Watch Out for Fraudulent Revenue Recognition!

Jun 30th 2010
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When it comes to fraud, there is little new under the sun.  We can be assured that in times of economic downturn, fraud will increase.  Misappropriation of assets increases and financial misrepresentation increases.

In a study published on, major publicized frauds occurring from 1997-2002 were analyzed.  Interestingly, more than 40% of the frauds had to do with revenues recognition.  Another 20% consisted of accounting errors that misstated net income.  Have things changed since that period?  Not really!  Only more of the same!

As we plan and perform audits in 2010, we should have an increased awareness of common revenue recognition frauds. Here are a few possibilities:

•    Recorded sales for which the customer's obligation to pay depends on credit approval, resale of products or other unsatisfied conditions.
•    Sales shipped in advance and recorded without customer agreement.
•    Invoicing and recording sales prior to the assembly and shipping of the product.
•    Sales recorded but not shipped until after the end of the period.
•    Sales recorded based on purchase orders.
•    Sales recorded for cancelled or duplicate orders.
•    Shipments made to a warehouse or forwarder without customer approval.
•    Products shipped and recorded that are subject to customer approval.
•    Recording multi-period contract revenues in the period the contract is signed.
•    Skimming, inflating cost reimbursements, manipulating percentage of completion calculations and unauthorized billing for products or services.

AICPA Practice Alert 98-3 suggests a long list of auditors’ responses.  Here are some illustrative responses:

•    Comparing revenues by month for product lines or segments with prior periods.
•    Confirming terms of certain customer agreements.
•    Performing detailed sales cutoff procedures and making inquiries of management about unusual or significant sales near the end of the period.
•    Testing internal controls for information systems.
•    Investigating unusual journal entries affecting sales, sales returns and discounts before and after the end of the period.
•    Scanning the general ledger, sales journal and accounts receivable sub-ledger for unusual activity before and after the yearend.
•    Investigating deferred revenues accounts and transactions.
•    Reviewing credit memos for a period after the yearend.

When the potential for fraud risk increases, so should the auditor’s professional skepticism.  Give the current economic times, the time for increased skepticism is now!

Interested in more?  Join me for my webcast, Auditing Revenue Recognition, at on August 10, 2010.

Larry Perry, CPA


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