Aggressive accounting is the use of optimistic projections or gray areas in the accounting standards to create financial statements that present a rosier picture of a company than is actually the case. These actions are taken to give the investment community a falsely enhanced view of a business, or for the personal gain of management.
Examples of aggressive accounting practices include:
- Reserves. Recording a reserve against inventory or receivables that is less than historical experience suggests should be recorded.
- Expense deferrals. Recording an expenditure as an asset, rather than charging it to expense as incurred.
- Asset inflation. There are a number of ways to increase the recorded value of an asset, which correspondingly reduces the amount of reported expenses. For example, the amount of overhead allocated to inventory can be manipulated, thereby driving up the recorded amount of inventory and reducing the cost of goods sold. Also, the capitalization limit can be reduced, so that more expenditures are classified as fixed assets.
- Revenue recognition. Revenue may be recognized before the seller has fulfilled all obligations associated with a sale transaction.
A company's management team may engage in aggressive accounting for several reasons, including the following:
- Bonuses. Managers may be paid significant bonuses if they can achieve certain financial results.
- Loans. A loan may be called by a lender if the company cannot meet or exceed certain covenants.
- Stock price. A publicly-held company may be under pressure from the investment community to continually deliver increased earnings that will increase the company's stock price.
Some types of aggressive accounting literally reflect the optimistic projections of management, such as for a reduced level of bad debt expense, and can be countenanced by a company's auditors, as long as the accounting can be reasonably justified. In other cases, aggressive accounting is clearly pushing the boundaries of fraud, and can result in an auditor being unable to render an opinion on a company's financial statements without significant changes being made to tone down the impact of management's assertive accounting.
Aggressive accounting may be confined to technical areas where detection is so unlikely that managers may be able to get away with it for a number of years. However, if these practices eventually increase the reported results or financial position of a business to a point well beyond that of comparable companies, it becomes increasingly likely that the accounting will be detected.