Warning sign 1

CFA Level I FRA
#1

Which of the following is an indication that a company may be recognizing revenue prematurely? Relative to its competitors, the company’s:

  1. asset turnover is decreasing.
  2. receivables turnover is increasing.
  3. days sales outstanding is increasing.

Solution

C is correct. If a company’s days sales outstanding (DSO) is increasing relative to competitors, this may be a signal that revenues are being recorded prematurely or are even fictitious. There are numerous analytical procedures that can be performed to provide evidence of manipulation of information in financial reporting. These warning signs are often linked to bias associated with revenue recognition and expense recognition policies.

Can Someone plz help me in understanding this solution?

#2

Sure! If you have sales outstanding you have yet to collect i.e. Accounts Receivables is increasing

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#3

What @TLHilz89 said above :+1:

Also - don’t get confused by Receivables Turnover increasing. It’s not the same thing as saying Receivables are increasing.

Receivables Turnover typically = Sales/Receivables.
So the lower the number of Receivables compared to Sales, the higher the ratio will be.

If Receivables are suspiciously high or increasing compared to a company’s sales (either a sign of deliquent customers, lazy collections or even worse, potential earnings manipulation), the Receivables Turnover will be suspiciously “low” or decreasing.

Cheers you got this👍

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