Description about accruals and cash basis accounting at a glance, the implication of accrual basis accounting on financial statement misrepresentation, despite its common usage, and how to detect this.

1. By: Suhari Pranyoto

2.  A non-finance person must be aware that
there are two different methods in recording
financial transaction, especially pertaining
with profit and loss statement: accrual basis
accounting and cash basis accounting.
 Common accounting practices use accrual
basis. While cash basis can “easily” be
confirmed with cash received or paid,
accrual basis accounting relies on
professional judgement. Unfortunately, one
may make fraud in using his/her judgement,
resulting in financial report
misrepresentation.

3.  In Accrual basis accounting, revenue is
recognized when both of the following
conditions are met: 1) Revenue is earned (i.e
when products are delivered or services are
provided) and 2) Revenue is realized
(received) or realizable (reasonably expected
to be received in the future). Expense is
recorded in the period in which related
revenue is recognized.

4.  Under cash basis accounting, revenue is
recognized when cash is received, while
expense is recognized when cash is paid
 Time difference in recognizing both revenue
and expenses in the two different methods,
results in:
 Deferred revenue/expenses: Recognizing
revenue/expenses after cash is realized
 Accrued revenue/expenses: Recognizing
revenue/expenses before cash is realized
Accrual Vs Cash Basis..Cont’d

5.  Management may recognize accounts
receivable as well as revenue more than it
should be.
 The above practices imply overstated balance
sheet (financial position looks better that it
should be) as well overstated income (profit is
higher than it should be).
 The risk is increasing bad-debts in the next
accounting periods.
Common Misrepresentation

6.  Another common fraud is overstating
inventory, by which one understates cost of
good sold, which in turn increases gross
profit and the bottom line.
 The implication is based on formula:
Cost of Goods Sold = Beginning Inventory +
Purchases – Ending Inventory.
while:
Gross profit = Revenue – Cost of Goods Sold
Common..Cont’d

7.  Analyze accounts receivable.
Compare receivable turnover (sales divided by
accounts receivables) among different
accounting periods and compare the ratio with
industry. If you have access to more detail
figures, analize outliers among accounts
receivables activities.
 Compare cash flow with revenue growth.
if revenue increase is not accompanied by a
corresponding increase in cash flow than you
must be aware if something is “engineered”.
Detecting Misrepresentation

8.  Beware of swings in assets or liabilities.
Swings in assets or liabilities must be
explainable. If otherwise happens, you should
ask for more detail information.
Detecting ..Cont’d

9. THANKS!
Links to which I belong:
www.uwin.ac.id
www.wininternasional.co.id