April 25, 2016

How to Spot Fraud in Business Financial Statements

Financial Statement Fraud or as it’s more commonly known, “Cooking the Books” involves overstating assets, revenues or profits and/or understating liabilities, expenses and losses. This is done deliberately.

When investigating financial fraud, a forensic accountant looks for red flags or accounting warning signs that indicate suspicious business accounting practices.

These red flags include the following:

  • Revenue recognition practices such as recognising revenue before the product was sold or the service delivered
  • In a period that can’t be attributed to standard seasonality, unusually high revenues and low expenses
  • Growth in inventory that doesn’t match growth in sales
  • Improper capitalisation of expenses in excess of what are considered to be industry norms
  • Earnings that are positive and growing but operating cash flow that appears to be declining
  • Growth in revnue that far succeeds growth in other companies within the same industry or peer group
  • Gross margin or operating margins out of line with peer companies
  • Fairly excessive use of off-balance sheet entities based on relationships that aren’t standard within the industry
  • Sudden incrases in gross margin or cash flow compared with prior performance and industry averages
  • Unusual increases in the book value of assets. This can include inventory and receivables.
  • Deliberately complex disclosure notes that make it impossible to fully determine the nature of a transaction
  • Invoices that go unrecorded in the company’s financial books
  • Loans to executives or other parties that appear to be written off.

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