7 types of sales fraud and how to detect them

Sales Fraud

7 types of sales fraud and how to detect them

There are many ways to create fraudulent sales that make the company look more economically active, to meet expectations of investors or simply to meet management targets. You will learn the different types of sales fraud in this article.

The seven ways are as follows:

  • Creating fake invoices
  • Acceleration of revenue recognition
  • Bill and hold transactions
  • Delay recording of discounts
  • Round tripping
  • Misclassification of sales
  • Consignment sales

Sales fraud

We will dive deeper into each of them below.

1. Create fake invoices

One of the more egregious ways to boost sales is to create fake invoices in order to boost sales. A clever perpetrator will create invoices of relatively small size that are unlikely to be audited, or invoices to foreign firms that the auditors may consider to be too difficult to confirm through their auditing activities. A fake shipping document will also be created to proof the sales actually occurred.

2. Accelerate revenue recognition

The client can do this by shipping goods earlier than requested. When a company sells a mix of goods and services, it overstates the price of goods (which can be recognized at once), while under-pricing the price of the services (which are recognized over a longer period of time).

3. Bill and hold transactions

Under these arrangements, the seller recognizes the revenue while retaining the goods that should have been shipped to the customer, allegedly because the customer wants the seller to store the goods on the customer’s behalf. The seller may forge documents, stating that the customer has authorized this arrangement.

4. Delay recording of discounts

When discounts are granted to customers on sales transactions, the amount eventually collected from the customers will be reduced, which means that the initial sales figure should be reduced by the amount of these discounts. Delaying recording sales discounts into a later period will result in a temporary boost in the sales figure. One way to systemize this concept is to bill the customers at the full list price and then deduct any discounts only when recording cash received from the customers.

5. Round tripping

An organization sells certain assets to another party, promising to buy back from them at a later date. By doing so, creates revenue, even though there is no economic justification for the continual shifting of assets back and forth.

The more elaborate forms of this arrangement may even involve three parties, so the nature of the activity is more obscure and difficult to detect. More on round tripping.

6. Misclassify sales

A one-time gain on an asset sale is misclassified as being part of revenues. Another variation is to classify investment income as sales.

7. Consignment sales

A business sends goods to a third party, which has agreed to sell the goods to the ultimate buyer on behalf of the company. Under a consignment arrangement, there is no sale until delivery is made to the ultimate buyer. When business records a sale at the point when it delivers goods to the consignee, this is a fraudulent acceleration of the related sale.

Detection of fraudulent transactions

We have spoken about the types of sales fraud, where the client report higher than actual sales that actually occurred. Here are the 7 methods on how to detect those fraudulent transactions.

1. Obtain customer purchase orders from client

When reviewing a sample of customer invoices, verify that there is a genuine customer purchase order included in the supporting documentation. If there is no customer purchase order, you can confirm with the customer directly and verify the purchase. If the customer denies of any purchases, the entry could be a false sale. Further investigation is needed to understand why the client posted the sales in the first place.

2. Test if there is manual revenue journal entries

Sales can be increased by posting a journal entry to revenue account. Accordingly, inquire into the reasons for any manual journal entries posted to revenue account instead of having to post through the sales function in the accounting software.

3. Scan through the GL and look for low priced revenue within a product category

When sales are made to a customer at consistently low prices, it is possible that the customer is actually a fake business set up by an insider, who is acquiring the goods from the company at a low price and reselling them for a profit. In these situations, investigate whether the customer is a real entity.

4. Look for new customers with high credit

When a client has obtained several new customers in its most recent fiscal year and awarded them with high credit levels, this is an indicator that the customer may be fake, or a related party. These customers were created in order to boost sales with fake revenue transactions. If it is not fake, or a related party, due diligence is made to ensure the customer is credit worthy. For example, it could be a well-known company in the industry, or a listed company.

5. Look for no-commission sales

The client’s managers are unlikely to pay commissions on fake sales, so look for those revenue transactions for which there is no associated commission. For small businesses, it could be that the owner of the business closed the deal herself and hence not taking any commission.

6. Issue special confirmation

Send confirmations to every customer that received goods from the client near the end of its reporting period. This group is most likely to have been targeted for fake sales to pump up the client’s reported revenue.

7. Match customers to supplier list

When a customer also appears on the client’s supplier list, it is possible that the parties are engaged in a round-tripping scheme, where the client sells goods or services to the customer and then buys them back. Doing so increases the reported revenue level. In some circumstances, the client’s customers can be their suppliers as well. This is especially true in the commodities trading business, where the traders look for the best price to trade.

Conclusion

We have covered some of the most common types of sales fraud type in this article. However, in the real world, there are many other types of sales fraudulent. Some are more creative than those covered in this article.

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