David Anderson is principal of David Anderson & Associates, a Philadelphia forensic accounting firm that provides a full range of fraud investigation, forensic accounting, and marital dissolution services in Philadelphia and the Delaware Valley.
As noted in my recent six-part series on the state of fraud in 2022 based on the Association of Certified Fraud Examiners’ (ACFE) “Occupational Fraud 2022 – A Report to the Nations,” most fraud losses come from financial statement fraud. One of the most significant causes of such fraud is the overstatement of revenues or revenue recognition fraud.
Recently, the AICPA (Association of International Certified Professional Accountants, formerly American Institute of Certified Professional Accountants) published an article discussing types of revenue recognition fraud and red flags which would identify potential revenue recognition fraud. This blog will discuss key takeaways from that article.
The article identified several types of revenue recognition fraud. These included:
- Improper timing: This type of revenue recognition fraud usually occurs when a company prematurely records revenues to create the appearance that it is hitting revenue targets (announced either internally or publicly) and therefore making its financial statements appear stronger than they really are. Recent SEC actions against Under Armor and Belden (as well as Sunbeam in the 1990s) were based on the use of improper timing.
- Delayed revenue recognition: This less-common fraud scheme is the opposite of improper timing. This type of revenue recognition fraud occurs when a company, already having met certain revenue targets, improperly shifts revenue to the future to ensure revenue targets are met in upcoming time periods. One key result of such revenue shifting is to increase executive bonuses based upon meeting certain revenue targets. This type of revenue recognition fraud was the basis for certain recent SEC actions against American Rental Associates.
- Fictitious revenue: This type of revenue recognition fraud results from a company inflating its revenues and earnings by recognizing revenue related to fake contracts, fake customers, or other non-existent sales. This type of fraud may be harder to commit because it requires overriding key internal controls. Two well-known SEC cases involving fictitious revenue were Satyam Computer Services Limited (2011) and Anicom Holdings (2002).
- Channel stuffing: This revenue recognition fraud scheme involves companies sending excessive amounts of products to their distributors, wholesalers, or customers over and above demand. This usually occurs near the end of a reporting period for which the companies realize they will miss their targets. To induce the recipients to accept the excess inventory, companies will offer kickbacks, excessive discounts, or other incentives. Well-known SEC cases involving channel stuffing were Bristol-Myers Squibb (2004) and Symbol Technologies (2004).
The article also identified certain red flags which can indicate the potential for revenue recognition fraud. These include:
- An aggressive sales culture and poor tone at the top.
- Hitting revenue targets due to sales booked in the last few days (or even the last day) of a sales reporting period.
- Journal entries, especially manual ones, that can’t be explained or have no support. Such entries include topside adjustments at the end of the sales reporting period.
- Anomalies or large balances within accounts receivable aging and unusual fluctuations in bad debt reserves.
- Re-aging of invoices (such as due to a change in payment terms) or canceling and reissuing invoices.
- Unusual fluctuations or patterns of returns from period to period.
- Holding the books open beyond the accounting period.
- Loss of major customers.
- Pressure from executive management to hit sales targets without any mention or reminder of acting ethically or following company policies or procedures.
- Distributors or wholesalers with higher-than-normal inventory levels at the end of a reporting period.
If you require the services of a Certified Valuation Analyst in Philadelphia or any other forensic accounting services in Philadelphia and the Delaware Valley, please contact the Philadelphia forensic accounting firm of David Anderson & Associates by calling David Anderson at 267-207-3597 or emailing him at firstname.lastname@example.org.
About David Anderson & Associates
David Anderson & Associates is a Philadelphia forensic accounting firm that provides a full range of forensic accounting services in Philadelphia and the Delaware Valley. The experienced professionals at David Anderson & Associates provide forensic accounting, business valuation, fraud investigation, fraud deterrence, litigation support, economic damage analysis, business consulting and outsourced CFO services. Company principal David Anderson is a forensic accounting expert in Philadelphia who has more than 30 years of experience in financial and operational leadership positions and is a Certified Public Accountant, a Certified Valuation Analyst, and a Certified Fraud Examiner in Philadelphia.