Assume a company is convicted of fraud, stemming from fraudulent revenue recogni
ID: 2416820 • Letter: A
Question
Assume a company is convicted of fraud, stemming from fraudulent revenue recognition. Generally, who bears the legal liability when such a situation occurs, the auditor, the company (and its executives), or both? Present an argument who is responsible and why. DO NOT regurgitate someone else's answer. If you agree or disagree with someone else's posting, state so but bring something new to the discussion other than what has already been stated. There are plenty of things to say regarding this topic that you will not be stepping on each other's thoughts. You can discuss actual cases and the particular circumstances surrounding them. Assume a company is convicted of fraud, stemming from fraudulent revenue recognition. Generally, who bears the legal liability when such a situation occurs, the auditor, the company (and its executives), or both? Present an argument who is responsible and why. DO NOT regurgitate someone else's answer. If you agree or disagree with someone else's posting, state so but bring something new to the discussion other than what has already been stated. There are plenty of things to say regarding this topic that you will not be stepping on each other's thoughts. You can discuss actual cases and the particular circumstances surrounding them.Explanation / Answer
financial frauds generally falinto three four broad categories:
Most auditors would consider only to the first two categories (fraudulent financial reporting and misappropriation of assets) to be financial statement frauds. The final two categories although financial in nature, are not generally considered to be financial statement frauds, as they do not impact upon the balances in the financial statements.
Most fraudulent financial reporting schemes involve “earnings management”, which the Securities and Exchange Commission (“SEC”) has defined as “the use of various forms of gimmickry to distort a company’s true financial performance in order to achieve a desired result.”[i]
Earnings management, however, does not always involve outright violations of Generally Accepted Accounting Principles (“GAAP”) - - more often than not, entities manage earnings by choosing accounting policies that bend GAAP to attain earnings targets. Thus, it is important to distinguish between earnings management techniques that are aggressive in nature but otherwise permitted by GAAP, and those that clearly violate GAAP.
Accountants working with public companies, however, take note. The SEC takes the position that compliance with GAAP will not necessarily protect an entity from an SEC enforcement action, if financial performance is distorted.
Some financial frauds have no grey; that is, earnings management that are clearly not within the parameters of GAAP. These techniques can inflate earnings, create an improved financial picture, or conversely, mask a deteriorating one.
Examples cited by the SEC include:
Example of revenue recognition fraud:
Improper recognition of revenue - either prematurely or of fictitious revenue – is the most common form of fraudulent earnings management. Premature recognition of revenue involves the recording of revenue generated through legitimate means, at any time prior than would be allowed under GAAP. Premature recognition should be distinguished from recognition of fictitious revenue derived from false sales or to false customers.
The Report of the National Commission on Fraudulent Financial Reporting (hereinafter, “ the COSO Report”)[i] found that improper revenue recognition was alleged in 47% of the cases reviewed by the Commission from 1981 to 1986. A second COSO Report found that the number of revenue recognition alleged matters accounted for 50% of all matters enforced by the SEC from 1987-1997.[ii] According to SEC figures, 32 of the 90 actions bought by the Commission in 1999 involved improper revenue recognition using such techniques as side letters, rights of return, consignment sales, and the shipping of unfinished products. Another 12 cases involved the booking of fictitious sales.[iii] A PricewaterhouseCoopers study revealed that in the year 2000, 66% of the shareholder actions filed alleged revenue recognition violations.[iv] In 2001, the number of revenue recognition actions jumped to 69% of all actions filed.[v] Finally, of the approximately 140 earnings management/accounting cases brought by the SEC in 2002, more than half related to revenue recognition.[vi] With respect to premature recognition, SEC Staff Accounting Bulleting 101, Revenue Recognition in Financial Statements, (“SAB 101”) [vii] spells out four basic criteria that must be met before a public company may recognize revenue. Specifically, these criteria require:
Company Fraud Scheme Result Cendant Corp. As a result of its merger of HFC with CUC International, it was revealed that CUC overstated revenue by $500 million between 1995 and 1997 using assorted techniques such as recording fictitious revenues and understating liabilities. Restated 1997 earnings decreased by more than $161 million. Former CFO, VP, and controller pled guilty to numerous other charges. Company settled $3.2 billion shareholder suit Ernst & Young paid $335 million to settle shareholder lawsuit. MicroStrategy Improperly recognized revenue from sales of software as agreements were entered into rather than as services were provided. Restated earnings for fiscal years 1998 and 1999, which caused revenues to be reduced by almost $66 million. Former CEO, COO, and CFO each fined $350,000. Xerox Overstated revenue for over 4 years by accelerating the recognition of $3 billion in revenue and inflating earnings by about $1.5 billion. Alleged scheme included the recognition of revenue on its office copier leases too early in their cycles. Co. agreed to pay $10 million in fines and restate its income for the years 1997-2000. SEC sued three current KPMG partners and one former partner of securities fraud in the claiming the firm fraudulently let the Co. manipulate its accounting practices to fill a $3 billion gap and make it appear to be meeting market expectations.Related Questions
drjack9650@gmail.com
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.