Fraudulent Financial Reporting and Governance

It is important to note that fraudulent financial reporting takes place when there is a conscious effort to mislead others regarding the financial condition of a business. It is the intentional omission (or commission) to alter the overall image created by the financial statements that are issued to investors and ultimately to the general public.

A common practice is to overstate the amount of revenue earned. This way the company shows better results, sales people increase their incentives, executives earn an extra bonus and the share prices perform well. This is defined as a fraud in the auditing standards. Revenue is recognized when the risks and rewards of ownership have substantively transferred to customers, regardless of whether legal title has transferred. This condition is normally met when the product has been delivered or upon performance of services.

Let me set out some basic rules for revenue recognition in the manufacturing industry;

Export- Free on Board terms ( FOB)
FOB terms generally indicate which party pays for shipping. Normally the party who pays for shipping  owns the goods during shipment. Therefore, if the seller pays for shipping, he cannot recognize revenue until delivery to the buyers port.
Local sales
Revenue should be recognized at the time of actual delivery or at time of delivery to a common carrier. It is not on invoicing, if there is a considerable gap to deliver and during the time goods are in the sellers’ warehouse/factory he is responsible for any loss.
Consignment sales (sale or return)
At time consignor (seller) is paid and notified by consignee (agent) of sale (not on delivery)
Commitment to Buyback 
At the time a buyback period expires.(knowledge of agreement is important)
Sales with a high Rate of Return
At the time -return period expires (assume rate of return cannot be estimated). Normal returns should be estimated in terms of the past record.
Bill and Hold
This is when the customer pays for the goods and asks the seller to hold the goods, the seller can still recognize the revenue if the goods are segregated from the seller’s inventory. There must be substantial business purpose for the buyer to do this, otherwise sellers can use this method for manipulation. 

Revenue recognition problems involve;
* businesses fraudulently setting aside inventory not actually sold,
* written agreements for sales that are not signed by both parties,
* the seller would recognize revenue with only a verbal acknowledgment, 
* undisclosed side agreements,
* sales are returned after the year end/ closure of accounts.
* under the terms of the sale, the buyer may have the right to return the product,
* the seller may be required to repurchase the product at the buyer’s discretion.

Based on the above, even delivery of the product does not always mean that revenue should be recognized. Companies may use a variety of agreements for sales-type transactions, so the nature of the agreement must be understood in order to ensure that revenue recognition requirements have been met. Customer acceptance is a key focus for revenue recognition.

About surenraj

“Views expressed are my own”
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