When a public company puts together a financial statement for the public, it wants to portray itself in the best possible light. That has led to fraudulent statements that have misled investors and others. Good examples are the last statements of Enron and MCI before they went bankrupt. Their statements failed to tell the whole truth about their perilous condition. The Securities and Exchange Commission (SEC) watches this practice and it censures those companies that commit fraud for issuing misleading financial statements. Here are a few of the ways that a company can commit fraud.
Fictitious Revenue and Sales
Companies can show revenue and sales on their financial statements that they actually have not received. They do this by manipulating sales by sending out product by truck, and then having that same truck return with the original load, or round-tripping. Also, barter arrangements with other companies are entered, and then declared sales to them as revenue. Also, they will report revenue on sales that they have billed but not delivered.
Insufficient Reserves For Loss
Let's say a company has agreed to take back any of its products if retailers fail to sell it during the holidays. The company should have reserved enough to cover that promise. By not reflecting that reserve, it is actually reporting revenue and profit that it has not made.
Phantom Revenue
Some companies try to report revenue from products sold that are actually consigned to customers, not sold to them. By doing so, a company will inflate both its revenue and its profitability.
Manipulation of Assets
Some companies flagged by the SEC for financial statement fraud understate their assets as a way to bolster their financial condition. One way to do this is to have an arrangement with another company to state that certain major equipment is leased to the reporting company, thereby reducing the assets and their costs.
Financial Statement Fraud Is Isolated
Of the more than 1,200 cases pursued by the SEC during the first half of this decade, almost half of them involved either consumer products companies, or companies in the media and telecommunications arenas. Because of the peril that can exist for an investor or a lender as a result of misstatements on financial statements, the SEC is expanding its efforts to prosecute more companies for fraud.
