Unnatural Gross Margin Stability or Expansion During Industry Downturn
Gross margins remain miraculously steady or expand during an industry-wide price collapse or input cost inflation.
RED FLAG PROFILE & FORMULA
- Indicator: Unnatural Gross Margin Stability or Expansion During Industry Downturn
- Screening Formula:
Company Gross Margin Variance < 0.5% while Peer Group Gross Margin drops > 3.0% - Targeted Schemes: phantom inventory, capitalising operating expenses, big bath, cookie jar reserves.
- False Positive Context: Proprietary patented technology, successful long-term commodity hedging contracts, or sudden favorable automation efficiencies.
MATHEMATICAL FORMULA & EXTRACTION METHOD
10-K COMPUTATION
Mathematical Formula
Company Gross Margin Variance < 0.5% while Peer Group Gross Margin drops > 3.0%
How to Compute from Form 10-K
Compare company gross profit percentage across eight quarters against the median gross profit margin of its top five SIC/NAICS peer competitors.
False-Positive Boundaries & Legitimate Explanations
Proprietary patented technology, successful long-term commodity hedging contracts, or sudden favorable automation efficiencies.
FRAUD SCHEMES DETECTED BY THIS INDICATOR
SCHEME CORRELATIONS PHANTOM INVENTORY Click to view journal entries and debits/credits for this scheme. CAPITALISING OPERATING EXPENSES Click to view journal entries and debits/credits for this scheme. BIG BATH Click to view journal entries and debits/credits for this scheme. COOKIE JAR RESERVES Click to view journal entries and debits/credits for this scheme.
CASES WHERE THIS RED FLAG APPEARED BEFORE DISCOVERY
3 HISTORICAL CASES| Case Title | Jurisdiction | Primary Scheme | Action Date |
|---|---|---|---|
| WorldCom: $11B Operating Expense Capitalization Fraud | US | capitalising operating expenses | 2002-06-26 |
| Enron Corp.: Off-Balance-Sheet SPEs and Mark-to-Model Fabrication | US | off balance sheet entities | 2001-10-31 |
| Sunbeam Corporation: 'Chainsaw Al' Dunlap's Big Bath and Bill-and-Hold | US | big bath | 2000-09-20 |