12-Creative Accounting and Failed Risk Management (Pages 73-75)

8/13/2019 12-Creative Accounting and Failed Risk Management (Pages 73-75)

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BOOKS REVIEWED:

de la Torre, Ignacio, 2008,Creative Accounting Exposed(Houndmills, Basingstoke,Hampshire, UK: PalgraveMacMillan).

Hubbard, Douglas W., 2009,The Failure of Risk Manage-ment: Why Its Broken and Howto Fix It(Hoboken, NJ: Wiley).

The books selected for reviewaddress deceptive financialreporting practices and improv-ing risk management. InCreative Accounting Exposed,Ignacio de la Torre describeshow organizations legally andillegally mislead users of finan-cial statements. In The Failureof Risk Management, DouglasW. Hubbard shows how to iden-tify and fix hidden risk manage-ment problems.

CREATIVE ACCOUNTING

EXPOSED

Creative AccountingExposedis a comprehensivecompendium of aggressiveaccounting practices across the

world. Written in a clear, con-cise, and surprisingly nonjudg-mental and factual style, authorIgnacio de la Torre detailsnumerous examples of howorganizations legally and ille-gally achieved desired reportingresults that were not truly repre-sentative of their financial per-formance or position. For manyreaders, this book will provideeye-opening insights into thedegree and ease with which

financial statements can bemanipulated.

In the books introduction,the author defines creativeaccounting as the use of subjec-tivity in the interpretation ofaccounting rules to the extentthat the financial informationdoes not reflect the real situationdespite complying with the law.The techniques and examplespresented in later chapters sug-gest he also includes illegalmethods in his definition of theterm. The schemes and methodspresented in the book range fromsimplistic aggressive revenuerecognition techniques to highlysophisticated financial statementmanipulations involving both theuse of complex derivatives and

the complicity of multiple exter-nal entities. As an academic, theauthor does a great job ofexplaining the economic effectsof a transaction and then showshow a particular scheme oper-ates and results in a desiredreporting distortion in the finan-cial statements.

This book is organized intoeight chapters, the first six ofwhich address different cate-gories of creative accounting

schemes and techniques. Forexample, Chapters 1, 3, and 5discuss creative accounting inthe revenue recognition, off-balance-sheet f inancing, andrecognition of financial itemscategories, respectively. Chapter7 covers creative accounting ingovernmental and privately heldentities, while Chapter 8 relatesthe authors perspective on cre-ative accounting practices inthe context of recent historyand international accounting,reporting, and regulatoryenvironments.

Creative AccountingExposedis extremely well writ-ten, belying the fact that it is atranslation of a work written andoriginally published in Spanish

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2009 Wiley Periodicals, Inc.Published online in Wiley InterScience (www.interscience.wiley.com).

DOI 10.1002/jcaf.20550

Creative Accounting and Failed

Risk Management

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David M. Cannon, Joseph H. Godwin, and Stephen R. Goldberg


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in 2006. The text flows seam-lessly between descriptions ofaggressive accounting tech-niques, their effects, the motiva-tions of those that use them, theunderlying accounting principles

and true economic effects of thesupporting graphs and tables,and copious real-life examplesof the use and effects of aggres-sive accounting. The seamlessquality also applies to how de laTorre is able to effortlessly shiftbetween examples of creativeaccounting practices under U.S.generally accepted accountingprinciples (GAAP), country-specific accounting standards,and International Financial

Reporting Standards (IFRSs).In spite of massive changes in

the economy since the original2006 publication of CreativeAccounting Exposed, the bookremains highly relevant. Theauthor notes that the bursting ofthe economic bubble in 2007exposed the billions and billionsof dollars that the main Westernbanks . . . kept out of their bal-ance sheets. Other types oforganizations were likewise found

to have been using many of theschemes outlined by the authorwhen the schemes or organiza-tions failed in the face of the mas-sive economic events of late 2008whose reverberations continue tothis day. The lone additions tothe 2006 Spanish edition, whichwas updated and published (inEnglish) in 2008, appear to be abrief mention of 2007 economicevents in the acknowledgmentpage in the books front cover, anda two-page epilogue in Chapter 3that describes the role of creativeaccounting in the mid-2007economic crisis.

One of the underlying les-sons of this book is that theadoption of new accountingstandards, and in particular,IFRSs, can expose the prior use

of creative accounting practices.Many of the examples used byde la Torre were illustrated bythe differences in reportingbetween national accountingstandards and IFRSs. While all

such differences cannot beattributed to creative accounting,there are some that have no otherrational explanation.

This book is highly recom-mended for executives, investors,lenders, auditors, forensicaccountants, credit analysts, oranyone with an interest in thereliability of financial state-ments. Most readers, and particu-larly graduate accounting andbusiness students, should benefit

from the insights they can gaininto legal and illegal accountingchoices and schemes that affectthe quality of financial reporting.

THE FAILURE OF RISK

MANAGEMENT

Natural, financial, andgeopolitical disasters at thebeginning of the twenty-firstcentury encouraged growth andapplication of financial and non-

financial risk management meth-ods. The Failure of Risk Man-agementpoints out that mostrisk management methods do notaddress known sources of errors,and there is a growing realiza-tion that systematic errors haveundermined the validity of thesemethods. Also, typical risk man-agement methods have no per-formance measures to determinetheir effectiveness.

Douglas W. Hubbard showsexecutives how to measure riskmanagement performance andfix hidden problems. He uses hisconsiderable expertise to illus-trate calibrated risk analysis andattendant benefits. He provideschecklists and practical exam-ples, which allow managers tohit the ground running. Hubbard

invented Applied InformationEconomics. He is an expert inmeasuring intangibles, risks, andvalue (especially informationtechnology [IT]). His methodshave applied to dozens of For-

tune 500 IT investments, mili-tary logistics, venture capital,aerospace, and environmentalissues. He has written andspeaks extensively on his areasof expertise.

Hubbard questions whethertraditional methods work,whether anyone in the organiza-tion would know if they did notwork, and what would the conse-quences be if they didnt work.The Failure of Risk Management

includes just enough technicalinformation to make the subjectaccessible to a general manage-ment audience. The authorsobjectives in the book are (1) toreach the widest possible audi-ence among managers and ana-lysts, (2) to give them enoughinformation to quit using inef-fective methods, and (3) to getthem started on better solutions.

Common mode failure ariseswhen a single event causes fail-

ures of multiple components in asystem. One example is an air-plane crash in which a tail-mounted engine failed and, withturbine blades flying out of theengine like shrapnel, cut all threeredundant hydraulic systems,making the plane uncontrollable.Aviation officials referred to thisas a one-in-a-billion failurebased on the likelihood of allfour events occurring indepen-dently. However, the events arenot independent. A similaranalysis can be made of the cur-rent financial crisis. Initial riskassessment must be based onmeaningful measures for realrisk mitigation. The authorapplies his technique to exam-ples such as approval and prior-itization of investments and

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DOI: 10.1002/jcaf 2009 Wiley Periodicals, Inc.


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project portfolios and evaluationof major security threats.

Failure of risk managementmay not be obvious. A singledisastrous event does not neces-sarily constitute a failure of risk

management. The author identi-fies three reasons for failure ofrisk management. The first rea-son is a failure to measure theeffectiveness of risk manage-ment. A second reason for fail-ure is not using methods orresearch known to work.Examples are (1) failing to useresearch that shows howhumans misperceive and sys-tematically underestimate risksand (2) adding error through

arbitrary scales or nave use ofhistorical data. The f inal reasonis not using methods that areproven to work.

The book consists of threeparts, 12 chapters, and 260 pages,plus a preface, a calibration test,

and an index. Part One: AnIntroduction to the Crisis con-sists of three introductory chap-ters. Hubbard introduces theproblem being addressed,outlines the diversity of risk

management approaches, andexamines how to evaluate riskmanagement methods. The sixchapters in Part Two: Why ItsBroken introduce four schoolsof thought to risk managementand differences in terminology.Sources of errors in popularmethods that have not beenaddressed are discussed. Falla-cies are listed that keep firmsfrom using better methods. Thelast chapter of this part high-

lights significant problemswith quantitative methods thatare used.

Part Three: How to FixIt introduces methods thataddress sources of errors identi-fied in the second part. Basic

concepts behind better methodsare discussed. Hubbard sug-gests how to think about proba-bilities and how to introducescientific methods and mea-surements into risk management.

The book concludes by lookingat issues involved in creating aculture in organizations thatfacilitates better risk manage-ment. As the author indicates,he attempts to give readers a10,000-foot view; in addition,he refers readers to his Web sitewith more hands-on samplespreadsheets to see examplecalculations.

Hubbard makes an interest-ing contribution to the risk

management literature. TheFailure of Risk Managementisrecommended reading for man-agers at all levels and aspiringexecutives interested in orinvolved in risk management,and strategic planning.

The Journal of Corporate Accounting & Finance / November/December 2009 75

2009 Wiley Periodicals, Inc. DOI: 10.1002/jca

David M. Cannon, PhD, CPA, CISA, is an assistant professor at Grand Valley State University. Dr. Cannonsteaching interests are in accounting information systems, management information systems, and man-agerial accounting. His research areas include accounting information systems and methodologicalissues in accounting research. Joseph H. Godwin, PhD, CPA, and Stephen R. Goldberg, PhD, CPA, areprofessors of accounting at Grand Valley State University. Their teaching and research interests focuson financial accounting, international accounting, financial derivatives, and economic value added. Theyhave published articles in a number of academic and practitioner-oriented journals.

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12-Creative Accounting and Failed Risk Management (Pages 73-75)