The Interrelationship Between Fraud and Financial Statement Assurance Accountants and Advisors

The alternative is to reverse these methods to make the current period look worse and the next period look better. Postponing expenses – delaying booking expenses to the next period, decreasing the expenses and raising profits for the current period. Both methods make the current period look good, but will cause problems in the next period. To make the performance look worse (to lower the company’s tax liability). Some only remain hidden long enough for the fraudster to make their get-away.

• The bank failed in 2009, costing the FDIC’s Deposit Insurance Fund an estimated $2.8 billion.
• Companies must have defined policies for maintaining books of accounts, categorization of accounts, periodic overview of high-risk accounts and cashflows and undertake book-keeping as per the GAAP to warrant quality and compliance.
• The author examines some recent and historical cases of external-party financial statement fraud, identifies common threads, and provides lessons from these examples for today’s auditors and management.
• The CPA Journal is a publication of the New York State Society of CPAs, and is internationally recognized as an outstanding, technical-refereed publication for accounting practitioners, educators, and other financial professionals all over the globe.

Nonstandard entries might not be subject to the same level of internal control. In addition, other adjustments such as consolidating adjustments, report combinations, and reclassifications generally are not reflected in formal journal entries and might not be subject to the entity’s internal controls. Accordingly, the auditor should consider placing additional emphasis on identifying and testing items processed outside of the normal course of business. Fraudulent financial reporting often involves management override of controls that otherwise may appear to be operating effectively.6 Management can either direct employees to perpetrate fraud or solicit their help in carrying it out. In addition, management personnel at a component of the entity may be in a position to manipulate the accounting records of the component in a manner that causes a material misstatement in the consolidated financial statements of the entity.

Footnotes (AS 2401 – Consideration of Fraud in a Financial Statement Audit):

Field warehousing requires control procedures beyond routine controls over receiving, storing, and delivering goods common to terminal warehousing applied at both the field location and warehouseman’s central office. The internal controls were deficient at both points, particularly in the examination of the DeAngelis warehouse operations by the central office. The publicity surrounding the DeAngelis fraud caused the AICPA to undertake a study of controls and safeguards and audit procedures applicable to the warehousing industry. The resulting special report,Public Warehouses—Controls and Auditing Procedures for Goods Held,was issued as Statement on Auditing Procedure 37 in 1966. The primary focus of SAP 37 was on recommendations for the auditor of the warehouseman, especially operators of a field warehouse. Auditors records relating to the warehouseman’s accountability for all goods in custody and outstanding warehouse receipts, and to observe physical counts of goods in custody and reconcile test counts with records of accountability.

These lessons are summarized inExhibit 2and explained in more detail below. The Financial Statement Fraudsters never created false promissory notes or mortgages that Colonial was to hold in custody pending sale to a secondary market investor, typically a government-sponsored entity such as Fannie Mae or Freddie Mac. Colonial received only a data tape of information (e.g., names, addresses, Social Security numbers) on loans to individual borrowers for Plan B loans that TBW had already sold to others. COLB loans were supposed to have a takeout commitment from an end investor before sale to Colonial, and thus were expected to be held for relatively short periods, typically 30 days.

Warning Signs of Fraud

A company’s financial statement is the key basis for all investor judgments, and is the last line of defense for investor interests. If management attempts to withhold information, even when independent CPAs, investment banking and securities analysts are involved, investors can experience significant losses. Top management intentionally misled investors so as to profit by one billion USD. This caused bankruptcy for many investors and employees, and impacted the accounting and business community heavily. Fraudulent financial statements are intentional and illegal acts that result in misleading financial statements or misleading financial disclosure (Beasley 1996; Rezaee 2005; Ravisankar et al. 2011).

Borrowing money may seem like the easiest way to secure funding; however, it can be extremely risky, and even detrimental, for new startups, especially in today’s high-interest rate market. Venture lenders sometimes have rigorous repayment policies and likely don’t have a long-term interest in the success of your business. They may be more focused on obtaining immediate returns for their investment, rather than supporting the growth and development of your startup over time. Although you shouldn’t give up, you don’t want to be wasting your time with investors who aren’t seriously considering investing in your business. In the end, you want to find the right partners who are genuinely interested in supporting your vision and truly believe in your startup. Revenue overstatement can also occur in a very straightforward fashion through booking revenue for sales that have not occurred.

Occupational Fraud Series

Inquire of individuals involved in the financial reporting process about inappropriate or unusual activity relating to the processing of journal entries and other adjustments. The major external-party frauds described above highlight the importance of focusing on the one element of the fraud triangle that falls squarely within the expertise of accountants and auditors—the opportunities created by control deficiencies. In each case, there were material weaknesses in controls, but the opportunity for external-party fraud did not receive sufficient attention. Probably the most common financial statement fraud is the manipulation of sales figures. It’s in the company’s best interest to report higher sales, as opposed to lower sales, so virtually every company runs the risk of overstating sales.

• The FBI counts corporate fraud, including financial statement fraud, among the major threats that contribute to white-collar crime.
• Establish fair employment practices and an open-door policy regarding communication between staff and management.
• Assets or expenses may be manufactured to hide money that has been misappropriated, or ‘investments’ in other entities may disguise loans to various parties.
• Typically, these numbers rise and fall together; the more goods sold, the more materials and expenses that are incurred to produce them.
• As the person seated behind the front desk, a company’s receptionist is in control of visitors’ first impressions of the company.

Information gathered about the entity and its environment may help the auditor evaluate the reasonableness of such management estimates and underlying judgments and assumptions. The auditor may identify a fraud risk involving the development of management estimates. This risk may affect a number of accounts and assertions, including asset valuation, estimates relating to specific transactions , and other significant accrued liabilities .

The greater the incentive or pressure, the more likely an individual will be able to rationalize the acceptability of committing fraud. DeAngelis had been charged with cheating the federal government, and thus could not obtain a bank loan, but was able to persuade customers and suppliers to advance funds based on negotiable warehouse receipts that they in turn pledged as collateral for bank loans. The DeAngelis personnel leased by American Express falsified inventory in storage by methods that have since become legendary in the annals of inventory frauds .

Capitalizing expenses and writing them off slowly creates an asset that does not exist and reduces the expenses in the current period. These capitalized expenses can then be written off over an extended period spreading the expense. Doing the scheme in reverse lowers a profit in order to reduce a tax liability.