Question

When analysing financial statements, the analyst must be aware of possible asset and liabilities distortions. List three (3) asset and two (2) liability distortions which can occur and explain each by means of an example. The example must include the effect on the financial statements of the company.

Answer 1

As per analysts, the possible assets and liabilities where the distortion could take place are:

1) Assets: The current assets and fixed assets which could be devalued and overvalued to have advantages are :

Current Assets : The currents assets like inventory, accounts receivables, stores and receivables can be encouraged to get distortion effect on the balance sheet. This is because to increase the income of the company, the Net Income ie. Liabilities, are raised and consequently the value of the assets would be raised by the equal amount of assets. Thus the assets distortions takes place.

Fixed assets : The depreciation methods of usage of the fixed assets could be changed according to requirements of the manupulation or distortions.

2) Liabilities and shareholder's equity : The liabilities and shareholder's equity get distorted through reducing the liabilities so that the income of the concern are falsifyly altered and incresed as desired. The financial statements are raised for the higher profitability of the concern so that rosy picture is presented before the prospective investors. The current libilities like accounts payable, accrued liabilities and payables are distorted or reduced or falsify to have advantages like higher profitability level, low liability or debt concern.

Thus, the analyst have to analyse the financial statements / results in such a way to trap all possible asset and liability distortions or falsifications or manupulations.

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