Solution
David answered on
Dec 23 2021
FINANCIAL STATEMENT FRAUD
Introduction
In our modern world of Business, one of the biggest challenges is to deal with financial
fraud. This happens generally in the environment when Organizations are involved into those
particular practices which are designed to maneuver or hide the Income statements and other
financial accounts of the firm in order to appear in a way that looks attractive to stakeholders and
investors. There is a way identified to encounter the same i.e. financial statement frauds just after
the incident of the much known scandal, Enron in the year 2001-2002 then an act was introduced
Sa
anes Oxley Act, this is the compliance which is really required for all the United States
corporations.
The fraud in financial statement is actionable under both the Dodd Frank act and the
False claims act. Generally the occu
ence of the fraud is known when losses are deliberately
hidden or underplayed by the companies. A known and deliberate omission of disclosures or
misstatements of financial statement to hide with the investors, creditor’s alteration or outright
falsification come under Financial Statement Fraud.
Emanation of Massive issues:
The fraud undermines the quality, integrity and transparency of the financial reporting
that does jeopardize the auditor objectives. It diminishes the capital markets’ confidence as well
as the participants of markets, reliability of those statements
Measures to prevent Fraud in case of purchasing
We often witness the situations where purchase managers are blamed for committing
frauds. What exactly those frauds are all about and how purchase managers commit them, let us
understand with the help of an example: Suppose a multinational company, who has its presence
across the globe in 80 countries and operating through a chain of 2500 stores has annual
purchase turnover of $650 billion, now the company has got a full-fledged team of qualified
persons managing all purchase made by the company. Mr. Andy is the purchase manager of
etail store operating in Silicon Valley, the store has annual purchase turnover of $80 million.
Now the manager is suspected by the top level management personnel of being involved some
sort of fraud.
Manager is suspected due to the following reasons:-
1) The purchase cost of inventory has gone up to a significantly high level during last 2
years even though the inflation has not been much higher. So there is a scope, that
purchase manager is procuring inventory at higher rates to earn higher commission.
2) The quality of inventory procured does not match the price paid for it.
3) The stock audit exhibits that the amount of stock in records does not reconcile with the
actual stock lying in the store, which means that the goods are being stolen from the store
and it is responsibility of the purchase manager to prevent such situation to arise.
There are various other ways in which purchase managers commit frauds, it depends on
the nature of industry and size of company that how the fraud is planned and executed. There
should be strict internal controls to prevent such frauds and also timely audits ensure the check
on such frauds.
Fraud Triangle
Fraud triangle can be defined as the perception of those committing the fraud that the
scrutiny of fraud will not be successful in identifying two major perspectives of the fraud i.e.
pressure and rationalization. There are three major components of the fraud triangle which are as
follows:-
1) Incentive/Pressure,
2) Rationalization,
3) Opportunity.
Incentive/Pressure: it can be defined as the pressure either financial or other on the person
committing fraud to enter into such immoral act.
Rationalization: it can be defined as the act of person committing fraud to justify its action for
example “I will pay back the money”, “I was forced to do such act” etc.
Opportunity: Weakness in internal controls and lack of observance of the management creates
the opportunity for the fraudsters to commit the fraud. Fraudster starts committing fraud with the
small amount of money and over the period of time if no one notices then they do the same fraud
with large amount of money.
Importance of Transparency in Financial Statement Fraud
Accounting is mainly concerned with general rules, concepts and principles that are
established with the purpose of governing different fields of financial reporting. Accounting
principles are also known as accounting principles and guidelines, these acts as the base on
which more complex and critical rules are based. The authority responsible for issuing the
accounting standards (i.e. financial accounting standard board) also uses these basic principles to
formulate the accounting standards in a more efficient manner.
Generally accepted accounting principles (GAAP) consist of various rules and principles
which are used for preparing the financial statements. GAAP consist of three important fields:-
1) Basic accounting principles and guidelines.
2) Various accounting standards issued by FASB.
3) Generally accepted practices in the industry.
All those companies which are providing its financial statement to public is required to
follow the GAAP while preparing the financial statements. Further, if the company is a listed
entity then the federal law of the nation requires the company to get its accounts audited by an
independent certified public accountant.
There has been various corporate scams in past years which has made it compulsory for
the regulatory bodies to create various laws and amend the existing laws so that more accurate
and transparent financial statements can be prepared. Few of the corporate scams which has
created more awareness towards the need of accurate financial reporting are “The REPO 105”
scam by Lehman, this fraud helped the banks to improve their leverage and cap ratios in order to
gain more credit rating and in turn increasing the customers and investors. Due to lack of
accounting disclosures and loop holes in the accounting standards the banks are able to misuse
the accounting. In past there have been numerous accounting scams, these scams helped in
creating the awareness towards the importance of the transparency in accounting.
Regulatory bodies
There are various measures taken by the federal govt. and accounting board to improve
the transparency in accounting. Various bodies has come into play, these bodies regulates whole
accounting, auditing, financial reporting, corporate social responsibility, business ethics and
communication. The various entities are as follows:-
a) Generally accepted auditing standards.
) International auditing and assurance board.
c) Accounting standard board.
d) Public company accounting oversight board.
e) SOX (Sa
anes Oxley Act).
These entities plays very important role in managing the whole financial reporting
framework and ensuring the general public and various economic groups about the transparency
of the financial reporting and ethical conduct on part of every entity.
Tools for maintaining accuracy of the financial statements
Various tools are used by the management and other parties to evaluate the accuracy of
the financial statements. These tools also help the management to track the suspicious accounts
and figures, these tools are ratio analysis, budgetary analysis, credit ratings, horizontal analysis,
vertical analysis etc.
Ratio Analysis
Ratio Analysis is one of the most commonly used tool of financial analysis. It is
essentially an effort to develop useful relationship between individual items or group of items in
the balance sheet or income account. The objects and utility of ratio analysis is limited not only
to the internal parties but to the credit suppliers, banks and lending institutions also. Ratio
Analysis tells about the financial position of the enterprise as to whether the capital structure of
the business is in proper order, whether the...