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Accounting Frauds

Enron Scandal

Tyco International

Adelphia

Peregrine Systems

WorldCom

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Enron Corporation (ENE) American energy company Stock Price $90.75 in mid 2000.

Highlights of the Scandal Largest bankruptcy reorganization in American

history (63.4 billion) Reduced stock price from $90.75 to $0.61 in late

2001. Dissolution of Arthur Andersen, which was one of

the five largest audit and accountancy partnerships in the world

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Revenue Recognition: Other companies used agent model to recognize

revenue, while Enron using Merchant model Special purpose entities:

Hundreds of SPEs used to hide debt. Which were using company's own stock and financial guarantees.

Executive compensation: Reward its most valuable employees Resulted :

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SEC emphasized developing a method to detect next Enron in advance, formed a new Financial Reporting and Audit Task Force to design a new Accounting Quality model.

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The Crack Down on Fraud in Accounting and Financial Reporting (Unusual Accounting Choices) and make an alert to SEC.

Based on alerts SEC will be putting expensive audits on filer.

This is named as “ROBOCOP”.

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Analytical tool which trawls Corporate filings to flag high-risk activity (Unusual Accounting

Choices).

Robocop's objective – To identify earnings management (generally

attempt to estimate discretionary accrual amounts)

Automated Comparison of peer group

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Risk indicator: Accounting policies which result:

High book earningshigh proportion of transactions structured as ‘off-

balance sheet.Frequent conflicts with independent auditors,

changes in auditors, or filing delays.

Risk Inducer:Decreasing market sharelower profitability margins

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AQM produces a score for each filing and keeps a score card for each filer. Based on data SEC will put expensive audits.

Those companies able to minimize their risk score will be less likely to face unnecessary SEC audits for innocent activity.

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Dependence only on financial comparisons between filers.

Next Generation RoboCop

Focus on scanning Management Discussions & Analysis (MD&A) section of annual reports.

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Possibility of mapping MD&A section.

Reducing (XBRL) mapping errors since this is an automated tracker.

Mapping according to the peer group (Especially Accounting policies)

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Background for AQM Enron Scandal AQM (Robocop) as a fraud detector Weakness of RoboCop version 1 Impact on XBRL production

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