Accounting fraud is a deliberate and improper manipulation of the recording of sales revenue and/or expenses in order to make a company’s profit performance appear better than it actually is. Some things that companies do that can constitute fraud are:
–Not listing prepaid expenses or other incidental assets
–Not showing certain classifications of current assets and/or liabilities
–Collapsing short- and long-term debt into one amount.
Over-recording sales revenue is the most common technique of accounting fraud. A business may ship products to customers that they haven’t ordered, knowing that those customers will return the products after the end of the year. Until the returns are made, the business records the shipments as if they were actual sales. Or a business may engage in channel stuffing. It delivers products to dealers or final customers that they really don’t want, but business makes deals on the side that provide incentives and special privileges if the dealers or customers don’t object to taking premature delivery of the products. A business may also delay recording products that have been returned by customers to avoid recognizing these offsets against sales revenue in the current year
The other way a business commits accounting fraud is by under-recording expenses, such as not recording depreciation expense. Or a business may choose not to record all of its cost of goods sold expense fore the sales made during a period. This would make the gross margin higher, but the business’s inventory asset would include products that actually are not in inventory because they’ve been delivered to customers.
A business might also choose not to record asset losses that should be recognized, such as uncollectible accounts receivable, or it might not write down inventory under the lower of cost or market rule. A business might also not record the full amount of the liability for an expense, making that liability understated in the company’s balance sheet. Its profit, therefore, would be overstated.
A public corporation is a business whose securities are traded on the public stock exchanges, such as the New York Stock Exchange and Nasdaq. A private company is held solely by its owners and is not traded publicly. When the shareholders of a private business receive the periodical financial reports, they are entitled to assume that the company’s financial statements and footnotes are prepared in accordance with GAAP. Otherwise the president of chief officer of the business should clearly warn the shareholders that GAAP have not been followed in one or more respects. The content of a private business’s annual financial report is often minimal. It includes the three primary financial statements – the balance sheet, income statement and statement of cash flows. There’s generally no letter from the chief executive, no photographs, no charts.
In contrast, the annual report of a publicly traded company has more bells and whistles to it. There are also more requirements for reporting. These include the management discussion and analysis (MD&A) section that presents the top managers’ interpretation and analysis of the business’s profit performance and other important financial developments over the year.
Another section required for public companies is the earnings per share (EPS). This is the only ratio that a public business is required to report, although most public companies report a few others as well. A three-year comparative income statement is also required.
Many publicly owned businesses make their required filings with the SEC, but they present very different annual financial reports to their stockholders. A large number of public companies include only condensed financial information rather than comprehensive financial statements. They will generally refer the reader to a more detailed SEC financial report for more specifics.