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
Revenue
Accounts
2. Record
Revenues
Prematurely
Factoid
Revenue
fraud is the
most
common
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
Goods Returned
3 From
Customer
NO
Receivable Paid
YES
Discount Taken
YES
6
4
Write Off
Receivables
NO
as Uncollectible
NO
Collect Cash
After Discount
5 Period
Collect cash within discount period
Discuss
What to Look For?
1.Analyze the balances & relationships
within the statements.
2.Look for unusual changes in revenuerelated 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 company’s 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
Balances and
Relationships
within Financial
Statements
Look for unusual
changes in
revenues and
accounts receivable
balances from
period to period
(trends).
Look for unusual
changes in
revenue-cycleaccount
relationships from
period to period.
Comparing
Financial Statement
Accounts or
Relationships with
Nonfinancial
Statement
Information
Compare financial
results and trends
of the company
with those of
similar firms in the
same industry.
Compare recorded
amounts in the
financial
statements with
nonfinancial
statement
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
Margin
Sales
Return %
Sales
Discount %
A/R Turnover
Number of
Days in A/R
Sales Returns
Total Sales
Gross Profit
Net Sales
Net Sales
A/R
A/R Turnover
365
Sales Discounts
Gross Sales
Match Ratio to Explanation.
Allowance for
Uncollectible
Accounts
Bad Debt
Expense
Common Size
Financial
Statements
Earnings
per Share
A measure of
profitability
Estimated uncollectible
A/R, a contra-asset,
Financial statements
converted to %
Expense for revenues or
receivable presumed
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
Search for internal control
weaknesses
Leads to
Opportunity
Comment on Behavior &
Lifestyle Flags.
Revenue Fraud
Enhanced
Performance
Indirect Benefit to Perpetrators
Questions and Observation
Discuss TIPS.
Ombudsman or Hotline
People don’t know who to talk to
People don’t 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
Gross Margin
-Expenses
Net Income
Understated
Overstated
Overstated
Review Effect of Overstating
Inventory & Understating
Purchases on Cost of Goods Sold.
Beginning Inventory
+Purchases
-Returns to Vendor
-Purchase Discounts on
Inventory
Goods Available for Sale
-Ending Inventory
Cost of Goods sold
Overstated
Ending Inventory
Understated
Purchases
No Effect
No Effect
No Effect
Understated
No Effect
No Effect
No Effect
No Effect
No Effect
Understated
Overstated
Understated
No Effect
Understated
Complete Inventory
Cycle.
Purchase Inventory
Determine
Inventory Costs
Count Inventory
Inventory Counted?
Obsolete?
Return Goods?
Take Discount?
Pay Vendor
Sell Inventory?
Identify Some Inventory
Fraud Symptoms.
Complete Chart.
Analysis of
Period-to-Period Changes
Inventory Account Balances
1. Focus on Changes in
Statement Numbers
2. Study Statement of Cash
Flow
3. Use Horizontal Analysis
Inventory Relationships
1. Examine Changes in
Relevant Ratios
2. Use Vertical Analysis
Analysis of
Period-to-Period Changes
With Industry Competitors
1. Compare Statement
Results with Similar
Companies
2. Compare Company’s
trends with those of
similar companies
With Real-World Numbers
1. Compare Statement
Amounts with the Assets
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
Doubtful
Accounts
Bad Debt
Expense
Cost of
Goods Sold
Common-Size
Financial
Statements
Financial statements
converted to %
The expense of goods
sold to customers
A contra receivable,
estimated uncollectible
A/R
Expensing estimated
uncollectible A/R or
revenues
Match Ratio to Name.
Earnings Per
Share
Revenue
Recognition
Sales
Returns
Sales returned by
customer for refund
Determining when revenues
are earned & can be
reported on the income
statement
A measure of profitability