Pros And Cons Of Revenue Recognition Fraud

Revenue Recognition Fraud: Methods and Reason In today’s corporate arena, fraud has taken its seat among the top priorities of those who make policies and set standards. The majority of large-scale fraud is perpetrated by the improper recognition of company revenues and is, in practice, generally simple. Revenue recognition fraud can be carried out by keeping the books open past the end of the accounting period, recording consignment goods as sales, improper bill-and-hold transactions, failure to record offsetting accruals, and many other methods that boost earnings. Internal auditors need to understand the types of revenue recognition fraud and the internal controls that prevent the use of improper techniques. This knowledge will allow
Playing with time is not the only way to improperly recognize revenue. Another way to commit revenue recognition fraud is by recording goods on consignment as sales. Consignment goods are those that a party ships to a selling agent. The shipment of these goods to the selling agent should never be recorded as a sale because they are still inventory of the consigning company. This method of revenue recognition fraud is detected by the reversal of sales that must take place in order to correctly record the revenue. Again, auditors should be able to identify these situations and take necessary actions [Wells 2001]. Along with these two methods, bill-and-hold transactions can be used to prematurely recognize revenue. Douglas R. Carmichael, in his article “Hocus-Pocus Accounting,” says that bill-and-hold scams are “difficult to audit and have long been associated with incidents of financial fraud,” [Carmichael 1999]. In a bill-and-hold transaction, after the customer says they will purchase goods, the seller bills the customer and holds the goods until the customer requests delivery. Even though this is not a GAAP violation, the SEC does have a checklist stating requirements that a transaction must fulfill in order to recognize the
This definition includes an area of internal control labeled the control or internal environment, which has seven components. Each of these components has an effect on every business that is in existence. There are two, however, that, if not taken into consideration, can lead to unethical decisions such as revenue recognition fraud. The first control environment component is commitment to integrity and ethical values, which means that management should strive for a culture that stresses integrity. Also, “top management should make it clear that honest reports are more important than favorable ones,” [Romney and Steinbart 2003]. If this were truly stressed in organizations, improperly recognizing revenue in order to boost profits would be a problem rarely found. The second and possibly more important component of the control environment is management philosophy and operating style. In an ideal organization this would be the channel through which commitment to integrity would flow. In this component it is stated that “the more responsible that management’s philosophy and operating style are, the more likely it is that employees will behave responsibly in working to achieve the organization’s objectives,” [Romney and Steinbart 2003]. However, in many instances this is not the case. Pressure from many directions causes a shift or change