FRAUD EXAMINATION ALBRECHT, ALBRECHT,

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FRAUD EXAMINATION ALBRECHT, ALBRECHT, ALBRECHT

• Revenue- and Inventory-Related Financial
  Statement Frauds

Chapter 12
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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.

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Learning Objectives

1. Understand the importance of, and ways to follow
   up on, revenue-related fraud symptoms.
2. Identify inventory and cost of goods sold
   financial statement fraud schemes.
3. Understand inventory and cost of goods sold
   financial statement fraud symptoms.

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Learning Objectives

1. Identify ways to search for inventory and cost of
   goods sold financial statement fraud schemes.

1. Understand the importance of, and ways to follow
   up on, inventory and cost of goods sold fraud
   symptoms.

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List Common Ways to Commit Revenue Fraud.

1. Manipulate Revenue Accounts
2. Record Revenues Prematurely

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Why Are Revenue Frauds so Common?

• GAAP (Generally Accepted Accounting Principles)
  allows too many alternative ways to recognize
  record revenue.
• It is an easy fraud to commit.
• How is it done?
• Report Early
• Create Fictitious Revenues
• Hold Books Open 1 Year

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Complete the Chart
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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.

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What Kind of Changes Should You Look For?

1. Compare the statement amounts relationships
   with other data.
2. Compare the companys financial results trends
   with those of similar firms in the same industry,
   and
3. Compare financial statement amounts with the
   assets they are supposed to represent.

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Discuss Revenue-Related Fraud Symptoms.
FRAUD

• Analytical symptoms
• Accounting or documentary symptoms
• Lifestyle symptoms
• Control symptoms
• Behavioral or verbal symptoms
• Tips and complaints

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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-cycle-account 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
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What is the Formula for Measuring Period to
Period Changes?
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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

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Match Ratio to Name.
Gross Profit Margin
Sales Returns Total Sales
Gross Profit Net Sales
Sales Return
Net Sales A/R
Sales Discount
A/R Turnover 365
A/R Turnover
Number of Days in A/R
Sales Discounts Gross Sales
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Match Ratio to Explanation.
A measure of profitability
Allowance for Uncollectible Accounts
Estimated uncollectible A/R, a contra-asset,
Bad Debt Expense
Common Size Financial Statements
Financial statements converted to
Expense for revenues or receivable presumed
uncollectible
Earnings per Share
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Do Ratio, Vertical or Horizontal Analysis Tell if
Fraud Has Been Committed?
NO! They provide symptoms. You must investigate
to determine if fraud exists.
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List Other Investigative Procedures You Could
Perform.

• Compare to companies in same industry
• Compare F/S to actual assets
• Search for internal control weaknesses

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Comment on Behavior Lifestyle Flags.
Indirect Benefit to Perpetrators
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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

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Explain How Inventory Cost of Goods Sold Are
Manipulated to Commit Fraud.
Overstating Inventory Increases Net Income
Because Cost of Goods Sold Decreases
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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
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Review Effect of Overstating Inventory
Understating Purchases on 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 No Effect
Understated Understated

• Beginning Inventory
• Purchases
• -Returns to Vendor
• -Purchase Discounts on Inventory
• Goods Available for Sale
• -Ending Inventory
• Cost of Goods sold

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Complete Inventory Cycle.
Purchase Inventory
Determine Inventory Costs
Return Goods?
Take Discount?
Count Inventory
Inventory Counted?
Pay Vendor
Sell Inventory?
Obsolete?
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Identify Some Inventory Fraud Symptoms.
Inventory moves are very visible
Ask inventory handlers what moves what doesn't
Check Inventory Costs with Vendors
Talk to Large Customers
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Complete Chart.

• Inventory Account Balances
• Focus on Changes in Statement Numbers
• Study Statement of Cash Flow
• Use Horizontal Analysis

• With Industry Competitors
• Compare Statement Results with Similar Companies
• Compare Companys trends with those of similar
  companies

• Inventory Relationships
• Examine Changes in Relevant Ratios
• Use Vertical Analysis

• With Real-World Numbers
• Compare Statement Amounts with the Assets They
  Are Supposed to Represent

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Discuss Inventory Fraud Symptoms.
FRAUD

• Analytical symptoms
• Accounting or documentary symptoms
• Lifestyle symptoms
• Control symptoms
• Behavioral or verbal symptoms
• Tips and complaints

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Match Ratio to Name.
Financial statements converted to
Allowance for Doubtful Accounts
The expense of goods sold to customers
Bad Debt Expense
A contra receivable, estimated uncollectible A/R
Cost of Goods Sold
Common-Size Financial Statements
Expensing estimated uncollectible A/R or revenues
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Match Ratio to Name.
Sales returned by customer for refund
Earnings Per Share
Determining when revenues are earned can be
reported on the income statement
Revenue Recognition
Sales Returns
A measure of profitability