26 Jul

Management’s Judgment and Financial Statement Fraud

With thousands of detailed accounting rules, how can there be financial statement fraud? There are areas of the financial statements that rely heavily on the judgment of management. They make estimates and decide how to apply the accounting rules. This leaves the door wide open for abuse.

Many accounting entries are pretty simple. It’s easy when the company buys a small item, gets an invoice for it, and pays it. We can record the amounts and the dates pretty simply based on that information.

But it gets more difficult when the situation is not so black and white. For example, when a company sells a long-term service contract to a customer, when is that revenue recognized? The revenue usually is going to be recorded over time, and the way to calculate this can vary.

Who is to say that management won’t decide to recognize the revenue using a schedule most beneficial to that company? There may be reasons for wanting to recognize that revenue sooner or later, and management has the ability to manipulate the situation.

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