Red Flags Associated with Fictitious Revenues

C

Red flags are warning signs that can indicate the presence of fraud in a company's financial statements. One type of fraud that can be perpetrated is fictitious revenues, where false sales are recorded in order to inflate revenue numbers. The following is a detailed explanation of the four answer options provided:

A. Slow growth or usual profitability, when not compared to other companies in the same industry.

This red flag may indicate that a company is struggling to grow and is not performing as well as its competitors in the same industry. However, slow growth or usual profitability in and of itself is not necessarily indicative of fictitious revenues. This is because there may be legitimate reasons for a company to experience slower growth or profitability, such as increased competition or changes in the market.

B. Usual growth in the number of days purchase in receivables.

The number of days purchase in receivables measures the average number of days it takes a company to collect payment from its customers after a sale has been made. A sudden increase in the number of days purchase in receivables may indicate that a company is having difficulty collecting payments from customers, which could be a red flag for fictitious revenues. This is because a company may be recording false sales in order to inflate its revenue numbers, but it may not be able to collect payment for these fictitious sales.

C. A significant volume of sales to entries whose substance and ownership is not known.

This red flag is a strong indicator of fictitious revenues. If a company is making a significant number of sales to entities whose substance and ownership is not known, it may be recording false sales in order to inflate its revenue numbers. For example, a company may be recording sales to shell companies or other entities that do not actually exist or do not have the capacity to make purchases.

D. A usual surge in purchase by a majority of units within a company, or of purchase recorded by corporate headquarters.

This red flag is not necessarily indicative of fictitious revenues. A usual surge in purchases may be due to a legitimate increase in demand for a company's products or services. However, it could also be a red flag for fictitious revenues if the surge in purchases is not supported by an increase in sales or if the purchases are not being used in the normal course of business. Additionally, purchases recorded by corporate headquarters may be a red flag if they are not supported by documentation or if the purchases are not being used in the normal course of business.

In summary, options B and C are red flags that are indicative of fictitious revenues. Option A is a less strong indicator, while option D is not necessarily indicative of fictitious revenues on its own.