Financial Statement Fraud: Strategies for Detection and Investigation

CHAPTER FOUR

Misclassification Schemes

RECORDING FINANCING ARRANGEMENTS AS REVENUE

One way to quickly improve a company's financial statements is to find a party willing to temporarily take some inventory off its hands, purportedly as a sale, with an understanding that the inventory will be returned after year-end.

U.S. GAAP addresses this issue at ASC 470-40-25 under the topic of product financing arrangements by distinguishing such arrangements from ones generating sales revenue. Generally, transactions that purport to be a sale of inventory should be treated as financing arrangements when the risks and rewards of ownership have not been transferred to the purchaser. Under ASC 470-40-25, if a company sells a product to another entity and, in a related transaction, agrees to repurchase the product (or a substantially identical product) or processed goods of which the product is a component, the company must record a liability at the time the proceeds are received from the other entity to the extent that the product is covered by the financing arrangement. The company may not record the transaction as a sale nor may it remove the covered product from its balance sheet.

The Delphi Corporation case is an excellent example of improperly recorded income in connection with a financing transaction. Delphi, an auto parts supplier, had planned to sell an inventory of precious metals, earmarked for use in coating catalytic converters, to another company (its former parent company and largest ...