In these unpredictable times, regretfully there are going to be instances where the scruples of some customers, for whatever reasons, may begin to fall short. Consequently, we need to be vigilant about the validity of financial statements submitted to support significant credit level increase requests. 

I was recently talking with a client who recounted a situation in which they received a request from their customer to double the credit limit from $100K to $200K. Although my client was pleased over the idea of receiving more orders, a dramatic credit level increase required that their financial statements be submitted to evaluate and support the request.

The customer asked if it was alright to submit their internally prepared quarterly financial statements, but my client responded that they would need to see their most recent independently prepared statements, even if they were not audited. In other words, a review performed by a third-party CPA firm would be acceptable. 

What exactly do you get when you are looking at a financial statement prepared under a review? In short, a review is a cursory examination by which a third-party accountant (CPA) receives assurance from the entity (owners, executive management) that there are no material discrepancies in the entity’s financial statements that would preclude them from not being in conformity with reporting standards. A review neither requires the accountant to verify the entity’s internal control procedures, nor to assess if there is any risk of fraud. As such, a review does not provide the accountant, or those who may rely on the financial statements, with assurance as to the validity of the financial statement figures, which would otherwise be provided under a full-scale audit. 

Therefore, even with financial statements that have been prepared under a review, if the entity wants to alter or fabricate the underlying data that results in giving misleading figures to the accountant, it could very well do so. 

According to my client, subsequent to an evaluation of their customer’s reviewed financial statements that showed a healthy financial picture, the amount of credit requested was approved, and double the usual orders were received. In turn, the orders were filled, shipped out and billed. 

At this point, you can probably see the writing on the wall and that within a very short period of time, the customer did not pay the approximate $190K balance due. Moreover, the customer eventually declared bankruptcy and through the bankruptcy procedures, it was uncovered that the figures in the recent financial statements were purposely misstated as follows:

  • Revenue from fictitious customers was recorded, greatly increasing annual sales figures. 
  • Loans from non-bank sources were also recorded as revenue. 
  • Large ordinary business expenses were mislabeled and capitalized as long-term liabilities, shifting them from the income statement to the balance sheet.
  • Short term expenses were either inaccurately reported or not reported at all. 
  • Certain inventory was included twice to inflate the total amount of the inventory value on the balance sheet. 

Although the company went bankrupt, due to the fraudulent financial statements and other fraudulent acts, an effort to pierce the corporate veil and hold the owner personally liable was attempted by several creditors and ultimately successful. The problem however is that the debtor cannot be located. 

I would venture to say that accepting a financial statement that was only reviewed is not necessarily a bad decision by itself. In this case however, the amount of credit extended may have warranted an audited statement, which may have then given the client another layer of assurance. Even if they had not granted the full credit increase, they still may have incurred an unpaid receivable up to the original credit limit of $100K. 

Your questions and comments are most welcome (

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Nancy Seiverd, President, CMI Credit Mediators, Inc.

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