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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