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by H2R CPA Team
A company's management team is often interested in painting the rosiest possible picture of a company’s financial performance. But aggressive earnings management, or “spin,” can mislead investors and lenders. Here are some ways U.S. Generally Accepted Accounting Principles (GAAP) can be manipulated to obscure the truth.
Creative accounting vs. cooking the books
Earnings management usually starts out small, but it can become increasingly aggressive and eventually cross the line into fraud if it goes unchecked. An external audit may help detect the red flags of earnings management, including:
Premature revenue recognition. Some companies recognize revenue early to make the income statement temporarily appear more attractive. This ploy is common when a company is applying for bank financing or up for sale.
Miscellaneous “cookie jar” reserves. Management can create a hidden reserve of funds during good times. Then the reserves can be tapped into to nourish earnings in lean times.
“Big bath” restructuring changes. Some companies overstate the costs associated with restructuring. This enables them to clean up their balance sheets and create reserves for a rainy day.
Immediate acquisition write-offs. Acquired companies may classify a portion of the purchase price as “in process research and development,” which they immediately write off. This reduces the amortization of the purchase price to future earnings.
Overreliance on EBITDA. Earnings before interest, taxes, depreciation and amortization (EBITDA) and other non-GAAP metrics have become popular ways to evaluate a company’s performance. But they aren’t usually audited, and they may be calculated differently from company to company.
EBITDA is generally intended to resemble cash flow. But this metric can obscure problems for start-up companies with major debt. Although their EBITDAs give these start-ups appeal, their debt service may mean they won’t be profitable for many years.
Too good to be true?
Pay attention when reviewing financial statements and corporate press releases — the opportunity and pressure to spin earnings is everywhere.
Contact H2R CPA at 412-391-2920 or firstname.lastname@example.org for more information on how to identify when a business may have engaged in “creative” accounting practices to improve their financial picture. Our team would be pleased to provide a complimentary consultation.
by Joseph M. Delisi, CPA
With audit season upon us, it is important to remember that auditors are required to address “risk of fraud” during the audit process for both businesses and nonprofit organizations. The most common type of fraud is asset misappropriation, occurring in 85% of cases, according to a Global Fraud Study by the Association of Certified Fraud Examiners (ACFE). Financial statement fraud occurred in only 9% of cases.
What is interesting to note in the study is that tips are consistently (and by far) the most common fraud detection method. Over 40% of all cases were detected by a tip – more than twice the rate of any other method. Employees accounted for nearly half of all tips that led to the discovery of fraud.
Organizations with hotlines were much more likely to catch fraud by a tip, and they also experienced frauds that were 41% less costly, and detected frauds 50% more quickly. This is in contrast with the public expectation that the role of auditors is to detect fraud. According to the study, external audits are among the least effective control methods in combating fraud, and were the primary detection method in only 3% of fraud cases.
The most effective fraud detection methods are broken down as follows:
Takeaways about Fraud
Some of the conclusions reached as a result of this and previous fraud studies by the ACFE are:
Contact H2R CPA at 412-391-2920 or email@example.com to learn more about how we can assist you with putting internal controls in place to prevent fraud or any other Assurance needs you may have. Our team would be pleased to provide a complimentary consultation.
by Joseph M. Delisi, CPA, Principal
Despite the continuing decline in overall paper check usage, check fraud continues to pose a risk for many organizations. Since checks are passed person-to-person on their way to payment, they can easily be stolen, duplicated, altered or cashed illegally.
Are you concerned about check fraud losses at your business? Positive Pay may be the solution for you. It is essentially an insurance policy against unauthorized disbursements from your bank account. It is a service offered by banks for a fee, although some banks are now offering this service at no cost.
Here’s how it works: Positive Pay requires a company to transmit to the bank a file of checks issued each time checks are written. The file submitted to the bank contains the check number, date, amount, and bank account number. When those checks are presented to the bank for payment, they are compared electronically against the list of transmitted checks.
When a check presented for payment does not match the information on the file transmitted to the bank, it becomes an exception item. Before the bank processes the check for payment, it sends an image of the exception item to the client. The client then reviews the image, and instructs the bank to either process the check for payment, or return the check as unpaid. This allows the company to identify fraudulent checks before they are paid by the bank.
Positive Pay is an effective way to institute check fraud protection, stop bad payments, and reduce liability when dealing with a large volume of checks.
H2R CPA is pleased to assist clients in finding ways to protect themselves against fraud. Contact our team at 412-391-2920 or firstname.lastname@example.org for more information. We would be pleased to provide a complimentary consultation.
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For additional insight and expertise, visit the following blogs from some of our CPAAI member firms:
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