the ratio of accruals to average net operating assets can be used to measure earnings quality. The interpretation of both ratios is the same: the lower the ratio, the higher the earnings quality.

Measurement and Timing Issues

Errors in measurement and/or timing typically affect multiple financial statement elements. For example, aggressive revenue recognition practices increase reported revenues, profits, equity, and assets. Similarly, conservative revenue recognition practices reduce reported revenues, profits, equity, and assets. Similarly, omission or postponement of expense recognition would increase profits, equity, and assets.

management can affect cash flows via strategic decisions (timing issues) even though its harder to manipulate

For example, OCF can be increased by slowing payments to suppliers (increasing accounts payables) or by selling receivables. Analysts can identify such practices by reviewing activity ratios (receivables and payables turnover ratios). Management may also try to shift positive cash flows from investing or financing activities into operating activities to boost OCF (classification issues).

3. Capital Structure

A firm's capital structure must be able to support management's strategic objectives as well as to allow the firm to honor its future obligations. Referring to Figure 3, Thunderbird's financial leverage ratio has decreased over the last three years from 2.2 in 2014 to 2.0 in 2016. Unfortunately, the ratio does not reveal the true nature of the leverage, as some liabilities are more burdensome than others. Financial liabilities and bond liabilities, for example, can be placed in default if not paid on time, or in the event of noncompliance with the lending covenants (technical default). On the other hand, liabilities such as employee benefit obligations, deferred taxes, and restructuring provisions are less burdensome and may or may not require a cash outflow in the future

Altman Model While not directly related to earnings quality, Altman's Z-score model was developed to assess the probability that a firm will file for bankruptcy.

Altman's model relies on discriminant analysis to generate a Z-score using five variables. Each variable is positively related to the Z-score, and a higher Z-score is better (less likelihood of bankruptcy). The variables used include: 1) net working capital as a proportion of total assets, 2) retained earnings as a proportion of total assets, 3) operating profit as a proportion of total assets, 4) market value of equity relative to book value of liabilities, and 5) sales relative to total assets. One limitation of the Altman model is that it is a single-period static model and, hence, does not capture the change in key variables over time. Additionally, similar to the Beneish model, Altman's model mostly uses accounting data. Other market based data sources may provide more meaningful information for evaluation of default risk.

2. Asset Base

Analysis of the asset base requires an examination of changes in the composition of balance sheet assets over time. Presenting balance sheet items in a common-size format (as a proportion of total assets) is a useful starting point.

LOS 19.g: Explain mean reversion in earnings and how the accruals component of earnings affects the speed of mean reversion

Analysts should be aware that earnings (NI) at extreme levels tend to revert back to normal levels over time. This phenomenon is known as mean reversion. Because of mean reversion, analysts should not expect extreme earnings (high or low) to continue indefinitely. When earnings are largely comprised of accruals, mean reversion will occur faster—and even more so when the accruals are largely discretionary.

Figure 13- CF/Avg Assets and EBIT margin explained:

Average assets are calculated as beginning assets + ending assets divided by 2. Using data from Figure 9, the 2016 average assets for the aircraft division is ($14,777 + $6,861)/2 or $10,819. Hence, for 2016, the cash flow to average assets for the aircraft division is $2,612 / $10,819 = 24.1%. Figure 13 confirms poor capital allocation decision to the specialty products division. In addition, we can see that the aircraft division—while continuing to produce superior operating margins—has fallen behind in cash generation in the latest year.

LOS 19.i: Describe indicators of cash flow quality

High-quality cash flow means the reported cash flow was high (i.e., good economic performance) and the underlying reporting quality was also high. Because operating cash flow (OCF) has the most direct impact on the valuation of a company, we will focus on OCF while evaluating cash flows.

A cash flow statement should be evaluated in the context of the corporate life cycle as well as industry norms

It would be quite normal for early-stage startups to have negative operating and investing cash flows, financed by cash flow from financing activities (e.g., equity issuance). For a mature firm, negative operating cash flow coupled with positive financing cash flow is usually problematic.

Mean Reversion (CFA Def)

Mean reversion can be explained with basic principles of economics: the competitive marketplace corrects poor performance; thus, losses are eliminated as firms abandon negative value projects. Conversely, capital is attracted to successful projects thereby increasing competition and lowering returns.

Business Combinations—Acquisition Method Accounting

Mergers and acquisitions often provide opportunities and motivations to manage financial results: For example, companies with declining operating cash flow may be motivated to acquire other cash-generating entities to increase cash flow from operations. Cash acquisitions are reflected in cash flow from investing activities. If acquisitions are paid for using stock, such a payment would bypass the cash flow statement altogether. Stock acquisitions provide an incentive for the acquiring company management to pursue aggressive accounting so as to inflate their stock price prior to acquisition. Similarly, target company managers may also be motivated to inflate their firm's stock price to fetch an attractive price at acquisition. In some cases, misreporting is actually the impetus for acquisitions: acquiring company managers may pursue acquisitions to hide pre-acquisition accounting irregularities. Such companies may acquire targets with dissimilar operations or with less publicly available information to reduce the comparability and consistency of their own financial statements. Acquiring company must allocate the purchase price to fair value of identifiable net assets of the subsidiary and the balance to goodwill. Acquiring companies often underestimate the value of identifiable net assets—thereby overestimating goodwill on acquisition. Fair value adjustments for identifiable assets typically result in excess depreciation which reduces profits for future reporting periods. Since goodwill is not amortized, the effect of overestimating goodwill (and underestimating the value of identifiable assets) is to increase future reported profits. Such inflated goodwill will eventually have to be written down as part of impairment testing but such losses can be timed. In addition, impairment losses can be downplayed as a one-off, non-recurring event.

Analysts should be aware that accounting standards afford some flexibility in the treatment of certain items in the statement of cash flows.

For example, while interest paid, interest received, and dividends received have to be treated as operating cash flows under U.S. GAAP, interest paid can be classified as either operating or financing cash flow under IFRS. Also, interest/dividend received can be classified as either operating or investing cash flow under IFRS. A company reporting under IFRS and accounting for interest paid as an operating cash flow could instead report it as a financing cash flow, giving the appearance of an increase in operating cash flows in a year-over-year comparison. Also, cash flows from sale of available-for-sale securities are treated as investing cash flows, while cash flows from sale of trading securities are treated as operating cash flows. Remember that companies have significant flexibility in designating investments as trading or available for sale. Hence, managers can shift cash flows from one classification to another. Such variation in the classification of cash flow items reduces comparability across companies

Equity Method Regarding Complenetes

For intercorporate investments, the equity method of accounting allows one-line consolidation for investments in associates. The equity method of accounting would result in certain profitability ratios (e.g., net profit margin, return on assets) being higher than under the acquisition method. Firms consolidating several subsidiaries with close to a 50% ownership stake by using the equity method would be a cause for concern.

Can you have high quality earnings and low reporting quality

One cannot have both low-quality reporting and high-quality earnings; high-quality earnings assume high-quality reporting. However, one could have a situation in which the company has high quality reporting but low-quality earnings. For example, a strike during the reporting period may have resulted in LIFO liquidation and, hence, given a one-off boost (i.e., earnings have low persistence) to reported earnings. However, the underlying reporting was accurate and decision-useful.

Capitalization to under report expenses

One way to boost reported performance is to under-report an operating expense by capitalizing it. Capitalizing an expense does however show up on the balance sheet as an asset and an analyst should be wary of unsupported changes in major asset categories. When the proportion of PP&E increases over time in common size balance sheets, analysts should question whether there is a systematic capitalization of expenses underway.

Other indicators of low quality earnings

1. Companies that repeatedly meet or barely beat consensus estimates. While this is not a foolproof metric, analysts should be wary of a company that narrowly beats its benchmarks consistently. 2.External indicators of low-quality earnings include enforcement actions by regulatory authorities (e.g., SEC) and restatements. External indicators are not very useful as they cannot be used to forecast deficiencies before such deficiencies are publicly known.

The conceptual framework for assessing the quality of a company's reports entails answering two questions:

1.Are the underlying financial reports GAAP compliant and decision-useful? 2.Are the earnings of high quality? For this discussion, GAAP is used in a generic sense and refers to either U.S. GAAP or IFRS.

Figure 1: Financial Reports Quality (High to Low)

1.GAAP compliant and decision-useful, high-quality earnings. 2.GAAP compliant and decision-useful, low-quality earnings. 3.GAAP compliant but not decision-useful (biased choices). 4.Non-compliant accounting. 5.Fraudulent accounting. Biased accounting provides information that hinders an analyst's ability to generate accurate forecasts of the future performance of the company. Biased accounting can be aggressive (recognizing future revenues/earnings in the current period) or conservative (postponing current earnings to the future). A related bias is 'earnings management' (e.g., earnings smoothing).

LOS 19.f: Describe indicators of earnings quality. High-quality earnings are characterized by two elements:

1.Sustainable: high-quality earnings tend to persist in the future. 2.Adequate: high-quality earnings cover the company's cost of capital. As stated previously, high-quality earnings assume high-quality reporting. In other words, low-quality earnings come about due to (a) earnings that are below the firm's cost of capital and/or (b) earnings that are not sustainable and/or (c) poor reporting quality (i.e., the reported information does not provide a useful indication of a firm's performance).

DuPont Results Explained

Note the slight improvement in ROE over the period, from 19.51% to 21.26%. The decomposition reveals that this is the result of an increasing EBIT margin and decreased effects of taxes and interest, which is offset to some degree by a reduction in financial leverage. Note that an increase in the interest and tax burden ratios indicates that the effective tax rate and impact of interest charges on operating earnings have decreased. By removing the equity income of Eagle from earnings and the equity investment from total assets, we can examine Thunderbird's performance on a standalone basis. Another common adjustment made by analysts is to remove the effects of any unusual items (e.g., provisions for restructuring and litigation, goodwill impairment, etc.) from reported operating earnings (EBIT) before computing the EBIT margin and the tax burden ratios.

LOS 19.b: Explain potential problems that affect the quality of financial reports.

Potential problems that affect the quality of financial reports may arise from: •Measurement and timing issues and/or •Classification issues.

Reporting quality

Reporting quality is an assessment of the information disclosed in the financial reports. High-quality reporting provides decision-useful information; information that is accurate as well as relevant. Low-quality reporting impedes assessment while high-quality reporting enables it.

GAAP Accounting but not Economic Reality

Sometimes, an accounting treatment may conform to reporting standards but, nonetheless, result in financial reporting that does not faithfully represent economic reality. For example, prior to mandatory consolidation requirements for variable interest entities under U.S. GAAP, Enron was able to avoid consolidation of various special purpose entities on technical grounds—thereby keeping large losses and liabilities off-balance-sheet. Restructuring provisions and impairment losses provide opportunities to time the recognition of losses (i.e., earnings management). Typically, recognition of impairment or restructuring losses in a period reflects overstatement of income in prior periods. Conversely, impairment or restructuring provisions may be strategically timed to shift future expenses into the current period. For example, impairment losses on long-lived assets recognized in the current period will reduce future depreciation expense. Similarly, restructuring provisions allow managers to effectively set aside profits in the current period to be used in the future. Provisions are non-cash expenses charged in the current period; future expenses from such provisions bypass the income statement. In such cases, losses recognized in the current period will boost income in the future when reversed.

Steps in evaluating the quality of financial reports:

Step 1:Understand the company, its industry, and the accounting principles it uses and why such principles are appropriate. Step 2:Understand management including the terms of their compensation. Also evaluate any insider trades and related party transactions. Step 3:Identify material areas of accounting that are vulnerable to subjectivity. Step 4:Make cross-sectional and time series comparisons of financial statements and important ratios. Step 5:Check for warning signs as discussed previously. Step 6:For firms in multiple lines of business or for multinational firms, check for shifting of profits or revenues to a specific part of the business that the firm wants to highlight. This is particularly a concern when a specific segment shows dramatic improvement while the consolidated financials show negative or zero growth. Step 7:Use quantitative tools to evaluate the likelihood of misreporting.

High-quality earnings

The term high-quality earnings refers to a high level of earnings (i.e., meets the required return on investment) as well as sustainability of earnings. Good economic performance and sustainable earnings are considered higher quality. Conversely, low-quality earnings arise either due to genuinely bad performance or due to misrepresentation of economic performance Earnings quality is also referred to as results quality. High-quality earnings increase the value of a company more than low-quality earnings.

Balance sheet approach

Using the balance sheet, we can measure accruals as the change in net operating assets over a period. Net operating assets (NOA) is the difference between operating assets and operating liabilities. Operating assets are equal to total assets minus cash, equivalents to cash, and marketable securities. Operating liabilities are equal to total liabilities minus total debt (both short term and long term). (BS based aggregate accruals formula) In order to make comparisons, it is necessary to scale the accrual measure for differences in size. Just like ROA and ROE, the measure can be distorted if a firm is growing or contracting quickly. Scaling the measure also allows for comparisons with other firms. Scaling is done by dividing the accrual measure by the average NOA for the period. The result is known as the accruals ratio

1. Sources of Earnings and Return on Equity

We begin our analysis by identifying the sources of Thunderbird's earnings and determining whether these sources are sustainable over time. The DuPont decomposition allows us to identify the firm's performance drivers to potentially expose effects of weaker operations that are being masked by the effects of stronger operations. For example, a firm could offset a declining EBIT margin by increasing asset turnover or increasing leverage

Sustainable or persistent earnings

are earnings that are expected to recur in the future. Earnings comprised of a high proportion of non-recurring items are considered to be non-sustainable (and hence low-quality).

High-quality financial balance sheet reporting is evidenced by

completeness, unbiased measurement, and clarity of presentation

Quantitative Tools - The Beneish Model

probabilities. M-score = -4.84 + 0.920 (DSRI) + 0.528 (GMI) + 0.404 (AQI) + 0.892 (SGI) + 0.115 (DEPI) - 0.172 (SGAI) + 4.67 (Accruals) - 0.327 (LEVI) where: M-score > -1.78 (i.e., less negative) indicates a higher-than-acceptable probability of earnings manipulation. •Days Sales Receivable Index (DSRI): Ratio of days' sales receivables in year t relative to year t - 1. A large increase in DSRI could be indicative of revenue inflation. •Gross Margin Index (GMI): Ratio of gross margin in year t - 1 to that in year t. When this ratio is greater than 1, the gross margin has deteriorated. A firm with declining margins is more likely to manipulate earnings. •Asset Quality Index (AQI): Ratio of non-current assets other than plant, property, and equipment to total assets in year t relative to year t - 1. Increases in AQI could indicate excessive capitalization of expenses. •Sales growth index (SGI): Ratio of sales in year t relative to year t - 1. While not a measure of manipulation by itself, growth companies tend to find themselves under pressure to manipulate earnings to meet ongoing expectations. •Depreciation index (DEPI): Ratio of depreciation rate in year t - 1 to the corresponding rate in year t. The depreciation rate is depreciation expense divided by depreciation plus PPE. A DEPI greater than 1 suggests that assets are being depreciated at a slower rate in order to manipulate earnings. •Sales, general and administrative expenses index (SGAI): Ratio of SGA expenses (as a % of sales) in year t relative to year t - 1. Increases in SGA expenses might predispose companies to manipulate. •Accruals = (income before extraordinary items - cash flow from operations) / total assets. •Leverage index (LEVI): Ratio of total debt to total assets in year t relative to year t - 1.

Total asset Turnover

revenue / [(beginning total assets - beginning equity investment + ending total assets - ending equity investment) / 2]

Due to this subjectivity in revenue and expense recognition, disaggregating income into its two major components, cash and accruals, further enhances its quality as an input for forecasting future earnings. The accrual component of income is less persistent than the cash component. In the following regression model,

β1 > β2: earnings(t+1) = α + β1 cash flow(t) + β2 accruals(t)+ ε

Biased Accounting: Mechanisms to misstate profitability:

•Aggressive revenue recognition, including channel stuffing (aggressively selling products to distributors on generous terms such as lax return policies), bill and hold sales (where economic title to goods may not truly pass to customers), and outright fake sales. •Lessor use of finance lease classification. •Classifying non-operating revenue/income as operating, and operating expenses as non-operating. •Channeling gains through net income and losses through OCI.

Biased Accounting: Mechanisms to misstate assets/liabilities:

•Choosing inappropriate models and/or model inputs and thus affecting estimated values of financial statement elements (e.g., estimated useful lives for long-lived assets). •Reclassification from current to non-current. •Over- or understating allowances and reserves. •Understating identifiable assets (and overstating goodwill) in acquisition method accounting for business combinations.