By far the most common way that executives manipulate financial statements is through the overstatement of revenue. The reason is simple: It’s the easiest way to improve the appearance of the company’s financial condition.
Revenue can be inflated by doing things such as:
- Booking fictitious sales
- Holding the books open at the end of a period
- Recognizing legitimate sales early
- Shipping items not ordered by customers and booking the sales
- Booking revenue before it has been earned on projects in progress
- Recording sales for items produced but not yet shipped, or only partially shipped
- Booking sales but delaying shipment to customers (bill-and-hold schemes)
- Not properly recording allowances for returned goods
Revenue overstatement is detected by examining revenue patterns and looking for irregularities. Unusual changes in cost of goods sold might signal a problem, as companies that book fictitious revenue do not always book corresponding expenses. Revenue overstatement may also be suspected when a company has consistent cash flow problems, even in light of apparently increasing sales and profits.