Financial statement fraud is the misrepresentation of financial information that is communicated to the investing public. Public companies primarily report significant events to the public via a press release and a current report, Form 8-K, and their financial condition via quarterly filings with the SEC, i.e., Form 10-Q for each of the first three quarters and Form 10-K for the fourth quarter and fiscal year end. In addition, public companies communicate with the public by other means including hosting analyst conference calls.
Common financial statement frauds include improper revenue recognition, failure to record incurred liabilities, and failure to disclose contingent liabilities.
Improper Revenue Recognition
Fictitious revenue: More than 40% of all financial statement fraud involves revenue recognition schemes, and approximately 35% of all revenue recognition schemes involve recording fictitious revenues. Fictitious revenue schemes typically involve fabricating invoices for phantom customers or improperly billing legitimate customers for items that they never ordered. There is no economic basis for fictitious revenue recognition schemes. In simple terms, companies record and report fabricated revenue, thereby overstating revenue and earnings in their financial statements.
Revenue Timing Schemes: Intentionally recording revenue in the wrong accounting period is an earnings management method whereby a company manipulates its revenue for a number of reasons, including meeting analyst estimates.
Premature revenue recognition results in overstated revenue and earnings: If a company records revenue for items that were not yet shipped or when services are still due, the company is prematurely recognizing revenue. The relevant transaction is real, but the company records the sale in the wrong reporting period.
Improperly deferring earned revenue: If a company’s earned revenue significantly exceeds estimates for a reporting period, the company may improperly defer recording some of the earned revenue for a future unfavorable reporting period.
Unrecorded liabilities fraud typically involves one of two schemes: (1) intentionally and improperly omitting a material liability (unrecorded liabilities) from the books and financial reports, and (2) manipulating a previously reported liability (e.g., an inventory or accounts receivable reserve).
Unrecorded liabilities include unpaid obligations for goods or services received as well as contingent obligations for probable liabilities that can be reasonably estimated (e.g., liabilities involving pending litigation).
Accounting reserve manipulations are enticing to fraudulent reporters since there is no external party of accountability (e.g., a bank or vendor) to confirm accuracy. Instead, the company is required to establish the reserves using professional judgment pursuant to relevant accounting standards.
Undisclosed Contingent Liabilities
Public companies are required to disclose risks of loss or liability such as pending litigation, claims or assessments.
If you are a corporate insider, an analyst, accountant; or if you are a former employee or a third party with specific information related to the above-mentioned wrongdoings or similar fraud, contact us and we will analyze your case and provide step-by-step assistance with filing a whistleblower claim to stop the fraud.
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