Efficient Tests of Balances Series--No. 36: Revenue Misrepresentations in Financial Statements

Common Financial Statement Misrepresentations

 

Citizen Works, a nonprofit corporation founded by Ralph Nader, produced “The Corporate Scandal Sheet” which presented 41 major scandals involving corporations and large accounting firms that occurred in the five years or so up to and including 2002.  These findings remain the cause of misrepresentations in today's financial statements. The causes of the scandals can be summarized in four main categories:

 

   Causes of Scandals                                                                Number of Cases

 

Off-balance sheet loans or accounting activity.                                      4

Various violations of laws.                                                                    8

Accounting errors overstating net income.                                             10

Improper revenue recognition.                                                               19

 

Reading further documentation of these scandals will reveal that many of improper activities involve simple manipulations of income.  WorldCom, for example, simply capitalized certain operating expenses and arbitrarily reduced its allowance for uncollectible accounts.  Enron and others created vehicles and contracts in order to record immediate revenues and, at the same time, ignored potential losses inherent in the agreements.  At least four of the energy companies increased revenues using artificial “round trip” energy trades to inflate income.  At least two telecommunications companies used network capacity swaps with other similar companies to inflate revenues.

 

For decades, most auditors of large corporations performed limited tests of internal controls and analytical procedures to verify financial statement assertions for revenues.  This list of scandals gives us understanding about why current accounting and auditing standards revisions focus on revenue recognition.

 

Improper Revenue Recognition in Smaller Entities

Many CPA firms have experienced revenue recognition problems with smaller clients.  Here are a few examples:

  • A nightclub that continually reports a very low gross margin from beer and liquor sales (Skimming).
  • An operator of nursing homes includes numerous relatives on multiple payrolls (Inflating Medicaid reimbursements).
  • A construction contractor that purchases all materials for certain contracts to increase actual costs before its year end (Dumping materials at sites to inflate the percentage of completion).
  • A trailer leasing company that bills customers for extra, unused trailers each month (Fraud).
  • Products shipped subject to customer approval are recorded before receiving such approval (Improper cutoff).
  • Billing customers for products shipped on consignment, or before products are shipped and recording revenue prematurely (Inflating revenues).
  • Recording multi-year contracts, or revenues benefiting future periods, at the date of the contract or customer order (Improper matching of costs and revenues).
  • Recording grant revenues when received rather than as expended (Improper matching costs and revenues).
  • An entity that won’t provide inventory quantities and pricing information until the CPA informs management of the taxable income before the inventory adjustment (Fraud).  Ouch!  This one could be personal!

We can see from the discussion above that opportunities for misrepresentations of revenue recognition are many and varied.  Some may be inadvertent and some may be intentional.  In the materials that follow, we’ll discuss approaches to enable auditors to effectively verify financial statement assertions and respond to risks of material misstatements due to error or fraud.

This subject and others are included in my live and on-demand webcasts which can be accessed by clicking the applicable link on the left side of my home page at www.cpafirmsupport.com.

This blog

by Larry Perry, CPA, CPA Firm Support Services, LLC - Larry has over 40 years experience as a CPA practitioner, author of accounting and auditing manuals, author and presenter of live staff training seminars and author of webcast and self-study CPE programs.  He is co-founder of CPA Firm Support Services, LLC (www.cpafirmsupport.com), an organization providing resources, training and consulting to smaller CPA firms.  Larry writes a weekly blog on AccountingWEB.com focusing on small audits, reviews and compilations.  He is currently developing documentation manuals and handbooks for small audits, reviews and compilations and related electronic practice aids.

More from this blog

Bloggers crew

Steve Knowles has spent 25 years in business and practice in the UK, but he also worked in the states and the years haven't dulled his way of seeing an alternative view to everyone else, and every day is a new adventure.

43193

Joel M. Ungar, CPA is a lifelong resident of the Detroit area and a graduate of The University of Michigan. He is a principal with Silberstein Ungar, PLLC, a Top 15 auditor of SEC public reporting companies.

75640

Allan Boress, CPA, with over 25 years as a practitioner and consultant to the accounting profession. Mr. Boress is the author of 12 published books in 6 different languages, including a best-seller, The "I-Hate-Selling" Book.

48151

Larry Perry, CPA, CPA Firm Support Services, LLC, is the author of accounting and auditing manuals, author and presenter of live staff training seminars, and author of webcast and self-study CPE programs. He blogs about small audits, reviews, and compilations.

88634
Sandra Wiley, COO and Shareholder, is ranked by Accounting Today as one of the 100 Most Influential People in Accounting as a result of her prominent role as an industry expert on HR and training as well as influence as a management and planning consultant. She is also a founding member of The CPA Consultant's Alliance. Sandra is a certified Kolbe™ trainer who advises firms on building balanced teams, managing employee conflict and hiring staff.
20334

Maria Calabrese, CIR, Human Resources manager for Fazio, Mannuzza, Roche, Tankel, LaPilusa, LLC in Cranford, New Jersey, Maria's topics revolve around the world of: Mentoring, Performance management, and The "Y Generation," a.k.a. "The whY generation".

55333

William Brighenti is a CPA, Certified QuickBooks ProAdvisor, and Certified [Business] Valuation Analyst, operating an accounting, tax, and QuickBooks consulting firm in Hartford, Connecticut, Accountants CPA Hartford.

80311

Ken Garen, CPA, is the co-founder and President of Universal Business Computing Company (www.ubcc.com), a software development firm of high-volume, high-productivity accounting and payroll technology.

24804

Eva Rosenberg, MBA, EA, is the publisher of TaxMama.com, and author of the weekly syndicated Ask TaxMama column. She provides answers to tax questions from taxpayers and tax professionals worldwide.

63816

Amy Vetter, CPA, CITP is the CPA Programs Leader for Intacct Corporation responsible for leading the CPA/BPO Partners nationally.

34246
Brian Strahle is the owner of LEVERAGE SALT, LLC where he provides state and local tax technical services to accounting firms, law firms and tax research organizations across the United States. He also writes a weekly column in Tax Analysts State tax Notes entitled, "The SALT Effect." For more info, visit his website: www.leveragestateandlocaltax.com
102347
Scott H. Cytron, ABC, is president of Cytron and Company, known for helping companies and organizations improve their bottom line through a hybrid of strategic public relations, communications, marketing programs and top-notch client service. An accredited consultant, Scott works with companies, organizations and individuals in professional services (accounting, finance, medical, legal, engineering), high-tech and B2B/B2C product/service sales.
25654

Rita Keller is a nationally known CPA firm management consultant, speaker, author, mentor and blogger. She has over 30 years hands-on experience in CPA firm management, marketing, technology and administrative operations.

52266
Stacy Kildal is the mom of two fantastic kids, an Advanced Certified QuickBooks ProAdvisor, Certified Enterprise Solutions ProAdvisor, Sleeter Group Certified Consultant, a nationally recognized member of the Intuit Trainer and Writer Network, and co-host of RadioFree QuickBooks.
27542
Michael Alter's blog specializes in providing practical advice to those who seek greater profitability and practice management tactics that enhance deeper client relationships.
31844

Sally Glick, CMO, Principal, Marketer of the Year in 2003 and AAM Hall of Famer in 2007, leads a lively discussion of the constantly expanding roles of marketing and the professional marketers that drive this initiative in accounting firms of all sizes.

100085

The IMA Young Professionals Blog features the insights of IMA’s Young Professionals Committee. Committee members share advice and experiences on careers, continuing education, work/life balance, and other issues affecting young accounting and finance professionals.

33018

FEI Financial Reporting Blog provides highlights from SEC, PCAOB, FASB, IASB, and other regulatory news, including reporting under Sarbanes-Oxley Sect 404. It is written by Edith Orenstein, Director of Technical Policy Analysis at FEI.

111035

Sue Anderson has 30 years of experience in continuing education for accountants. Currently she is the program director for online CPE provider CPE Link.

60726

Jim Fahey is COO of Apple Growth Partners, a regional CPA firm in Ohio. His focus is on the effective and efficient use of technology within the firm by all team members.

38956
Caleb Newquist is the Editor-in-Chief of Sift Media US, overseeing content for both AccountingWEB and Going Concern.
66174

Leita Hart-Fanta, CPA, CGFM, and CGAP is the author of "The Yellow Book Interpreted" and owner of Yellowbook-CPE.com a website devoted to training for governmental auditors.

92184

AccountingWEB is more than just a U.S. team of journalists and financial and technology experts - we have an international side, too! Members of our British team who publish AccountingWEB.co.uk share their ideas, insights, and perspectives from across the pond.

53223