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Forensic Accounting, Forensic Techniques, and Fraud Detection Copyrighted 2001 D. Larry Crumbley, ... - page 282 / 352

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© D.L. Crumbley

Red Flags or Fraud Identifiers

Earnings problem: downward trend in earnings

Reduced cash flow: If net income is moving up while cash flow from operations is drifting downward, something may be wrong.  

Excessive debt: the amount of stockholders' or owners' equity should significantly exceed the amount of debt.

Overstated inventories (California Micro) and receivables (BDO Seidman): If accounts receivables exceeds 15 percent of annual sales and inventory exceeds 25 percent of cost of goods sold, be careful.

Inventory plugging: Record sales to other chains as if they were retail sales rather than wholesale chains (e.g., Crazy Eddie).

Balancing Act: Inventory, sales, and receivables usually move in tandem because customers do not pay up front if they can avoid it.

CPA Switching: Firms in the midst of financial distress switch auditors more frequently than healthy companies.

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