The how and why of balance sheet manipulations

BANGALORE, INDIA: As corporate India is in shock over Satyam's revelation of fraudulent balance sheet accounting, it is a good time to understand how these errors - deliberate or otherwise - occur and how they should ideally be countered.

In financial accounting terms, a balance sheet or statement of financial position is a summary of company's Assets, liabilities and ownership equity at any given point of time, such as the end of its financial year.

Unlike other financial documents, the balance sheet is the only statement which applies to 'value' at any given point of time. So, where does fraud occur?

According to Journal of Accountancy, which is regarded as the one-stop-shop for understanding the mechanics of Commerce and Accountancy, "Most assets on a balance sheet are recorded at their original historical cost and, absent an impairment, are not adjusted as their market values change".

“Thanks to compliance laws, accounting standards-setters over the last decade have moved closer to reflecting values for assets and liabilities at current prices, especially if the values of those assets and liabilities are volatile and subject to significant change over short periods of time," it says.

In such a scenario, fraudsters can only manipulate balance sheets either by making incorrect accounting entries or indirectly by keeping transactions off the books entirely.

The latter category, according to accounting experts has grown significantly in sophistication and magnitude, and more likely to occur in companies that have rigid financial structures.

The simplest reason for a fraud in balance sheet numbers is to evade compliance to investors, if the company has defaulted under the terms of the loan.

There are a few global and national associations, besides standards that corporates are expected to follow for their financial accounting -- these include Generally Accepted Accounting Principles (GAAP), which includes sub-sections like Principle of Regularity, Principle of Consistency, Non-compensation, Continuity etc.

In India however, the Institute of Chartered Accountants of India has the authority to issuing accounting standards to companies. So far ICAI has issued 31 Accounting Standards and AS-32 is under preparation.

Has Satyam adhered to these guidelines? It's left to be seen.