GPI 335 – If you learn to recognize ways to inflate profits, you will learn how to also cut costs.

You may read this and ask how can I know how to increase profits from a list of ways to do it deviously?  Learning these methods teaches one to understand the business and where to look for problems in early stages before it becomes too late.

A few examples of methods to overstate a company’s profits:

• Inventory – Costs carried greater than market. Carry inventory on the balance sheet at costs greater than what current market prices will bear. If this is the case, calculate the difference and setup the loss within the inventory reserve. You can also write down the inventory, but either way, the net inventory should be equal to or lower than the current market selling price. Once the sale is made in the future, you can offset the loss against the reserve held on the balance sheet so that there is no income statement impact in period two.
• Inventory – Items with no or decreased market value. Carry inventory on the balance sheet that does not sell or is about to be outdated by new competitive versions (i.e. iphone 5 versus iphone 6).
• Overstate sales: Recognize (book) sales as earned, when it is not.  For example, construction companies must earn a percentage of their total revenue each month as they build a structure. They might book 40% of revenues since they might claim 40% of costs are complete, yet those cost estimates may reflect only 30% of total estimate costs thereby overbooking profit margin. When reviewing their costs to complete, they might ignore new projections that are higher than previous cost estimates and thus overstate the anticipated profit margin on the entire project.  The final correction might not occur until late in the two-year project during the last two or three months.
• Under accrued expenses: Accounts payable neglects to accrue items in the proper period (i.e. service performed in September, bill arrives in October, not accrued Sept, Sept P&L overstated, Oct understated)
• Unrecognized payroll expenses: Company pays the 4^th quarter’s bonuses in the next year, neglects to accrue these expenses in prior year to match sales expense with recognized revenue. Note:  If tax rates are cut in the second year, you paid too much tax in the prior year.
• Unrecognized property taxes: Company pays property taxes in year 2 based upon the 12-31 values from year 1 and did not accrue those property taxes in the prior year.  Note: Also learn to avoid tax penalties.
• Unrecognized sales tax liabilities: Companies are to accrue sales tax on purchases where they were not taxed properly.  Note:  At yearend when they pay the sales tax that they self-assess, they pay it in year 2 when it should have been accrued in year 1. Learn to avoid tax penalties.