Here’s the link for course ->https://class.coursera.org/accounting-002
Read this (A true story copied from the internet)
As we all know, public companies all hope to earn more profits,but the public company I mentioned suffered loss this year.
The loss was heavy, about RMB100 million. But this company didn’t want others to know about its loss,so it was determined to change the loss to profit.But how can it make it happen? It discovered that it had about RMB160 million worth of debt with banks. You may think there is no link between having debt and the status of profitability. However, this company said that the debt was not due yet, so it would repay ahead of the due. Then what could be taken as the repayment? It used a house worth RMB30 million. You may wonder how a RMB30 million house can repay the RMB160 million debt. The company would say, it used the house as the mortgage and would spend RMB160 million cash on buying back the house on the second day. You will see that in this whole process, the house was not given to the bank at all. In the end, the company would use RMB160 million cash to pay for the RMB160 million debt.But things are different now. How come?Let’s think in this way.
On the first day, the company took RMB30 million house as the mortgage for the repayment of the RMB160 million debt.
So we can say it earned RMB130 million, minus its loss worth RMB100 million then we get RMB30 million profit.You may think it invalid because the house would be bought back on the second day with RMB160 million cash at a price of RMB30 million. No doubt this was a bad deal, but what happened to the financial statement of the company? Up until now, you may have no idea. But I can tell you an important principle, that is, your profit is only related to things you sell. So to buy a RMB30 million house with RMB160 million cash will not affect the profitability because it is not selling things. The only impact on the financial statement is that the house value increased from RMB30 million to RMB160 million. As a result, several changes happened to the financial statement of the company. First, it would turn from a company suffering
from RMB100 million loss to one with RMB30 million profit.
Second, there is one item in the category of asset on the statement calling house.
Its value would increase from RMB30 million to RMB160 million.
You may have different thoughts about whether this company is involved in fraud.
In fact, a famous media did accuse this company of fraud.
But in the end, the company filed a law suit against the media for defamation.
Can you guess the result?
The company won the case. Why?
The judge recognized that the company’s behavior didn’t break the accounting principles,
therefore, no fraud involved.
As you can see, without doing fraud,
a company with RMB100 million loss can become one with RMB30 million profit.
Now as an investor would I want to invest in such a company. NO and NEVER. If I just saw the results like most novice investors do they would have been carried away with a 30million profit but if it was somebody who was smart enough the go through the entire earning profile, understand and comprehend it correctly, you would have been spared the agony. So therefore, its important to educate oneself against these frauds and also identify hidden gems. Sometimes, even opposite happens, especially with small caps where the balance sheet is very strong, but purely its a small company its away from the limelight and thats where maximum compounding happens.
If you are a non-finance guy like me and want to know a bit about accounting, so as to read and analyze balance sheets, understand cash flows, Statement of profit and Loss etc, I would recommend this course. Here’s the link ->https://class.coursera.org/accounting-002
I had to go through the pains of reading text books to brush up my accounting skills. I hope this course would help others like me.
NOTE: I will not spend my energy in answering any accounting related questions 🙂 . Please use the forum on the coursera to do it.