Unethical accounting practices occur when a company does not follow the rules of generally accepted accounting principles or GAAP. The rules of GAAP are established by the federal government. Examples of not following GAAP include recognizing revenue before a customer takes shipment, not recognizing expenses associated with revenue and not writing down bad inventory.
A company can inflate its sales by recording revenue for inventory still in its possession. According to GAAP, a customer must take physical possession of the inventory. A company can still invoice the customer, but it cannot record it as a sale on its profit and loss statement. Similarly, GAAP has rules that pertain to expenses. A company that capitalizes expenses and places them on the balance sheet instead of listing them as an expense is "cooking the books." The telecommunications giant MCI unethically recorded its revenue and expenses between 1999 and 2002. The now-defunct public auditor, Arthur Andersen, signed off on MCI's financial statements and committed fraud in the process.
A company can also understate its expenses by not writing down bad inventory. Bad inventory is inventory that is no longer saleable or in working condition. An unethical company could avoid writing down the expense to inflate net income and thus financial performance.