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.