“Fraudulent Revenue Schemes and How to Detect Them,”
by Dr. Barry Jay Epstein, CPA, CFF, January, 2015.
Of the two major sub-categories of revenue recognition financial reporting fraud – premature recognition of real revenue, and recordation of wholly bogus revenue – the latter should, by all rights, be the easiest to detect, since extraordinary accounting measures have to be taken to perpetuate concealment of what are, after all, nonexistent claims to customer cash. Furthermore, as with most financial reporting frauds, the perpetrators’ perceived need to “up the ante” from period to period – in order, e.g., to be able to report continuing trends of greater sales volumes and profitability – means that what may have begun as a small matter easily concealed and below most external auditors’ materiality thresholds eventually grows, like the proverbial dirt swept under a rug, to an impossible-to-miss hill which even the most sanguine managers and mediocre auditors will eventually have to metaphorically trip over.
Forensic Accounting Fact Sheets
Fraudulent Revenue Schemes and How to Detect Them
Friday, January 2nd, 2015An Auditor’s Guide to Uncovering Under-Reported Income in Cash Businesses
Friday, January 2nd, 2015“An Auditor’s Guide to Uncovering Under-Reported Income in Cash Businesses,”
by Dr. Barry Jay Epstein, CPA, CFF, January, 2015.
Auditing is the process of obtaining and evaluating evidence that supports (or refutes) the material financial statement assertions made by management of the entity under examination. Auditors must examine sufficient appropriate evidence to support their opinions (per U.S. Auditing Standards, AU-C Section 500, and PCAOB Auditing Standard No. 15), but have always been inclined to focus on documentary evidence, whether internal (books of account, purchase orders, etc.) or external (confirmation responses, etc.) in origin. This bias is probably a normal consequence of auditors’ education and training and, in the author’s experience, has been exacerbated by the rise in so-called “computer-based auditing,” which tends to keep auditors firmly planted behind computer screens and disinclined to engage in what some fail to appreciate as key activities, such as touring the physical facilities.
Revenue Recognition: The Easy Route to Financial Reporting Fraud
Friday, January 2nd, 2015“Revenue Recognition: The Easy Route to Financial Reporting Fraud,”
by Dr. Barry Jay Epstein, CPA, CFF, January, 2015.
Many studies conducted over the years have found that the most common vehicle for financial reporting fraud has been improper revenue recognition – although in a minority of periods this has been exceeded by manipulation of so-called “cookie jar” reserves, which are bogus estimated obligations that can be opportunistically reversed to compensate for earnings shortfalls. Revenue recognition abuses include both the deliberate mis-timing of recognition of otherwise-valid revenue, and the outright fabrication of revenue that does not deserve recognition at all. There are several reasons why improper revenue recognition has proven to be the easiest route to perpetration of financial reporting fraud.
Fraud Modeling and Financial Reporting Fraud
Tuesday, December 2nd, 2014“Fraud Modeling and Financial Reporting Fraud,”
by Dr. Barry Jay Epstein, CPA, CFF, December, 2014.
Fraud, and in particular financial reporting fraud, costs investors huge sums each year. The headline cases – Enron, WorldCom, Adelphia, Parmalat – are widely reported and become MBA class case studies, but fraud is far more pervasive than these isolated major events suggest. The Association of Certified Fraud Examiners (ACFE) publishes its biennial study, Report to the Nations, which regularly reminds us that businesses, on average, lose as much as 6% of revenues to various forms of fraud, of which financial reporting fraud probably accounts for about half, impacting privately held companies as well as “issuers” having public investors.
Accounting for Leases: A White Paper
Monday, April 21st, 2014“Accounting for Leases: A White Paper on Significant Financial Reporting Changes for Lessees and Lessors,” by Dr. Barry Jay Epstein, CPA, CFF, Updated October, 2014.
The proper accounting for lease arrangements, both by lessees and by lessors, has been one of the more contentious areas of financial reporting theory for at least the past fifty years. A disproportionate fraction of all extant accounting guidance in many jurisdictions has been devoted to this matter, and it remains seemingly as controversial today as it was a half-century ago. Simply put, the issue is whether leases (with the possible exception of very short-term rentals) give rise to property rights – i.e., assets – as well as obligations that are to be reported by the lessee, with an analogous, if not necessarily totally symmetrical, accounting by the lessor.
Click on the link to read Dr. Epstein’s white paper on Lease Accounting based on recent FASB rules.
Revenue Recognition: A White Paper on Fraud and Financial Reporting Risk
Thursday, December 19th, 2013Revenue recognition, which may appear to be a straightforward concept, in fact is rather complicated, as evidenced by the more than 250 specific pieces of guidance found within U.S. GAAP. Repeated studies have found that misapplication (whether by error or due to malfeasance) of the extant revenue recognition rules has been responsible for a preponderance of restatements and allegations of financial reporting frauds. This white paper summarizes the common types of revenue recognition fraud and discusses the new approach to revenue recognition about to be unveiled by FASB, which has been working towards this with international standard-setting body IASB for a number of years. Click on the link to download Revenue Recognition: A White Paper on Fraud and Financial Reporting Risk by accounting expert Dr. Barry Jay Epstein, CPA, CFF. Updated November, 2014.
Credit Impairment: New Fair Value Accounting Approach
Wednesday, December 11th, 2013A new fair value approach to recognition of estimated losses will apply to both lenders and other financial reporting enterprises holding financial assets. The use of fair value accounting has greatly expanded over the past decade, and this article shows that the trend will continue. Heretofore, different financial assets have been valued alternatively at lower of cost or market, at fair value, or at net realizable value, depending on the instrument and nature of the reporting entity. This is about to change in a very significant manner. This anticipated change in financial reporting standards is yet another step in the inexorable move toward fair value accounting. Whatever the limitations of fair value, it is evident that even necessarily imprecise estimates of fair value are more useful for making economic decisions that are mathematically exacting than measures based on historical costs. Look for this trend to continue. Click on the link to read the full article on credit impairment accounting.
Accounting for Leases: Off-Balance Sheet Lease Arrangements About to Become Extinct
Wednesday, December 4th, 2013The FASB and its international standard-setting partner, IASB, have agreed on a new, uniform standard for accounting for leases that arguably will result in capitalization treatment of virtually all leases of more than one year’s duration. The new standard, when issued, will likely require retroactive restatement of financial statements. This may create unpleasant surprises for reporting entities and their lenders alike, because newly recognized leases will cause debt-equity ratios to be altered, quite possibly creating apparent violations of loan covenants or other mandates. For this reason, early attention to this proposal is strongly encouraged, including preparation of “pro forma” historical financial statements which can be shared with creditors to demonstrate that this accounting change triggers breaches that might be more apparent than real. Doing so might convince lenders to rewrite the affected covenants or to insert “frozen GAAP” provisions that cover the remaining terms of the affected loans. In this situation, an ounce of prevention will be worth many pounds of cure. Read the full article.
MF Global Accounting
Sunday, December 4th, 2011Revelations about MF Global’s accounting for its “repo-to-maturity” financing arrangements in connection with Chairman and CEO Jon Corzine’s $6.3 billion bet on European sovereign debt securities should sound very familiar to those who studied the Lehman “repo 105″ and “repo 108″ accounting deceptions. At minimum, this violated the clear spirit of financial reporting rules that have long held that repos do not connote actual sales of securities, but merely their use as collateral for borrowings. Read Dr. Barry Epstein’s article titled MF Global Off-Balance-Sheet Accounting: It’s Déjà vu All Over Again.
Before You Sue: Understanding Auditors’ Defenses
Monday, November 7th, 2011The role of the outside auditors is to opine on a company’s financial statements. An unqualified (“clean”) opinion will declare without reservation that, “In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 20XX, and the results of its operations and its cash flows for the year then ended, in accordance with accounting principles generally accepted in (the country where the report is issued).”
If and when it is later revealed that the financial statements contain material misstatements, it’s only natural to ask whether the auditors may be liable for losses incurred by creditors or investors that arguably could have been averted if the auditors had detected the errors or irregularities before the financial reports were published.
The above is excerpted from: “Before You Sue: Understanding Auditors’ Defenses for Failures to Detect Erroneous or Fraudulent Financial Statements,” Elizabeth Kowalski and Barry Jay Epstein, Chicago Lawyer, Law Bulletin Publishing Company, October, 2011, Volume 34, No. 10.