What is accounting fraud?

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.

How is accounting used in business?

It might seem obvious, but in managing a business, it's important to understand how the business makes a profit. A company needs a good business model and a good profit model. A business sells products or services and earns a certain amount of margin on each unit sold. The number of units sold is the sales volume during the reporting period. The business subtracts the amount of fixed expenses for the period, which gives them the operating profit before interest and income tax.

It's important not to confuse profit with cash flow. Profit equals sales revenue minus expenses. A business manager shouldn't assume that sales revenue equals cash inflow and that expenses equal cash outflows. In recording sales revenue, cash or another asset is increased. The asset accounts receivable is increased in recording revenue for sales made on credit. Many expenses are recorded by decreasing an asset other than cash. For example, cost of goods sold is recorded with a decrease to the inventory asset and depreciation expense is recorded with a decrease to the book value of fixed assets. Also, some expenses are recorded with an increase in the accounts payable liability or an increase in the accrued expenses payable liability.

Remember that some budgeting is better than none. Budgeting provides important advantages, like understanding the profit dynamics and the financial structure of the business. It also helps for planning for changes in the upcoming reporting period. Budgeting forces a business manager to focus on the factors that need to be improved to increase profit. A well-designed management profit and loss report provides the essential framework for budgeting profit. It's always a good idea to look ahead to the coming year. If nothing else, at least plug the numbers in your profit report for sales volume, sales prices, product costs and other expense and see how your projected profit looks for the coming year.

How is accounting used in business?

It might seem obvious, but in managing a business, it's important to understand how the business makes a profit. A company needs a good business model and a good profit model. A business sells products or services and earns a certain amount of margin on each unit sold. The number of units sold is the sales volume during the reporting period. The business subtracts the amount of fixed expenses for the period, which gives them the operating profit before interest and income tax.

It's important not to confuse profit with cash flow. Profit equals sales revenue minus expenses. A business manager shouldn't assume that sales revenue equals cash inflow and that expenses equal cash outflows. In recording sales revenue, cash or another asset is increased. The asset accounts receivable is increased in recording revenue for sales made on credit. Many expenses are recorded by decreasing an asset other than cash. For example, cost of goods sold is recorded with a decrease to the inventory asset and depreciation expense is recorded with a decrease to the book value of fixed assets. Also, some expenses are recorded with an increase in the accounts payable liability or an increase in the accrued expenses payable liability.

Remember that some budgeting is better than none. Budgeting provides important advantages, like understanding the profit dynamics and the financial structure of the business. It also helps for planning for changes in the upcoming reporting period. Budgeting forces a business manager to focus on the factors that need to be improved to increase profit. A well-designed management profit and loss report provides the essential framework for budgeting profit. It's always a good idea to look ahead to the coming year. If nothing else, at least plug the numbers in your profit report for sales volume, sales prices, product costs and other expense and see how your projected profit looks for the coming year.

#74 Accounting entries to record impairment

Previously, we discussed about the objective of IAS 36- Impairment of Assets and all other related topics. We will proceed further on the accounting entries of impairment. Generally, upon recognition of impairment, the following entries should be passed:

Dr. Impairment Loss (Profit & Loss)
Cr. Provision for Dimunition in Value (Balance Sheet)

Provision for Dimunition in Value is a contra account to the existing asset account. For instance, the contra account of Stocks, in this case, is Provision for Stocks Obsolescence. The Provision for Dimunition in Value has properly disclosed the impact of impairment on the existing asset, that could be useful to financial statement users.

Singapore Fraud Cases- Fibrechem and Oriental Century

2 Singapore-listed China entities are reported to be involved in fraud scandals recently, namely: Fibrechem Technologies and Oriental Century.

Fibrechem Technologies' auditor, Ernst & Young Singapore have encountered difficulties in the firm final audit of ascertaining the Cash and Trade Debtor balance of the Group. Fibrechem Technologies is a China-based entity involved in producing chemical fibres and synthetic leather.

Whereas, Oriental Century's auditor, KPMG face a similar problem in ensuring the existence of cash and trade debtor balance. Oriental Century is a china-based education company, in which Raffles Education (SGX-listed education Group)holds 29.9% stake with cost of investment amounted to S$34.6mil. In worst case scenario, Raffles Education might have to write- off its investment in Oriental Century if Oriental Centruy could not operate on a going concern basis.

Similarly, in previously reported Satyam Fraud Case in India, Satyam's founder and CEO has mis-appropriated its cash balance in its balance sheet. How could the auditors being mis-led ?

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#73- Downgrading of Credit Rating

Media giant, Eastman Kodak Co. has recently received a downgrade on its credit rating to "B-" from "B". The downgrade was due to the company's high rate of cash consumption and concern that the cash balance will quickly be utilised. The outlooks are unfavorable for Eastman Kodak Co.

A credit rating defines the financial strength of borrowers and help inventor to determine the likelihood of repayment of bonds, etc. The credit rating is always used as a reference by the princaipal banker of the Company being rated.

The downgrading of credit rating has an direct impact on the Company's interest expense. The lower the rating, the higher the interest rate. As such, as the Company's auditors, we should always beware of the credit rating position of the Company we are auditing and form expecation and the interest expense of the Company.

A credit rating is also One OF THE TOOLS to evaluate the financial position (i.e. strength ) of the Company, and assist in forming going concern assumption for the Company.

#72 Debtors Turnover Analaysis

In auditing debtor balance, auditor will perform some analysis of the debtors turnover of the audit client, and compared the result to prior year to identify unusual fluctuations.

Debtors Turnover (day) is computed as below:

Average Debtor Balance / Sales x 365 days = Debtor Turnover (day)

Debtors turnover ratio indicates the velocity of debt collection of a firm. In simple words it indicates the number of times average debtors (receivable) are turned over during a year.

We will expecting a deteriorating debtor turnover (day) in this gloomy economy environment. To illustrate with an example, a customer of our audit client would take longer period to repay its outstanding balance due on time, and herein increase the number of day the receivable stays in the debtors balance.

Customers are squeezing their creditors by pro-longed their repayment period. Our audit client may, in another leg, delay the repayment to its (audit client's) suppliers.

A economy efficient would have been created, as the delaying in repayment has direct impact on the ultimate's suppliers decision on resource allocation. In afraid of selling items to doubtful customers, the ultimate suppliers might have cancel/ stop the supplies to our audit client.

As such, working capital need to be analyzed by auditor to identify unusual circumstances that might occur.

Quasar software

Accounting has become more and more complex as have the businesses that use accounting functions. Fortunately, there are several excellent software packages that can help you manage this important function. Quasar is one such package.

All versions of Quasar offer comprehensive inventory controls. In its most basic use, the inventory module allows a business owner to track the locations and quantities of all inventory items. Additionally, the inventory capabilities go beyond simple record-keeping. Manufacturers and wholesalers can assemble kits using component items; whenever a kit is assembled, the inventory representing its component items are adjusted accordingly. Items can be grouped into various categories and the groups can be nested many levels deep. Vendor purchase orders can be generated for items whose quantities are below a preset level. Costs and selling prices for items can be set and discounted in a myriad of different ways. Finally, these items can be reported upon to show such things as profits, margins, and sales per item.

Sales and purchasing are another strength of Quasar. Customer quotes can be easily converted to invoices to be paid. Promotions can be created and discounts can be given based on date, customer, or store location. Margins can be reported upon for traits such as individual items, individual customers, or individual salesperson. Likewise, a purchase order can be created and converted to a vendor invoice, which can be paid in a number of different ways, including printing a check. Quasar can keep track of miscellaneous fees such as container deposits, freight charges, and franchise fees.

The intelligent design of Quasar's user interface allows for quick and easy data entry. Some programs you may encounter are not optimized for keyboard use. These programs require you to move your hand to the mouse to select frequently needed options. While some of Quasar's menu options are only mouse-accessible, the bulk of Quasar's user interface is designed in such a way that you can keep you hands on the keyboard by using special shortcuts. This allows for faster data entry, which can save time (and therefore money) in the long run.

Small Business Accounting - Prepayment

In practice, small business made one lump sum prepayment or downpayment for purchases or services accross a certain period. For instance, the business may entered into insurance contract to insure its asset for a period of 12 months.

From accounting perspective, the amount prepaid should be expensed over the period of servie covered. To illustrate, the 12-month insurance premium paid should be expensed off over a period of 12 months. What would be the accounting treatment then?

Assuming Company XYZ entered into insurance contract to insure its inventory. Total insurance premium paid is US$12,000.

Upon payment of insurance, the Company passed the following entries:

Dr. Prepayment (B/S- Asset)12,000
Cr. Cash 12,000
(Being prepayment to insurer for insurance contract)

At month end, the following entry will be passed to recognise the insurance expense

Dr. Insurance expense (P/L)1,000 (12,000/ 12)
Cr. Prepayment 1,000
(Being utilisation of monthly insurance expense)

At the end of 12 months, the prepayment accounted will be fully utilised.

Ernst & Young Australia sacked nearly 100 staffs

The Big 4 accounting firms, once considered resilient to global economy slow down and credit crunch, have started to laid off its staffs. Apparently, it's not only the bankers are affected, but also the auditors/ consultants.

It's reported that Ersnt & Young Australia has sacked nearly 100 staffs recently.

Just yesterday, Treasuer of Australia Wayne Swan reported that Australia economy fell in to a recession trap, as evidenced by GDP shrank by 0.5 percent in 4th Quarter 2008. The economy is contracting for the first time in 8 years.

What about other Big 4 ( namely: Pricewaterhouse Coopers, KPMG, Deloitte & Touche)? Are they retrenching ?

Please feel free to comment on the blog, or drop us an email at myauditing@gmail.com.

#71- Automotive Giant, General Motor- Going Concern Issue

America automotive giant, General Motor has highlighted in its earning release section that the Company anticipates receiving a “going concern” opinion from its auditor, Deloitte & Touche. The General Motor’s management has to determine whether there is substantial doubt about General Motor’s ability to continue as a going concern.

IAS 1 states that: “when preparing financial statements, management shall make an assessment of an entity’s ability to continue as a going concern. Financial statements shall be prepared on a going concern basis unless management either intends to liquidate the entity or to cease trading, or has no realistic alternative but to do so. When management is aware, in making its assessment, of material uncertainties related to events or conditions that may cast significant doubt upon the entity’s ability to continue as a going concern, those uncertainties shall be disclosed. When financial statements are not prepared on a going concern basis, that fact shall be disclosed, together with the basis on which the financial statements are prepared and the reason why the entity is not regarded as a going concern.”

General Motor's businesses are severely affected by the recent market downturn and its financial results have dropped drastically. The outlook for the global automotive industry remains gloomy and pessimistic. The Company is actively looking for funding, including request for additional fund from Treasury department of United States.

IAS 1 further required that: “In assessing whether the going concern assumption is appropriate, management takes into account all available information about the future, which is at least, but is not limited to, twelve months from the balance sheet date. The degree of consideration depends on the facts in each case. When an entity has a history of profitable operations and ready access to financial resources, a conclusion that the going concern basis of accounting is appropriate may be reached without detailed analysis. In other cases, management may need to consider a wide range of factors relating to current and expected profitability, debt repayment schedules and potential sources of replacement financing before it can satisfy itself that the going concern basis is appropriate.”

Small business accounting- Cash

Generally, the small business comprises:
- Cash on Hand
- Cash in Bank

Generally, the cash on hand amounts are not material, while significant amount of the businesses’ cash are kept in bank. What will be the accounting entries for cash receipt and cash disbursement (i.e. payment).

Upon receiving of cash from debtors:

Dr. Cash in Bank
Cr. Trade Debtors

Upon disbursement of cash (i.e. outflow of cash) for expenses

Dr. Trade Creditors/ Expenses
Cr. Cash in Bank

For bank charges on the bank account deducted from bank account directly:

Dr. Bank charges
Cr. Cash in Bank

It’s important to note that: a online bank account enable the small business to track the transaction on a real time basis. Conventionally, small business is required to check the cash inflow and outflow while they have received the monthly bank statement from the bank. With online banking account, the small business is allowed to view the transactions on a timely basis.

Small Business Accounting

Small business accouting, in general, are non-complex and straight forward. The fundamental is that the owner of the small business must develop certain level of undertanding of accounting before they could really appreciate the value and necessities of accounting.

Our blog has specially dedicated a separate section to educate our blog readers on basic accounting entries, specifically suits for small business.

Prior to introduction on accounting entries, we would like to highlight to business owner that it's important, convenient and cost-effective to use accounting software to perform daily book-keeping. There are already a few accounting softwares in the market, e.g. Microsoft Office Accounting Express, SAP small business accounting software.

An accounting software is considered imperative in today business environment.It reduces the time spent on book-keeping, prevent 'un-balance' entries, and provide the business owner an effective insight of the Company's financial position and results on a timely basis.