The most common type of fraud is revenue-related fraud (revenue and/or receivables) because of the various alternative acceptable ways to recognize revenue and  because of the ease of manipulating net income using revenue and accounts receivable accounts.  In fact, over 50 percent of all financial statement fraud involved revenues and/or accounts receivables (according to COSO-sponsored reports).

Common revenue-related fraud include the following.  Do NOT fall into the following pits:

  1. Related-party transactions.
    • Related parties exist between the business and 1) any affiliates or subsidiaries and 2) principals, owners and their families.
    • Disclosing related-parties who are involved in business transactions is important because related party transactions pose the highest risk of financial statement fraud; also collusion amongst related parties is easier than would be with an independent third-party.
    • If the business has transactions with related third-parties, it must be at “arms-length” and be disclosed on the financial statement disclosure notes.  (e.g., if a daughter loans her father’s business $20,000, the business cannot deduct an interest expense of 20 percent annual interest on her money when the business can get the same loan at a bank for six percent; this is an example of a loan between related parties at unusually favorable terms).
  2. Sham Sales
    • Fictitious sales
    • Sham sales are schemes that appear genuine but are artificial/contrived so the business can falsely recognize revenue.
  3. Bill-and-hold Sales
    1. The seller bills the customer for the goods/services but does not deliver the goods until a later date.  Have to be careful here with the revenue recognition rules.
  4. Side Agreements
  5. Consignment Sales
    • A sale to the consignor does NOT occur until the consignee actually sells the consigned product.
  6. Channel Stuffing
    • Used to inflate revenues by “stuffing” more products into the distribution channel than the business knows it can sell.
  7. Lapping or Kiting
  8. Redating or Refreshing Transactions
  9. Liberal return policies
  10. Partial shipment schemes
  11. Improper cutoff
  12. Round-tripping
    • When a company sells an asset to another party and agrees to buy the asset back  in the future.
    • When all of the transactions between the business and another party are completed, the business is in no different position than when it started, in other words, the transactions had no true economic purpose to either company.
    • Round-tripping is done to manipulate earnings.

 

Since fraud is rarely observed, one can detect it by looking for the following 6 fraud symptoms:

  1. Analytical
    • e.g., if your sales are increasing but your cash is not … then you either have a receivables problem or a problem with sales (e.g., fictitious, inappropriate recognition of revenue, et cetera)
  2. Accounting or documentary
    • e.g., missing documents in the revenue cycle, revenue-related ledgers (sales, cash receipts, etc) do not balance, et cetera
  3. Lifestyle
  4. Control
    • Management override of internal controls, weakness in internal controls, new customers who haven’t gone through the approval process, et cetera
  5. Behavioral and verbal
  6. Tips and complaints

Disclaimer: Unfortunately, it is impossible to give comprehensive financial, accounting, or bookkeeping advice through the internet. Before relying on any information given in this article or on GetAGripOnAccounting.com, contact an accounting professional to discuss your particular situation.