Financial statement fraud is the least common type of occupational theft (9% of incidents), yet it causes the most substantial financial losses for businesses, according to the Association of Certified Fraud Examiners (ACFE). In 2022, businesses scammed by financial statement frauds suffered median losses of $593,000. Financial statement fraud perpetrators frequently use early revenue recognition to skew earnings and artificially raise a company’s financial profile. To comply with Generally Accepted Accounting Principles (GAAP) and protect your company’s reputation, you must avoid these activities. It’s also crucial to identify them in the financial statements of business partners, such as acquisition targets and customers who apply for credit.
Schemes and Warning Signs
Owners, executives, and others with access to financial statements may inappropriately report income by recording revenue before the fulfillment of a contract, delivering products early, retroactively dating agreements, or leaving the books open after the end of a period. Some early revenue recorders have transported products to hidden warehouses and logged the shipments as sales. Alternatively, they have employed bill-and-hold agreements, in which the customer agrees to purchase something but the business keeps the goods until shipment is requested.
The most blatant indicator of early revenue recognition is when a company reports a significant portion of its revenue at the conclusion of a given financial period. Large transactions with atypical payment terms may also serve as a warning. When these or other red flags are raised, it’s time to contact a fraud investigator.
Fraud specialists often analyze revenue reported by month, product line, or business segment during the current period to that of previous, comparable periods. They can use software technology that finds inconsistent or unexpected revenue relationships or transactions. These experts are increasingly adopting artificial intelligence (AI) to examine large quantities of data and identify questionable patterns.
Examples of Investigations
If experts suspect that products have been billed before shipment, they will search for anomalies between the quantity shipped and the quantity billed. Experts can also examine sales orders, shipping papers, and invoices; compare pricing listed on these items published prices; and note any extensions on sales invoices.
So, what if experts believe the goods were transported prematurely? They can compare the period’s shipping expenses to those from previous periods. Significantly higher costs may suggest early revenue recognition.
Fraud specialists may also sample sales invoices at the end of a period and the beginning of the next period to ensure that corresponding revenues are recorded on time. If phantom sales are suspected, reversed sales in subsequent periods and increasing charges for off-site storage could be evidence of fraud.
Preventing Fraud
Early revenue recognition can be carried out by a single person or a group working together. One of the most effective strategies to prevent such scams is to reduce executive stress. For example, do not base an employee’s salary on meeting certain revenue targets. Strong oversight from your company’s board of directors and finance committee is also essential. Contact us with any questions or concerns.
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