LOS I requires us to:
describe accounting warning signs and methods for detecting manipulation of information in financial reports
There exist many transactions, both real and estimated that indicate manipulation of information in financial reports. Some of the examples of such warning signs are:
a. For revenue recognition, the following may be the signs of manipulations:
i. allowing the FOB at source,
ii. the bill-and-hold transaction at the year-end,
iii. the existence of significant barter transactions,
iv. increasing accounts receivable as a percentage of sales,
v. the shift in allocations related to multiple deliverables
vi. out of line revenue trends,
vii. inappropriate provisions for bad debts,
viii. unusual asset turnover and its trends, etc.
b. For inventories, the following may be the signs of manipulations:
i. higher growth in the value of inventories held in comparison to the growth in sales,
ii. existence of signs of LIFO liquidations,
iii. declining inventory turnover ratio, etc.
c. For capitalization policy, the capitalization of a cost when others in the industry are expending the same or vice-a-versa may be a sign of manipulation by the management.
d. The net income persistently remaining higher than the cash flow from operations is a sign of aggressive accrual policies.
e. Other signs:
i. estimates of depreciation or amortizations are inconsistent with standards,
ii. fourth-quarter revision in estimates or auditors reversals,
iii. unreasonable related party transactions,
iv. non-operating income or one-time sales included in revenue,
v. classifying expense as non-operating,
vi. out-of-line profit margins,
vii. lack of disclosures,
viii. long records of meeting projections,
ix. fixation on reported earnings, etc.
f. Further, there could also be some other indicators such as:
i. weak or under-qualified audit committees,
ii. CEO controlling the board of directors,
iii. restructuring or impairment charges that can impact the future results,
iv. orientation towards merger or acquisition, giving opportunity towards a revaluation of assets, etc.