What are the 2 basic type of frauds? Two basic accounting frauds involve inventory and account receivable. The accounts receivable balance that shows up in the asset section of a balance sheet is almost always an estimate of what accounts are actually collectible. It is an estimate because even if management can identify the precise amount its customers owe the business, usually it is less than certain that this is the actual balance that will ultimately be collected.
Sometimes the valuation of accounts receivable goes beyond simply making a good faith estimate of collectability. In some situations, management may be tempted to commit outright fraud. Because no cash is collected when sales are made “on account”, corrupt management can record fraudulent additional sales by simply creating fictitious customers and/or recording fictitious sales.
Another way of inflating accounts receivable and sales revenue involves “keeping the books open” at the end of the accounting period. In this case, the customers and sales are real, but January sales are recorded as December sales so the end-of-year financial statements include inflated assets and revenue. Inventory also offers a big opportunity for management to airbrush their financial statements.
If they want gross profits and, hence, operating profits to appear higher, the value of ending inventory simply needs to be overstated. There are many ways this can be done. The ending inventory value can be fudged upward by overstating the amount of inventory on hand.
Unit costs assigned to ending inventory can be inflated as well. Or obsolete or damaged inventory can be included in the ending inventory count. Sometimes for income tax purposes, management may want to show lower gross and operating profits. Ending inventory mismeasurement can be used for this purpose as well. In this situation, management seeks to undercount and undervalue ending inventory.
What are the most common frauds in small businesses?
Usually, the owners of small businesses are the victims rather than the perpetrators of small business fraud. Usually, the frauds are committed by trusted employees with access to financial records and software.
If such employees have access to cash or checks as well as access to accounting records they can cover their thefts by recording fictitious transactions.
Such frauds can be prevented by instituting segregation of duties where no employee with access to cash or checks also has responsibility for recording transactions.
