FRAUD EXAMINATION

ALBRECHT, ALBRECHT, & ALBRECHT

Revenue- and
Inventory-Related
Financial Statement
Frauds
Chapter 12
 Learning Objectives
1. Identify revenue-related financial
statement fraud schemes.
2. Understand revenue-related financial
statement fraud schemes.
3. Identify ways to proactively search for
revenue-related financial statement
fraud schemes.
 Learning Objectives
4. Understand the importance of, and
ways to follow up on, revenue-related
fraud symptoms.
5. Identify inventory and cost of goods
sold financial statement fraud
schemes.
6. Understand inventory and cost of
goods sold financial statement fraud
symptoms.
 Learning Objectives
7. Identify ways to search for inventory and
cost of goods sold financial statement fraud
schemes.

8. Understand the
importance of, and
ways to follow up
on, inventory and
cost of goods sold
fraud symptoms.
 List Common Ways to Commit
Revenue Fraud.

1. Manipulate Factoid
Revenue
Accounts Revenue
fraud is the
2. Record most
Revenues common
Prematurely 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 Early
2. Create Fictitious Revenues
3. Hold Books Open 1 Year +
 Complete the Chart
Typical Revenue Related Transactions
1 Sell goods & services to customers

2 Estimate uncollectible A/R

Accept YES
3 From Goods Returned
Customer NO 4
Write Off
NO Receivables
Receivable Paid as Uncollectible
YES
NO Collect Cash
Discount Taken After Discount
YES 5 Period
6 Collect cash within discount period
 Discuss
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), and

3.Look for changes in revenue-related

relationships from period to period.
 What Kind of Changes
Should You Look For?
4. Compare the statement amounts &
relationships with other data.

5. Compare the companys financial

results & trends with those of similar
firms in the same industry, and

6. Compare financial statement amounts

with the assets they are supposed to
represent.
Discuss Revenue-Related
Fraud Symptoms.
Analytical symptoms
Accounting or
documentary
symptoms
Lifestyle symptoms
Control symptoms
Behavioral or verbal
symptoms
Tips and complaints
 Complete this Table
Analyzing Financial Look for unusual Look for unusual
Balances and changes in changes in
Relationships revenues and revenue-cycle-
within Financial accounts receivable account
Statements balances from relationships from
period to period period to period.
(trends).

Comparing Compare financial Compare recorded

Financial Statement results and trends amounts in the
Accounts or of the company financial
Relationships with with those of statements with
Nonfinancial similar firms in the nonfinancial
Statement same industry. statement
Information amounts
 What is the Formula for
Measuring Period to Period
Changes?

Period 2 - Period 1
account balance account balance

Period 1 account balance

 What is an Alternative to
the Prior Formula?
Make the Balance Sheet & Income
Statement into Change Statements
HOW?

Perform Horizontal & Vertical Analysis

Compare to Statements of Changes in

Cash

Circle the Preferred

 Match Ratio to Name.
Gross Profit Sales Returns
Margin Total Sales
Sales Gross Profit
Return % Net Sales
Net Sales
Sales
A/R
Discount %
A/R Turnover
A/R Turnover 365
Number of Sales Discounts
Days in A/R Gross Sales
 Match Ratio to Explanation.

Allowance for A measure of

Uncollectible profitability
Accounts
Estimated uncollectible
Bad Debt A/R, a contra-asset,
Expense
Common Size Financial statements
Financial converted to %
Statements
Expense for revenues or
Earnings receivable presumed
per Share uncollectible
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
Leads to
Search for internal control
Opportunity
weaknesses
 Comment on Behavior &
Lifestyle Flags.

Enhanced
Revenue Fraud
Performance

Indirect Benefit to Perpetrators

Questions and Observation

 Discuss TIPS.
Ombudsman or Hotline
People dont know who to talk to
People dont want to wrongfully accuse
someone else
Whistleblower repercussions
People 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 Discounts
Net Revenues (Sales)
-Cost of Goods Sold Understated
Gross Margin Overstated
-Expenses
Net Income Overstated
 Review Effect of Overstating
Inventory & Understating
Purchases on Cost of Goods Sold.
Overstated Understated
Ending Inventory Purchases
Beginning Inventory No Effect No Effect
+Purchases No Effect Understated
-Returns to Vendor No Effect No Effect
-Purchase Discounts on
Inventory No Effect No Effect
Goods Available for Sale No Effect Understated
-Ending Inventory Overstated No Effect
Cost of Goods sold Understated Understated
 Complete Inventory
Cycle.
Purchase Inventory

Determine
Inventory Costs Return Goods?

Count Inventory Take Discount?

Inventory Counted? Pay Vendor

Obsolete? Sell Inventory?

Identify Some Inventory
Fraud Symptoms.
 Complete Chart.
Analysis of Analysis of
Period-to-Period Changes Period-to-Period Changes
Inventory Account Balances With Industry Competitors
1. Focus on Changes in 1. Compare Statement
Statement Numbers Results with Similar
2. Study Statement of Cash Companies
Flow 2. Compare Companys
3. Use Horizontal Analysis trends with those of
similar companies
Inventory Relationships With Real-World Numbers
1. Examine Changes in 1. Compare Statement
Relevant Ratios Amounts with the Assets
2. Use Vertical Analysis They Are Supposed to
Represent
 Discuss Inventory Fraud
Symptoms.
Analytical symptoms
Accounting or
documentary
symptoms
Lifestyle symptoms
Control symptoms
Behavioral or verbal
symptoms
Tips and complaints
 Match Ratio to Name.
Allowance for Financial statements
Doubtful converted to %
Accounts
The expense of goods
Bad Debt sold to customers
Expense
A contra receivable,
Cost of estimated uncollectible
Goods Sold A/R
Common-Size Expensing estimated
Financial uncollectible A/R or
Statements revenues
 Match Ratio to Name.

Earnings Per Sales returned by

Share customer for refund

Determining when revenues

Revenue
are earned & can be
Recognition
reported on the income
statement
Sales
Returns A measure of profitability