15revenue and inventory fraud
TRANSCRIPT
FRAUD EXAMINATION
Revenue- and Inventory-Related
Financial Statement Frauds
List Common Ways to Commit Revenue Fraud.
1. Manipulate Revenue Accounts
2. Record Revenues Prematurely
Factoid
Revenue fraud is
the most common
fraud committed
.
Why Are Revenue Frauds so Common?
1. GAAP (Generally Accepted Accounting Principles) allows too many alternative ways to recognize & record revenue.
2. It is an easy fraud to commit.How is it done?1. Report Early2. Create Fictitious Revenues3. Hold Books Open 1 Year +
Typical Revenue – Related TransactionsComplete the Chart
Collect cash within discount period6
Estimate uncollectible A/R2Sell goods & services to customers1
Receivable PaidYES
Goods ReturnedNO
YESAcceptFrom
Customer
3Write Off
Receivablesas
Uncollectible
4NO
Discount TakenYES
NO Collect Cash After
Discount Period
5
What to Look For?1. Analyze the balances & relationships
within the statements.
2. Look for unusual changes in revenue-related accounts balances from period to period (looking for trends)
What Kind of Changes Should You Look For?
3. Compare the statement amounts & relationships with other data.
4. Compare the company’s financial results & trends with those of similar firms in the same industry, and
5. Compare financial statement amounts with the assets they are supposed to represent.
Discuss Revenue-Related Fraud Symptoms.
Analytical symptomsAccounting or
documentary symptoms
Lifestyle symptomsControl symptoms*Behavioral or verbal
symptomsTips and complaints
Lack of accountability for invoice numbers issued. Lack of segregation of duties between the - Processing of accounts receivable invoices and posting to sub
ledger - Posting to accounts receivable sub ledger and cash receipts Lack of policies and procedures regarding write-offs to satisfy
industry standards. Frequent undocumented and/or unapproved adjustments,
credits, and write- offs to accounts receivable sub ledger. Low turnover or slow collection cycle for accounts receivable. Dramatic increase in allowance for doubtful accounts in view
of positive economic events and stringent credit policies. No reconciliation of accounts receivable sub ledger to general
ledger control account. Insufficient supervisory review of accounts receivable activity
as well as customer account aging schedule. Unrestricted access to sub ledgers and general ledger.
Control Systems – Red Flags
Analyzing Financial Balances and Relationships within Financial Statements
Look for unusual changes in revenues and accounts receivable balances from period to period (trends).
Look for unusual changes in revenue-cycle-account relationships from period to period.
Comparing Financial Statement Accounts or Relationships with Nonfinancial Statement Information
Compare financial results and trends of the company with those of similar firms in the same industry.
Compare recorded amounts in the financial statements with nonfinancial statement amounts
Do Ratio, Vertical or Horizontal Analysis Tell if Fraud Has Been Committed?
List Other Investigative Procedures You Could Perform.
Compare to companies in same industry
Compare F/S to actual assets
Search for internal control weaknesses
Leads to Opportunit
y
Material Weaknesses Account-specific or transaction-level material weaknesses(1) Inadequate internal controls for accounting for loss
contingencies, including bad debts(2) Deficiencies in the documentation of a receivables
securitization program(3) No adequate internal controls over the application of new
accounting principles or the application of existing accounting principles to new transactions
Company-level material weaknesses(1) Override by senior management(2) Ineffective control environment
It is shown* that “material weaknesses in internal control are more likely for firms that are smaller, less profitable, more complex, growing rapidly, or undergoing restructuring”* http://faculty.washington.edu/geweili/DGM1JAE.pdf
Discuss TIPS.Ombudsman or HotlinePeople don’t know who to talk toPeople don’t want to wrongfully accuse
someone elseWhistleblower repercussionsPeople feel they have suspicions, not
knowledge
Explain How Inventory & Cost of Goods Sold Are Manipulated to Commit Fraud.
Overstating Inventory
Increases Net Income
Because Cost of Goods Sold
Decreases
Review Effect of Overstating Inventory on a Simplified Income Statement.
Gross Revenues (Sales)-Sales Returns-Sales DiscountsNet Revenues (Sales)-Cost of Goods SoldGross Margin-ExpensesNet Income
Understated
Overstated
Overstated
Review Effect of Overstating Inventory & Understating Purchases on Cost of Goods Sold.
Overstated Ending Inventory
Understated Purchases
No Effect No EffectNo Effect UnderstatedNo Effect No Effect
No Effect No EffectNo Effect Understated
Overstated No EffectUnderstated Understated
Beginning Inventory+Purchases-Returns to Vendor-Purchase Discounts on
InventoryGoods Available for Sale-Ending InventoryCost of Goods sold
Complete Inventory Cycle.
Purchase Inventory
Return Goods?
Take Discount?
Pay Vendor
Sell Inventory?Obsolete?
Inventory Counted?
Count Inventory
Determine Inventory Costs
Identify Some Inventory Fraud Symptoms.
Inventory Relationships1.Examine Changes in
Relevant Ratios2.Use Vertical Analysis
Inventory Account Balances
1.Focus on Changes in Statement Numbers
2.Study Statement of Cash Flow
3.Use Horizontal AnalysisWith Real-World Numbers1.Compare Statement
Amounts with the Assets They Are Supposed to Represent
With Industry Competitors
1.Compare Statement Results with Similar Companies
2.Compare Company’s trends with those of similar companies
Analysis of Period-to-Period
Changes
Analysis of Period-to-Period
Changes