Bookkeeping Questions and Lessons from American Realty Capital Scandal

The American Realty Capital Scandal has raised a number of bookkeeping questions that investors, regulators and executives can learn from. How will this scandal impact corporate finance?


American Realty Capital (ARG) recently came under fire after admitting to a series of accounting irregularities. The scandal wasn’t as serious as the fallout from Enron in 2001, but has still fueled ire among Wall Street investors. Executive Chairman Nicholas Schorsch and two other executives have resigned over the scandal.

While the case has significantly dampened sentiments of American Realty Capital investors, it has created even more significant concerns on Wall Street. Investors have raised a number of bookkeeping questions about the practices at ARG, which other corporations will need to answer as well. Investors should learn the fundamentals of bookkeeping or hire a professional accountant to research a company before investing in it.

 

Bookkeeping Questions Raised Over New Scandal

ARG first faced problems in October. The company admitted to SEC auditors that it had inflated operating revenue figures, presumably to inflate their stock price.

The SEC is still investigating possible accounting errors with the company. William Stanley was reportedly appointed as interim CEO until the company can find a permanent replacement. Stanley said that the discovery is a positive development, because it allows ARG to take the necessary steps to change its accounting practices and increase transparency. However, it still highlights a number of problems that have become a cause for concern on Wall Street.

Lessons for Executives and Investors

The problems with ARG have led to a number of bookkeeping questions for everyone that works with or invests in a publicly traded company. Here are some of the questions that stakeholders are probably asking:

  • Can investors trust other companies to report their finances honestly?
  • Should investors only invest in companies with the right compliance programs in place?
  • Will companies need to be more straightforward with their reporting to survive SEC audits?

The SEC has been trying to crack down on accounting malfeasance, insider trading and other financial crimes. However, the regulator’s power was recently called into question after an appellate court overturned insider trading convictions of two hedge fund managers. Therefore, investors will need to be more diligent about reading financial sheets and learn to identify possible bookkeeping errors on their own.

 

Reading Between the Lines with Corporate Financial Statements

Every investor should read corporate financial statements carefully before purchasing stock. However, they also need to be wary of the figures, because they can be influenced by a number of factors. The Frankfurt Stock Exchange in Germany shared some tips that are also applicable to U.S. investors.

One of the most important takeaways from the ARG scandal is that companies have a lot of leeway with reporting Earnings Before Interest and Taxes. However, they don’t have the same flexibility with reporting net income, so investors should look at that revenue metric on the income statement very carefully.

Some companies may blatantly misrepresent their finances, but very few are willing to take the risk since the SEC monitors transactions so closely. The biggest mistake most companies make is trying to get too creative without breaking the law. They may unwittingly cross the line, but at least the majority of these errors are more noticeable. Here are some things that they need to pay attention to:

  • Unusual changes in revenues or gross profits
  • Earning trends that do not reflect news about demand
  • Changes in financial documents are grossly inconsistent with those in the industry
  • Few explanations are offered for significant changes in revenues

Every investor needs to be a detective answer any bookkeeping questions while reading a financial document. Keep in mind that companies are rarely entirely transparent when reporting income, so investors should always take these reports with a grain of salt.

Seek Help Reading Financial Sheets

Investors need to study financial statements very carefully before purchasing common stock. Unfortunately, the ARG case provides new evidence that corporations aren’t completely honest when they report their earnings. You will need to raise different questions and learn to discern accurate information from these reports. Please feel to reach out to Horne Financial if you have any bookkeeping questions about reading these financial documents.


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