Revenue Recognition Fraud: A Brief History
The SEC in its accounting and auditing enforcement releases from 2000 through 2008 alleged the most common financial statement fraud scheme was revenue recognition fraud, which amounted to 38 percent of alleged financial statement fraud schemes. The schemes can include improperly recognizing sales before they are officially sales in accordance with Generally Accepted Accounting Principles (GAAP), recording fictitious sales and channel stuffing, where employees are “stuffing” products through a sales channel to increase the appearance of sales activity, while providing customers with the opportunity to return products without penalty.
Chief financial officers (CFO), chief accounting officers (CAO), controllers and chief executive officers (CEO) were the executives named most often in fraud cases filed by the SEC. CFOs, CAOs and controllers collectively represented 44 percent of the individuals alleged by the Securities and Exchange Commission to have committed financial statement fraud in 2008. The report did not provide separate figures for the three positions, however. CEOs represented 24 percent of the executives cited, while directors and general counsel were each identified as subjects in 4 percent of the enforcement releases. Other members of management represented 24 percent of the executives charged.
In 2008, the technology, media and telecommunications industry (30 percent) and the consumer business industry (29 percent) had the greatest proportion of financial statement fraud schemes alleged by the SEC, followed by financial services (18 percent) and life sciences and health care (12 percent).
"The results have been damaging, not just to the companies themselves, but also to the financial reporting process, to the accounting profession, to investors and to the American economy."
Analyzing financial statement fraud requires diligence, and persistence. Shareholders – Stockholders, Auditors, and investors may not be aware that the financial statements are misstated in any way when first reading them. Some financial statement frauds may contain highly correlated earnings, revenues, and receivables.
Six early warning signs of fictitious earnings can point to potential evidence of erroneous revenue recognition, but users must be very diligent in examining all components of the financial statements and their relationships to each other.
- Earnings that exceed, or consistently, or precisely meet analysts’ expectations;
- Cash flows that do not correlate with earnings;
- Receivables that do not correlate with revenues;
- Allowances for uncollectible accounts that do not correlate with receivables;
- Reserves that do not correlate with balance sheet items; and
- Acquisitions with no apparent business purpose.
Identifying financial statement fraud can take experience and a trained eye. Shareholder and investment losses due to fraud can be avoided with extra homework and due diligence by professionals with both legal and accounting expertise.
Hutton Law Group (“HLG”) is a law firm located in San Diego, California, that is dedicated to outstanding advocacy in the representation of investors in complex financial disputes. Our attorneys have experience representing clients in cases involving securities law, corporate governance, corporate fraud, breaches of fiduciary duty andother forms of corporate misconduct. Investors who are in need of legal help may contact the firm’s lawyers at (858) 793-3500.