According to a report by accounting and consulting firm PriceWaterhouseCoopers, manufacturing industries may lose up to five percent of revenues to fraud. The Deloitte Forensic Center, in a review of enforcement actions by the Securities and Exchange Commission found that about 10 percent of fraud schemes involved manufacturing industries. The Deloitte review identified revenue recognition to be one of the most prevalent forms of fraud in the industry, along with misstating assets, improper disclosure of important information and manipulation of expenses.
Revenue Recognition
Improper revenue recognition involves pumping up revenues to make a company's financial results appear better than they are, in violation of accounting rules. In the most severe cases, sales are faked by salesmen or management to obtain bonuses or commission. In other cases, sales and revenues meant to be recognized in a latter period are exported to an earlier period. For example, a sale occurs days after the close of the second quarter, but is included in second quarter results because management has missed revenue targets. Early revenue recognition schemes rob revenue from later periods, making it difficult for companies to meet expectations in subsequent periods. In complex schemes, companies arrange for the sale of material that they know -- because they have made arrangements with recipients -- will be returned.
Misstating Assets
Assets help investors value a company. Types of assets include the plant, property and equipment of the business, along with inventory and intellectual property. The value of assets may rely on estimates by management, who may receive bonuses based on a company's stock price. Accounts receivable -- an asset because it is comprised of money owed to a company -- can be overstated because the company is including severely past-due accounts that aren't likely to be collected. Including obsolete items in inventory may also lead assets to become overvalued.
Improper Disclosure
Investors should be informed of important accounting policies and significant events that may impact the value of a company. For example, a manufacturing company may be involved in a lawsuit that could affect its ability to operate. Failing to tell investors of the existence of the lawsuit could be improper, as would a failure to notify investors of a change in accounting policy, the terms of a loan or transactions with related parties.
Occupational Frauds
Like all industries, manufacturing industries are susceptible to theft and corruption from employees. Some manufacturing entities may see employees steal products or material. Others may see their equipment used on the weekend by moonlighting employees. Manufacturing industries may also be particularly susceptible to fraud by senior and mid-level managers, according to PriceWaterhouse Cooper.
