Term
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Definition
•involve the recording of sales of goods or services that did not occur
•fictitious/faked/exaggerated documentation: exaggerated involves genuine existing customer
•sales with conditions: involving key issue of when is something sold
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Term
Detection:
Fictitious Revenue
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Definition
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Term
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Definition
Premature revenue recognition
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Term
| Methods of Timing Differences |
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Definition
Expenses based: Recording expenses in the wrong period means costs are not properly matched against the income that they help produce. eg purchases at end of one year are used in the next.
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Term
| Methods of Timing Differences |
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Definition
long-term contracts (incl. multiple element):
- sales/expenses, sold/paid for at different points over a long period of time
- include multiple element revenue recognition schemes = sale of something with various elements which could be accounted for as having been sold or obtained at one or different points of time.
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Term
| Methods of timing differences |
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Definition
channel stuffing (aka trade loading): stuff or load a particular channel of distribution (distributor) with unusually large amount of goods.
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Term
Detection:
Timing Differences |
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Definition
•growth or unusual profitability, compared to that of other companies in the same industry
•inability to generate cash flows from operations while reporting earnings and earnings growth
•significant, unusual, a highly complex transactions, especially those close to period-end that pose difficult ‘substance over form’ questions
•Unusual increase in gross margin or margin in excess of industry peers
•Usual growth in the number of days’ sales in receivables
•unusual decline in the number of days’ purchases accounts payable |
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Term
| Concealed Liabilities and Expenses |
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Definition
Concealment/Failure to record liabilities and expenses.
•easier to commit these than frauds which require the falsifying of sales transactions
•more difficult for auditors to detect missing transactions than improperly recorded ones because there is no audit trail. |
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Term
| Concealed Liabilities and Expenses |
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Definition
•Liability/expense omissions
•Capitalised expenses
•Failure to disclose warranty costs and liabilities
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Term
| Concealed Liabilities and Expenses |
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Definition
Liability/expense omissions: failing to record liabilities and expenses is easiest method of concealing liabilities and expenses.
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Term
| Concealed Liabilities and Expenses |
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Definition
Capitalised Expenses: Cost that provide benefits to a company over more than one accounting period. e.g R+D project which may involve purchasing things.
•Capitalising revenue-based expenses is another way to increase income and assets since they pay off the initial debt(s) over a period of years rather than expensed immediately
•if expenditures are capitalised as assets and not expensed during the current period, income will be overstated
•as the assets are depreciated, income in subsequent periods will be understated
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Term
| Concealed Liabilities and Expenses |
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Definition
Expensing Capital Expenditures (the opposite to previous)
•Just as capitalizing expenses can be improper, expensing costs that should be capitalised can be a fraudulent
•An organization may want to minimize its net income due to tax considerations, or to increase earnings in future periods.
•Expensing an item that should be depreciated over a period of time would help accomplish just that—net income is lower and so are taxes.
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Term
| Concealed Liabilities and Expenses |
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Definition
Failure to disclose warranty costs and liabilities
•Product-Return and Warranty Liabilities
•Occurs when a company fails to accrue the proper expenses and related liabilities for potential product returns or warranty repairs
•Management’s job is to estimate what that value this will be, and to explain when it will be accounted
•In this type of fraud, the warranty liability usually is either omitted altogether or substantially understated.
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Term
Detection:
Concealed Liabilities |
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Definition
•Reducing accounts payable while competitors are stretching out payments to vendors
•Unusual increase in gross margin or margin in excess of industry peers
•Unusual reduction in the number of days purchases remain in accounts payable
•Recurring negative cash flows from operations or an inability to
generate cash flows from operations while reporting earnings and
earnings growth
•Assets, liabilities, revenues, or expenses based on significant estimates that involve subjective judgements or uncertainties that are difficult to corroborate.
•Allowances for sales returns, warranty claims, and the like that are shrinking in percentage terms or are otherwise out of line with industry peers
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Term
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Definition
•Management has an obligation to disclose all significant information appropriately in financial statements
•financial statements are accompanied by written notes
•improper disclosures involve intentionally portraying an inaccurate picture of financial health of firm |
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Term
| Themes of Improper Disclosures |
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Definition
–Liability-related omissions
–Subsequent events
–Management fraud
–Related-party transactions
–Accounting changes |
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Term
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Definition
Liability-related omissions
Nondisclosure financing arrangements and/or contingent liabilities |
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Term
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Definition
•Liability related omissions - Nondisclosure of financing arrangements and/or contingent liabilities. (loans, percentage rates, collateral and covenants for loans.
•Subsequent events - Nondisclosure of events which may affect the financial statements. e.g court judgements which may undermine company assets, indicate unrecorded liabilities or adversely reflect on management integrity.
•Management Fraud - Disclosure of fraud committed by management/ people in position of trust which may affect share price to shareholders.
•Related Party Transactions - Business relationships with entities whose management and operating policies can be controlled or significantly influenced by the company or other parties in common.
•Accounting Changes - Disclosure of accounting changes/ whether or not the financial statements appear weaker to avoid misleading the user. |
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Term
Detection:
Improper Disclosures |
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Definition
•Significant bank accounts or subsidiary or branch operations in tax-haven jurisdictions for which there appears to be no clear business justification
•Overly complex organisational structure involving unusual legal entities or managerial lines of authority
•Known history of violations of securities laws or other laws and regulations, or claims against the entity, its senior management, or board members alleging fraud or violations of laws and regulations
•Recurring attempts by management to justify marginal or inappropriate accounting on the basis of materiality
•Formal or informal restrictions on the auditor that inappropriately limit access to people or information or the ability to communicate effectively with the board of directors or audit committee
•Domination of management by a single person or small group (in a non–owner managed business) without compensating controls
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Term
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Definition
•involve the fraudulent valuation of assets, in particular manipulation of estimates. |
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Term
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Definition
•Inventory valuation
•Accounts receivable
•Business combinations
•Fixed assets |
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Term
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Definition
•Inventory must be valued at the acquisition (historical) cost–except when the cost is
determined to be higher than the current fair market value and in this case inventory with
little or no value should be written-down to its current value or written off altogether.
•Failing to write-down inventory results in; overstated assets, the mismatching of cost of goods sold with revenues.
•methods include: fictitious count of physical inventory, inflating the unit costs used to price out inventory, failing to relieve inventory for costs of goods sold. |
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Term
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Definition
Accounts receivable
•Accounts receivable should be reported at net realisable value—that is, the amount of the receivable less amounts expected not to be collected.
•2 most common schemes involve:
–recording of fictitious receivables
–failure to properly account for uncollectible customer accounts. |
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Term
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Definition
Fictitious Accounts receivable are common
–among companies experiencing poor sales
–with managers who receive a commission based on sales
•fictitious receivables are typically recorded with fictitious revenues
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Term
Improper asset valuation:
Concealing fictitious Account Receivable |
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Definition
concealing fictitious accounts receivable
•Fraudsters provide
–false confirmations of balances to auditors
–provide mailbox under their control: a home address, or business address of co-conspirator |
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Term
Improper asset valuation:
Failure to Write Down
Uncollectible Customer Accounts |
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Definition
- Accounting standards require accrual of losses on uncollectible receivables
- Management must estimate amount of customer account that will not be collectable
- Make provision for future account write-offs in a reserve for potential bad debts.
- Companies struggling for profits and income may be tempted to omit the recognition of such losses due to the negative impact on income.
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Term
Improper asset valuation:
Business Combinations |
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Definition
- Required to allocate purchase price to tangible and intangible assets and liabilities of a company.
- Changes in goodwill
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Term
Improper asset valuation:
Types of Business Combinations |
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Definition
•Recording fictitious assets
•Misrepresenting asset valuation
•Understating assets
•Capitalizing nonasset costs
•Misclassifying assets |
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Term
Improper asset valuation:
Types of Business Combinations;
Recording Fictitious Assets |
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Definition
•One of the easiest methods of asset misrepresentation involves recording of fictitious assets to improve balance sheet and inflate earnings. |
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Term
Improper asset valuation:
Types of Business Combinations;
Misrepresenting Asset Valuation |
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Definition
•Fixed assets should be recorded at cost, even if asset increases in value, this should not be recognised on the company financial statements. |
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Term
Improper asset valuation:
Types of Business Combinations;
Understating Assets |
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Definition
•understating fixed assets directly or through improper depreciation |
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Term
Improper asset valuation:
Types of Business Combinations;
Capitalising non-asset costs |
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Definition
•Under accounting regulations the interest and finance charges incurred in the purchase of a fixed asset should be excluded from the asset’s capitalised cost. |
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Term
Improper asset valuation:
Types of Business Combinations;
Misclassifying Assets |
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Definition
•assets sometimes are misclassified into accounts in which they do not belong |
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Term
Detection:
Improper Asset Valuation |
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Definition
•Unusual increase in gross margin or margin in excess of industry peers
•Unusual growth in the number of days’ sales in receivables
•Unusual growth in the number of days’ purchases in inventory
•Unusual change in the relationship between fixed assets and depreciation
•Adding to assets while competitors are reducing capital tied up in assets
•Increasing fixed assets that do not result in increased sales, capacity, or efficiencies |
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Term
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Definition
| A means of measuring the relationship between two different financial statement amounts. |
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Term
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Definition
The current ratio is a liquidity ratio that measures a company's ability to pay short-term and long-term obligations.
Current assets/current liabilities. |
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Term
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Definition
Compares assets that can be liquidated immediately.
Cash+Securities+Receivables/Current Liabilities |
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Term
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Definition
Measures the business ability to collect its receivables
Net sales on Account/ Average net receivables |
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Term
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Definition
The average time period for which receivables are outstanding
365/ Receivable turnover |
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Term
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Definition
The number of times inventory is sold during the period.
cost of goods sold/Average Inventory
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Term
Average number of days
inventory is in stock |
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Definition
Check inventory account for possible larceny schemes
365/ Inventory turnover |
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Term
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Definition
Use to equate the amount of debt and equity used to finance a company
Total liabilities / Total Equity |
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Term
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Definition
Reveals profit earned per sale
Net Income/ Net sales |
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Term
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Definition
Use to determine how efficiently assets are utilised.
Net sales/Average Assets |
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Term
Why would managers overstate
assets and income
in the financial statements |
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Definition
- To comply with loan covenants
- To meet personal performance criteria
- To support stock price in anticipation of a merger or acquisition or sale of personal stock-holding
- To meet performance criteria set by parent company
- To increase the amount of financing available from asset based loans
- To meet or exceed the revenue growth expectation of stock market analysts
- To meet a lender's criteria for granting/ extending loan facilities.
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Term
Why would managers overstate
assets and income
in the financial statements |
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Definition
- To reduce expectations now so future growth will be better perceived and rewarded.
- To preserve a trend of consistent growth and avoid volatile results
- to reduce the value of an owner-managed business for the purposes of divorce settlement.
- To take all possible write off in one big bath now so future earnings will be consistently higher
- The reduce the value of a corporate unit whose management is planning a buyout
- To deter surplus earnings to the next accounting period
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