Forensic Accounting For Dummies
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Financial statement fraud, commonly referred to as "cooking the books," involves deliberately overstating assets, revenues, and profits and/or understating liabilities, expenses, and losses. A business that engages in such a practice stands to lose a tremendous amount of money when penalties and fines, legal costs, the loss of investor confidence, and reputational damage are taken into account.

When a forensic accountant investigates business financial fraud, she looks for red flags or accounting warning signs. Red flags that indicate suspect business accounting practices include

  • * Aggressive revenue recognition practices, such as recognizing revenue in earlier periods than when the product was sold or the service was delivered

  • Unusually high revenues and low expenses at period end that cannot be attributed to seasonality

  • Growth in inventory that does not match growth in sales

  • Improper capitalization of expenses in excess of industry norms

  • Reported earnings that are positive and growing but operating cash flow that is declining

  • Growth in revenues that is far greater than growth in other companies in the same industry or peer group

  • Gross margin or operating margins out of line with peer companies

  • Extensive use of off-balance sheet entities based on relationships that are not normal in the industry

  • Sudden increases in gross margin or cash flow as compared with the company's prior performance and with industry averages

  • Unusual increases in the book value of assets such as inventory and receivables

  • Disclosure notes so complex that it is impossible to determine the actual nature of the transaction

  • Invoices that go unrecorded in the company's financial books

  • Loans to executives or other related parties that are written off

About This Article

This article is from the book:

About the book authors:

Frimette Kass-Shraibman is Associate Professor of Accounting at Brooklyn College ? CUNY. Vijay S. Sampath is Managing Director in the Forensic and Litigation Consulting business segment of FTI Consulting, Inc.

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