While some businesses commit FSF to get out of financial or liquidity problems, it's detrimental in the long run. That's because the person who makes these fraudulent recordings can face criminal charges.
According to the Practical Accountancy Loose Leaf, the two critical things to know about FSF are that:
That's why it's crucial you're aware of the most common FSF scheme and ways to spot the red flags in your financial statement.
Could your business be facing this common FSF scheme?
FSF scheme: Timing differences/revenue recognition
This is also known as improper treatment of sales. This fraud category's the most common form of financial statement fraud. Fraudsters use it to hide the real numbers of a bad accounting quarter or two.
Timing differences happen when the revenue or expenses are reflected in the wrong periods. This can increase or decrease earnings, by changing the revenue or expenses between periods.
Timing differences can occur in the following ways:
Let's look at each one in more detail.
#1: Premature Revenue Recognition: It's difficult to spot premature recognition because it looks like sales criteria are met. Here's a checklist you can use:
#2: Long-term contracts: If long-term contracts are negotiated, you must recognise revenue over the contracts lifecycle. Otherwise, this can put your business into a position where managers can manipulate the anticipated revenue to be received per year.
For example, construction companies use two methods to record revenue:
Depending on the method, expenses can be hidden away so any contract overruns aren't reflected, and revenues are prematurely recognised.
#3: Channel stuffing: This is where a company, or a sales force within a company, inflates its sales figures. They force more products through a distribution channel than the channels capable of selling.
This is also known as 'trade loading'. Companies do this to try inflating sales figures.
#4: Record expenses in the wrong period: Expenses are pushed into the wrong periods. Companies do this for different reasons, but the results are that the current period's earnings are inflated. Then in the next period, the earnings are reduced by the same margin.
So what are the Timing Differences red flags?
While this FSF scheme is complex, you can detect it and protect your company if you learn to spot the red flags.