How Companies Defraud Investors

When reviewing a company's financial records, there are some general guidelines to follow, such as spotting corporate fraud before it becomes front page news.

I'll explain how you can look into this fraud on your own and what general questions you should ask the business and yourself while looking over a set of financial records.

The first technique is when a firm understates its bad debt expenditure, which is a cost that appears on a company's profit and loss statement to reflect the fact that some of the company's customers may not be able to pay what they owe the company.

Let's walk through an example of what the business should be doing to accrue or to make an allowance for bad debt expense to illustrate this idea. Generally speaking, the business shouldn't wait until the customer stops paying; instead, it should periodically be collecting for the bad debt expense by setting up an allowance for bad debt expense.

The client’s name and the current column balance are shown in the aging schedule. The amount listed in the current column effectively represents what is left of the pay period or payment window that you allow on the invoice; for instance, if it is 30 days, the amount is current or still inside the payment window for client number one. Invoices that are past due for 1 to 30 days, 31 to 60 days, and so on, up to 91 days or more, are listed, along with basic information, along with the amount that is past due.

Therefore, it should basically be looking at the current column and saying that based on historical data, we haven't collected 1% of these amounts. Therefore, it should basically be assigning 1% probability of not collecting current ar um current ar and then for the past due for each of these columns, the company should basically be assigning a percentage of likelihood of collectability. and basically for example here 1 to 30 days the company could be assigning 2 and then.

The longer it takes for the accounts receivable to be received, the more likely it is that they won't be collected, meaning that what the business should be doing is adding up these figures and multiplying these percentages by the totals . If the company arrives at a total probability of uncollectible ar of $20,000 in this case, let's assume, then the business should be recording a journal entry for the period in question. The two most common ways for businesses to deceive investors in this step are to either completely omit recording the allowance and simply wait to see which customers fail to pay their bills before recording that expense as a bad one, or else to reduce the probability of not collecting the amount owed, for example here for 91 plus days instead of recognizing it as a bad expense.

The second technique occurs when a company prematurely recognizes revenue from a long-term contract. Let's say a company signs a contract with a client for $600,000 over three years, contingent on a specified deliverable, to explain and offer an example. Let's imagine that over the course of the three years, the company is required to give legal services. over the course of the contract based on the service delivered, so basically in this example here let's assume that the company delivers a service on an equal basis for years one, two, and three. In this case, the company should be recognizing $200,000 in years one, $200,000 in years two, and $200,000 in years three. However, what I've seen happen in some cases is that either the company in error would recognize the entire $600,000 upfront in year one or what I've seen as well is that the company would recognize the

That is essentially act number two that a company could employ occasionally to deceive investors because the agreement calls for the company to deliver the service over time longer than one year, but if you look at the letter of the agreement, the company will actually deliver the service over time longer than one year. The third trick is when a business capitalizes its operating expenses, which are essentially operating expenses as the name implies.

This is a highly typical approach for a corporation to falsify its financial statements and deceive investors since organizations may classify rent payments as an asset that will accrue benefits in the future rather than an operating expense during the period. In essence, there are three things you should be doing if you believe the company is understating an expense and that fraud of any kind may be occurring. Asking the company if it accrues for allowance or bad debt charge should be your first course of action.

Next, you ought to ask for a copy of the business' bad debt policy. These policies, which are typically one or two pages long and describe the steps the company takes to incur bad debt costs, ought to be in place in every company.

Finally you should look at the balance statement to determine if an allowance for bad debt charge is listed. If you have any cause to think that the corporation is recognizing revenue that it shouldn't be, there are two steps you should take. If there have been any irregularities with revenue recognition over the time, you should first inquire with the corporation. You may simply just gather information by asking the inquiry so the business can educate you whether there has been anything unique about the revenue in the period. Asking for a revenue by client list is the second thing you ought to accomplish. In essence, you need to examine the revenue by customer list.

Any sudden increases and generally that will give you some idea on what to ask for if you see one of the customers, for example, having a substantial increase in one of the months or years you should be asking the question to find out why the increase or why the decrease for this customer and the question will then prompt the company to give you some more information on the on the matter and that will help you identify if there's any issues with the revenue recognition.

The balance sheet should be viewed first, and each line item should be examined. Then, you should request a breakdown of the balance you see on the balance sheet because, in essence, this will make it clearer to you what the company's operating expenses are when you look at the breakdown of the line item. Request the business if it capitalized any costs throughout the period as well.