Mr. Levitt highlights five main accounting tricks currently in practice to shroud the true status of a company's finances. 1) "Big Bath" charges; 2) Merger Magic; 3) Cookie Jar Reserves; 4) Materiality; and 5) Revenue Recognition. The Big Bath, in which companies charges such as restructuring cleans up their balance statements to inflate future earnings. Next, Merger Magic, by which cost of acquisitions also inflates future earnings. Cookie Jar Reserves, another illusion by which companies accrual in accounts during good times and use them in times of need. Materiality, refers to very small items that have been purchased are not even reported or noted in the books again skewing the true numbers of the company. Lastly, Revenue Recognition, their boosting earnings by showing sales or earnings income before that income has truly been finalized; i.e. a sale that has yet to be completed. (1)
In short, Mr. Levitt proposes a broad comprehensive "Action Plan" to mitigate this growing problem chiefly consisting of changing the rules by which auditors and regulators monitor the accounting practices of businesses. This includes more disclosures required by businesses during audits, publishing guidelines to consider qualitative as well as quantitative factors of earnings, as well as a number of other significant SEC changes to enforce new regulations. In addition, he stresses the need to improve the auditing practices in this country including better-trained and equipped auditors and a strengthening of the Audit Committee Process to help guard the public interest. Perhaps most importantly, he sees a need for a vast cultural change in the business world through a mandate for a new level of trust, integrity, and accountability in the business world today. (1)
