The preparation of corporate financial statements needs to comply with accounting standards and regulations, but there are indeed some **legal but potentially misleading** adjustment methods. By taking advantage of the flexibility or ambiguity of accounting standards, these methods may affect the judgment of investors and analysts on the true financial status of the company. The following are common methods of operation and their potential effects： --- ### 1. **Adjustment of income recognition policy** -**Legal means**: by confirming income in advance (for example, when the goods are not delivered or the service is not completed) or by delaying the confirmation of income (for example, postponing the current quarter's income to the next quarter). -**Misleading impact**: Exaggerate current profits or smooth out income fluctuations to conceal the true performance of the business. -**Case **: When the income of long-term contracts is confirmed by the “completion percentage method”, the subjective judgment of the completion progress may overestimate the income. --- ### 2. **Manipulation of reserves and accrued items** -**Legal means**: Artificially adjust current profits by adjusting the provisions for bad debts, the provisions for inventory price declines, or the provisions for legal proceedings. -**Misleading impact**: Companies make more reserves in years with good profits, and release reserves in years with poor profits to ”smooth profits". -**Case **: A company's current profit has increased significantly by suddenly reducing the proportion of bad debt reserves. --- ### 3. **Asset revaluation and depreciation policy** -**Legal means**: Change the depreciation period or residual value rate of fixed assets (such as extending from 5 years to 10 years), or revalue the fair value of investment real estate. -**Misleading impact**: Reduce depreciation expenses (increase profits) or increase the value of assets to improve the balance sheet. -**Case **: Retail companies have reduced annual depreciation costs and increased net profit by extending the depreciation life of their stores. --- ### 4. **Off-balance sheet financing and Special purpose entities (SPE)** -**Legal means**: Transfer debt to the asset balance sheet through leasing, factoring or establishment of SPE. -**Misleading impact**: Hide the true debt level and reduce the leverage ratio. -**Case **: In the Enron incident, SPE was used to cover up huge debts, leading to financial collapse. --- ### 5. **Expense capitalization and R&D expenditure processing** -**Legal means**: Capitalize expenditures that should have been costed (such as R&D and advertising expenses) into long-term assets. -**Misleading impact**: Increase profits in the short term, but may form a risk of asset impairment in the future. -**Case **: Technology companies have inflated their current profits through capitalized development expenditures. --- ### 6. **Selection of inventory pricing method** -**Legal means**: Switch between the first-in, first-out method (FIFO) and the last-in, first-out method (LIFO), which affects sales costs and profits. -**Misleading impact**: In an inflationary environment, the use of FIFO will reduce sales costs and thereby increase profits. -**Case **: Commodity companies adjust their profits by changing their inventory pricing methods. --- ### 7. **Related party transaction and transfer pricing** -**Legal means**: Transfer assets or services at non-market prices through related party transactions. -**Misleading impact**: Exaggerate revenue or transfer costs to conceal true profitability. -**Case **: The parent company sells goods to its subsidiaries at high prices, artificially increasing the income of the consolidated statements. --- ### 8. **Classification of non-recurring gains and losses** -**Legal means**: Classify recurring expenses as “non-recurring losses” (such as restructuring expenses and losses on asset sales). -**Misleading impact**: Beautify core business profit (EBITDA or adjusted net profit). -**Case **: Companies have classified restructuring expenses as “one-time expenses” for many years, misleading investors about their judgment of sustainable profitability. --- ### How to identify potential misdiagnosis? 1. **Pay attention to cash flow**: Compare whether there is a long-term deviation between net profit and cash flow from operating activities. 2. **Analyze changes in accounting policies**: Frequent changes in policies may imply manipulative motives. 3. ***Off-balance sheet items**: Verify the off-balance sheet liabilities, guarantees and contingent items in the notes. 4. **Compare with peer standards**: Abnormal accounting policies (such as much higher than the industry's revenue recognition speed) need to be vigilant. 5. **Audit opinions and regulatory inquiries**: Reserved opinions or frequent regulatory inquiries may indicate risks. --- ### Summary Although the above-mentioned methods may comply with accounting standards, excessive use can damage financial transparency and even touch legal red lines (such as the US SEC's “financial fraud” determination). Investors need to combine quantitative analysis and qualitative judgment to penetrate the appearance of the report and identify the true operating status of the enterprise.