Chapter 12
REVENUE AND INVENTORY-
RELATED FINANCIAL STATEMENT FRAUDS
Short Cases
Case 3
After performing the analysis, the accounts that raise questions are Accounts Receivable and Retained Earnings. The percentage changes are shown in the following table:
2007
2008 Percent
Change
2009 Percent
Change
2010 Percent
Change
Cash $1,000 $1,200 20.0% $1,400 16.7% $1,500 7.1%
A/R 250 375 50.0% 600 60.0% 900 50.0%
Inventory 600 700 16.7% 825 17.9% 975 18.2%
PP&E (net) 1,500 1,700 13.3% 1,800 5.9% 1,950 8.3%
Notes Rec. 500 500 0.0% 500 0.0% 500 0.0%
Tot. Assets $3,850 $4,475 16.2% $5,125 14.5% $5,825 13.7%
A/P $ 700 $ 900 28.6% $1,000 11.1% $1,100 10.0%
Other Liab. 200 300 50.0% 350 16.7% 425 21.4%
Notes Pay. 1,200 1,400 16.7% 1,500 7.1% 1,750 16.7%
Tot. Liab. $2,100 $2,600 23.8% $2,850 9.6% $3,275 14.9%
Stock Out. $1,000 $1,000 0.0% $1,000 0.0% $1,000 0.0%
Ret. Earn. 750 875 16.7% 1,275 45.7% 1,550 21.6%
Total Share. Equity $1,750 $1,875 7.1% $2,275 21.3% $2,550 12.1%
Total Liab./
Share. Equ. $3,850 $4,475 16.2% $5,125 14.5% $5,825 13.7%
The Accounts Receivables balances are most questionable because of the huge jump from year to year. Those balances would be even more suspicious if there had been a drop in business incurred by most companies in the technology sector.
Case 6
The following are symptoms and schemes used in this case:
1. Funneling bank loans through third parties to make it look as though customers had paid when they had not.
2. Deliberately providing “false or incomplete information” to auditors and conspiring to obstruct the firm’s audits.
3. Factoring unpaid receivables to banks to obtain up-front cash. Side letters that were concealed from the auditors gave the banks the right to take the money back if they could not collect from the company’s customers.
4. The bulk of the company’s sales came from contracts signed at the end of quarters, so managers could meet ambitious quarterly sales targets and receive multimillion-dollar bonuses.
One of the first questions that needs to be examined is how the company explained the sudden growth in sales from hundreds to millions. The auditors should have investigated this increase. Also, the fact that most sales were recorded in the last days of the quarter should have been investigated. The auditors should have concluded that management had strong motivation to commit fraud because executives were being paid high bonuses based on sales volume.
As discussed in this chapter, the analytical symptoms and the accounting or documentary symptoms, if understood and analyzed by auditors, could have lead to earlier fraud discovery.
Case 7
1. One way to search for possible red flags of fraud would be to determine if the market value of inventories is higher or lower than reported inventory amounts. Doing this reveals the following:
Reported 2010 Market Value
Finished goods inventory $1,654,500 $2,400,000
(300 million × $.08)
(Approx. 300 million feet—2010)
Copper rod inventory $2,625,000 $2,832,000
(5.9 million × $.48)
(Approx. 5.9 million lbs.—2010)
Plastics inventory $ 224,500 $ 132,000
(1.1 million × $.12)
(Approx. 1.1 million lbs.—2010)
Market price of insulated wire (per foot) $ 0.008 $ 0.009
Market price of copper rod (per lb.) $ 0.480 $ 0.480
Market price of plastics (per lb.) $ 0.120 $ 0.190
2. From this table, if you multiply the market prices by the actual quantities of inventories in 2010, you can see that for two of the three inventories, the amounts reported in the balance sheet are much lower than what the market prices show. Because inventory should be carried on the balance sheet at the lower of cost of market, these amounts may be fine. However, changes in percentages from year to year should be examined. Since the market value is significantly less than the carrying amount of plastics inventory, this difference should be investigated, as it represents a possible fraud symptom.
Using vertical analysis results in the following:
2010 2009
Sales $8,450,000 100.00% $8,150,000 100.00%
Cost of goods sold 6,242,500 73.88% 6,080,000 74.60%
Finished goods inventory 1,654,500 19.58% 1,175,500 14.42%
(Approx. 300 million ft.—2010)
Copper rod inventory 2,625,000 31.07% 1,650,000 20.25%
(Approx. 5.9 million lbs.—2010)
Plastics inventory 224,500 2.66% 182,000 2.23%
(Approx. 1.1 million lbs.—2010)
Accounts payable (for inv. purchases) 450,000 5.33% 425,000 5.21%
We can see that even though Cost of Goods Sold has stayed relatively constant as a percentage of sales, finished goods inventory has increased as a percentage of sales. Copper Rod Inventory increased dramatically as a percentage of sales as well, but what is interesting is that Accounts Payable also maintained the relatively constant percentage with sales. You would expect to see an increase in Accounts Payable as inventory levels increase, but that is not the case here. This possible red flag demands further investigation.
