Financial Statement Fraud - Essay Example

Revenue Recognition Fraud Revenue Recognition Fraud In many occasions, companies find themselves in situations where they have to record their financial statements in the respective books of accounts in order to enable auditing as well as predict their profitability. Such financial statements that are crucial to an organizations accounts department include the balance sheet, the cash flow statements, profit and loss accounts, and the trial balance (Schrader & Toner, 2013). However, the process is not always rosy as sometimes it is marred with fraudulent incidences of all sorts with the most prevalent being the revenue recognition fraud.

Since the perpetrators of financial statement fraud may be outsiders who collaborate with certain account department employees, it is imperative for concerned organizations to carry out surprise financial audits regularly to detect and prevent any potential incidences of financial statement fraud. This paper focuses on revenue recognition fraud by examining the background, real-time incidence, detection, and statistics related to revenue recognition fraud. Background of revenue recognition fraud Commonly known as timing schemes or improper treatment of sales, this category of financial statement fraud is undeniably the most prevalent in many accounts departments of most corporations (Schrader & Toner, 2013).

The revenue recognition fraud is normally a matter of the organization at large especially when the management has the intention of hiding some real figure from public and financial scrutiny for a good section of the financial year. The motivating factors for the management’s engagement in revenue recognition fraud may be due to a weak season where the organization predicts unimpressive financial prospects. In addition, unscrupulous management systems could get involved in outright revenue recognition fraud in order to create the impression that the concerned organization is faring well in the financial market or simply to gain undue competitive edge over business rivals and the government at large (Stallworth & Digregorio, 2004).

According to Hutton Law Group (2011), revenue recognition fraud can occur in various forms depending on time and the nature of the concealment of useful sale projections and turnover. One of the mistakes that can result in this kind of fraud is the premature posting of legitimate sales, which would contravene the Generally Accepted Accounting Principles GAAP red flag. GAAP simply refers to the violation of the accounting procedures through the early recording of sale. Similarly, the recording of sales even before making any sales can land a corporate in trouble as the as the financial accounting rules and regulations are clear about the impropriety of stuff channeling.

Stuff channeling often leads to a tremendous increase in the number of subsequent periodic stock returns usually accompanied by unfamiliar soar in credits (Schrader & Toner, 2013). Detecting revenue recognition fraud and its dangers According to Stallworth and Digregorio (2004), there is a significant difference between the red flags of financial statement fraud from those of embezzlement of assets. One of the main ways of detecting revenue recognition fraud is by noting an uncommon rise in revenue and profits of a given company.

In financial accounting, there are known projections of predicting a company’s financial prospects and if any company’s financial trajectory disobeys such laws without visible explanation, then there is a likelihood of revenue recognition fraud. Auditors can also detect this kind of fraud when the total receivable amounts have little or no correlation with the total revenues generated. This could only mean the company’s earnings would exceed the expectation of the auditors and analysts (Deloitte, 2009).

The Street as a real-life example of revenue recognition fraud In December 2012, the Securities and Exchange Commission preferred charges of revenue recognition fraud against TheStreet, an online media company focusing on financial news. In their statement, SEC alleged that TheStreet and three executives including one of its former Chief Financial Officers and two others from promotions.com had maliciously inflated revenues at one of their subsidiaries in addition to understating the operating income to interested investors.

The allegation leveled against the online financial media company included the blatant ignorance of the fundamental accounting rules as stipulated in the Generally Accepted Accounting Principles [GAAP] (U.S. Securities and Exchange Commission, 2012). The report from SEC elaborated on how Eric Ashman who was the former CFO allowed one of TheStreet subsidiaries, Promotions.com to contravene the accounting principles by booking $ 305,000 worth of sales even before proper signing of the contract and delivery of the services.

Indeed, this improper treatment of sales is a serious fraud case that can seriously taint the reputation of a once thriving company (Hutton Law Group, 2011). Statistics relating to revenue recognition fraud In its auditing and accounting reports covering the period between 2000 and 2008, SEC found out that the most common type of financial statement fraud is the revenue recognition fraud that accounted for 38% of all the financial statement fraud cases in that particular period. In this scenario, the most dominant form was the improper treatment of sales as envisaged in the Generally Accepted Accounting Principles [GAAP] (Deloitte, 2009).

The release also discovered that the major culprits were always the top management comprising of the Chief Accounting Officers (CAO), Chief Financial Officers (CFO), Chief Executive Officers (CEO), and Financial Controllers who represented 44% of the parties accused by the Securities and Exchange Commission by 2008. In the release, the CEOs represented 24% while the directors and other general counsel mentioned were 4% with other members of the management charged accounted for 24% (Hutton Law Group, 2011).

References Deloitte. (2009). CFOs, CAOs as well as CEOs Most Often Named in SEC Enforcement Releases Alleging Fraud. Retrieved from http://www.deloitte.com/view/en_US/us/Services/Financial-Advisory-Services/b6e3d26d3c195210VgnVCM100000ba42f00aRCRD.htm Hutton Law Group. (2011). Revenue Recognition Fraud: A Brief History. Retrieved from http://www.shareholderlegalservices.com/case-studies/revenue-recognition-fraud-brief-history Schrader, R. W., & Toner, J. F. (2013). Revenue recognition under convergence: Strategic implications for time value of money in reported income.

 Journal of American Academy of Business, Cambridge, 19(1), 235-241. Retrieved from http://search.proquest.com/docview/1357565499?accountid=45049 Stallworth, H. L., & Digregorio, D. (2004). Improper revenue recognition. The Internal Auditor, 61(3), 53-56. Retrieved from http://search.proquest.com/docview/202749856?accountid=45049 U.S. Securities and Exchange Commission. (2012). SEC Charges Financial Media Company and Executives Involved in Accounting Fraud. Retrieved from http://www.sec.gov/news/press/2012/2012-270.htm