Chapter 12

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Chapter 12 Revenue and Inventory related Financial Statement Frauds
p. 400 Sunbeam how initial write-downs create future profits
write-downs “cookie-jar” reserves
Grumley Nano Tech
Fin State Frauds
#1 record fictitious revenue
#2 premature revenue recognition
p. 402 Qwest
round tripping with other telecoms - right to use fiber-optic cables
selling equipment at twice the price by discounting the service agreement
p. 402/03
Related Party
Grumley Nano Tech
Sham sales
Bill and hold
Side agreements – liberal return policies
Consignment
Channel stuffing
Redating Accounts Receivable
Cut off
Round Tripping
Identify symptoms
Analytical anomalies
Accounting anomalies
Extravagant lifestyle
Weak internal controls
unusual behavior
Tips and complaints
p. 405 Ananlytical see #2 -5, 7, 8, 10, 16, 17
2. sales discounts appear too low
3. sales returns appear too low
4. bad debt expense appears too low
5. accounts receivable appear too high or are increasing too fast
7. too little cash collected relative to reported revenues
8. unusual entries made at the end of the accounting period
10. unusual relationships between costs and revenues
16. A large and growing receivable balance with little cash received from customers
17. sales of assets that are very similar to subsequent purchases at similar amounts
Accounting or documentary
2. missing documents (in revenue cycle)
3. only photocopies of documents exist to support revenue transactions
7. nonstandard journal entries posted by top management
8. nonstandard journal entries posted near the end of accounting period
Weak internal controls
#1, 2
1. Management override of significant internal control activies
2. New, unusual, or large customers that appear not to have gone through the customer
approval process
Unusual behavior
#1, 2
1. Inconsistent, vague, or implausible responses from management or employees to
inquiries
2. Denied access to facilities, employees, records, customers, vendors,,,,,, ….
Active searching
Healthsouth
A memo sent to EY
How can they carry tens of millions of receivables that are over 360 days
Analytical
Trend analysis
Horizontal analysis
State of Cash Flows
Ratios
Gross profit margin
Sales return percentage ratio
/ Sales discount percentage ratio
Accounts receivable turnover (or days sales in accounts receivable)
Allowance for uncollectible accounts as a percentage of Acc Rec
Asset turnover
Operating performance margin ratio (profit margin)
Earnings per share
Vertical analysis
compare to industry averages and with other companies in the industry
p. 410
Top Side Journal entries
control symptoms
management override of internal controls
control exceptions need to be looked to see if it “has been abused”
Weak or inactive board of directors
Have you been asked to make any entries that you consider to be unusual
Or, you had questions about the propriety
Have you or others been asked to circumvent internal controls
Are you aware of unusual sales transactions near year-end
Some people in the organization have knowledge or suspicions about the fraud
12.5
Inventory Errors
Begin Inventory
+ Purchases
= Available
- Ending Inventory
=Cost of Goods
Gross Profit
p. 414 Phar-Mor
year 1
year 2
year 3
OK
OK
OK
over
under
over
OK
over
OK
over
OK
OK
OK
OK
OK
over
under
OK
How did Phar-Mor fool the auditors?
p. 415 Examples
 double count
 control mobile inventory
 capitalize costs that should be expensed
 cutoff
 bill and hold
 consigned inventory
p. 417 Analytical Symptoms
#1, 3, 4, 5
Reported inventory balances appear too high or are increasing too fast
Reported purchase returns appear too high
Reported purchase discounts appear too hing
Purchases appear too low for the reported sales
Accounting documentation
#3, 4, 7, 11, 12, 14
 End-of-period inventory or cost of goods sold adjustments significantly increase the
financial results
 Missing documents related to inventory or cost of goods sold
 Discrepancies between the entity’s inventory of cost of goods sold records
 Purchases from suppliers which are not on the approved vendor list
 Missing inventory when performing inventory counts.
 Nonstandard journal entries
Control Symptoms
#1, 2
 Management override of internal control
 New or unusual vendors that have not gone through the regular vendor approval
process
Unusual behavior
#1, 2
Inconsistent, vague or implausible responses to inquiries
Denied access
p. 418 MiniScribe
while management has incentive to overstate inventory, they have no incentive to
record the accounts payable
Proactive Inventory
Analytical
Trend analysis
Horizontal analysis
State of Cash Flows
Ratios
Gross profit margin
Inventory turnover (or days sales in inventory)
Purchase returns or Purchase discounts) as a percentage of purchases
or of Inventory
Vertical analysis
compare to industry averages and with other companies in the industry
p. 420 Crazy Eddie’s inventory ratios
p. 421 Non Financial
warehouse capacity
equipment (forklifts)
purchases
Topside Journal Entries
Assign from Chapter 13 for tomorrow
p. 446
p. 451
p. 451
p. 458
p. 459
p. 460
p.460
p. 462
p. 463
p. 463
p. 463
Waste Management
GEC General Electrodynamic Corp.
Pfizer
Computer Science Corp.
WorldCom
Malibu Capital Corp.
AFCO medical-dental equipment leasing
Lincoln Savings & Loan
PNC Financial Services Group, Inc.
Adelphia Corp.
Lehman Brothers Holdings, Inc.
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