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Introduction
This essay seeks to present a discussion on general rules for appropriate revenue recognition, methods that companies can use to manipulate revenue recognition and how they can be detected, warning signs of fraud that auditors should have a close examination at and lastly, an indication of some of the warning signs and their significance.
General rules for appropriate revenue recognition
Financial shenanigans are actions or omissions intended at misrepresenting the actual financial position of a company. That is, omission or inclusion of some elements of the financial statement to make the figures look good. However, there already exist the general rules for revenue recognition as established by the International Accounting Standards body. They are matching concept, prudence concept, materiality concept and realization concept. Matching concept states that the best time to recognize revenues and costs is as they are earned but not when money is being received or paid. The two items should be matched with one another provided that their relationship is justifiable. Prudence concept states that in a situation where an alternative valuation method is possible, the selected method should be the one that gives the most accurate presentation of the financial position of a business.
Methods of manipulating revenue recognition
Premature revenue recording- this method facilitates recording of revenues before they are realized. For instance, recording revenue that is to be generated by a future delivery that has not happened. Secondly, boosting income with one-time gain. Revenue should be generated by consistent business operations not one time operation. Therefore, actions like selling undervalued assets to boost profits is a manipulation method. The third point is failing to disclose all liabilities. For instance, omitting records of material obligations and unforeseen events to inflate profit levels.
Preliminary warning signs of fraud
Misrepresentation of accounting information to boost the financial appearance of a company is an act that is common. Unfortunately, it is not easy to recognize the misrepresentations unless with the help of warning-sign. Every company should have its own independent and highly competent auditors who actively engage in their duty. A company without auditing segment that meets the mentioned qualities should be a warning sign for persistent fraudulent activities. Fraud is illegal and can only be avoided by management team with high moral standards. Therefore, a management team exhibiting wavering moral standards and questionable characters should be a strong warning sign of where fraudulent activities thrive. Another warning sign is caused by change of accounting principles. Accounting principles are put in place by the international accounting standards to regulate the accounting practices and ensure conformity and eliminate fraudulent accounting practices. A company that implements accounting principles other than those given by the IAS should be suspected of illegal activities like fraud. Another sign to take a closer look at is companies with a lot of financial obligations and full of unforeseen events. Financial obligations like debts (both long-term and short-term) draw from companies substantial amount of assets due to repayment of interest and the principle amount. Unforeseen events such as changes in interest rates and unstable general macroeconomic performance pose a tough situation for companies. A company that records high profit levels in the midst of these obligations and uncertainties should draw auditors’ attention. Lastly, most auditing firms hired by companies should be independent to facilitate accurate auditing. A company that has nothing to hide concerning its accounting practices and financial reporting is less likely to engage in unauthorized change of auditors. In case that happens, more attention should be directed into the company’s accounting practices.
Conclusion
In conclusion, the IAS has established some general rules to guide accounting practices that encourage appropriate revenue recognition. The above stated are some of the ways a company would use to manipulate its revenue recognition. The significance of the warning signs is that they provide an easier way of recognizing potential fraudulent companies.
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