Financial Statement Fraud

• Financial Statement Fraud is the intentional misrepresentation of an enterprise's financial condition to deceive users through misstated or omitted amounts/disclosures.
• Financial Statement fraud is an intentional act.
• The International Standard on Auditing (ISA) says misstatements can arise from error or fraud, distinguished by whether the underlying action is intentional or unintentional.
• People may manipulate financial statements to quietly fix business problems, achieve expected earnings, comply with obligations, obtain loans, or prevent loans that are too small.
• Intent on profiting, people commit Financial Statement fraud to obtain loans, inflate share prices, or secure bonuses based on sales/profits.
• Financial Statement fraud almost always involves overstating assets, revenues, and profits while understating liabilities, expenses, and losses.
• Financial Statements are the responsibility of the organization's management.
• Financial Statement fraud is typically committed by individuals in managerial or senior executive positions, including CEOs, who bear ultimate responsibility.
• Financial statement fraud cases are often lengthy due to fraud investigations being conducted/overseen by management, delaying discovery by external auditors.
• Financial Statement fraud affects the organization's reputation, financial position, employees, and perpetrators.
• Affected items include infrastructure, retirement funds, savings invested in stock, healthcare, and other benefits.
• The most common motive for Financial Statement fraud is to falsely improve the appearance of earnings.
• Two ways of committing Financial Statement fraud include valuation judgments and manipulating the timing of transaction recording.
• The motivation to commit Financial Statement fraud is not always personal financial gain.
• Three reasons for committing Financial Statement fraud: encouraging investment through stock sales, covering inability to generate cash flow, and avoiding negative market perceptions.
• Factors known as "red flags" that increase Financial Reporting fraud risk: situational pressures, opportunity, and potential rationalizations.
• Examples of situational pressures include sudden revenue declines, unrealistic budget pressures, and financial pressures from bonus plans.
• The existence of an oversight function does not guarantee the detection of fraudulent acts.
• Three opportunities that enable fraudulent activity: absence of a board of directors/audit committee, unusual/complex transactions, and weak/nonexistent internal controls.
• involves a way of thinking that enables people to maintain their moral code and avoid guilty while partaking in unethical behavior: Rationalizing Fraud
• The ACFE's Occupational Fraud 2024 study reported that 5% of frauds involved Financial Statement fraud
• The median loss in fraud cases reported in the ACFE's Occupational Fraud 2024 study was $766,000.
• From 1998-2007, the total cumulative misstatement or misappropriation was nearly $120 billion across 300 cases of fraud.
• The average duration of Financial Statement fraud cases was 31.4 months, according to the report "Fraudulent Financial Reporting (1998-2007), An Analysis of US Public Companies".
• CEOs were named as parties involved in 72% of Financial Statement fraud cases in the "Fraudulent Financial Reporting (1998-2007)" report.
• SEC stands for Securities and Exchange Commission.
• AAERs stands for Accounting and Auditing Enforcement Releases.
• GAAP stands for Generally Accepted Accounting Principles.
• AICPA stands for American Institute of Certified Public Accountants.
• Three common organizational issues/factors underlying fraud schemes in the "Fraudulent Financial Reporting (1998-2007)" report: a high-pressure environment, lack of experienced accounting personnel, and material internal control weaknesses.
• Overstating assets or revenue falsely reflects a stronger company by including Fictitious asset costs or artificial revenues.

Classifications of Financial Statement Fraud

• Fictitious Revenues

• Timing Differences

• Improper Asset Valuations

• Concealed Liabilities and Expenses

• Improper Disclosures

• Fictitious or Fabricated Revenues involve the recording of sales of goods or services that did not occur.

• Fictitious Sales most often involve fake customers but can also involve legitimate customers.

• A fictitious invoice, though prepared, is not sent to a customer; goods/services are not delivered/rendered.

Examples of Red Flags with Fictitious Revenues

• Unusually large amounts of long overdue accounts receivable.
• Rapid growth/unusual profitability, especially compared to others in the industry.
• Significant, unusual, or highly complex transactions.
• A significant volume of sales to entities whose substance and ownership is unknown.
• Outstanding accounts receivable from customers who are hard to identify/contact.
• Asset Misappropriation is the most common form of Occupational Fraud.

Asset Misappropriation Categories

• Cash Receipts
• Fraudulent Disbursements
• Inventory/Other Assets
• Cash Receipts breaks down into Skimming or Larceny.
• Cash Larceny is the theft of money that has already appeared on a victim organization's books.
• Cash Skimming is the theft of cash that has not been recorded in the accounting system.
• The method used to extract cash may be identical for Cash Larceny and Cash Skimming schemes.
• Skimming is removing cash from a victim entity before it's recorded in the Accounting System
• Skimming schemes occur because assets are stolen before they have a chance to be recorded.
• In skimming schemes, the fraudster has the primary advantage.
• Skimming can happen at points where cash enters a business and anyone handling cash, like salespeople, tellers, and waitpersons, could skim.
• Employees handling/recording mail payments commonly engage in skimming by taking customer payments without posting them to the account.
• Sales Skimming is an unrecorded sales scheme where an employee sells goods or services, collects payment, but doesn't record the sale.
• Register Manipulation is when a false transaction is entered on the register so that it appears a sale has been made; the perpetrator opens the register drawer and pretends to place the cash they received into the drawer, but in reality they put it in their pocket.
• Unusual gaps in a register log are atypical and may indicate skimming.
• Transactions in a register are sequentially numbered; Gaps therefore could indicate fraud.
• Employees can skim sales during non-business hours by opening the business early or closing late & pocketing all profits made at this time.
• Remote sales-persons have a high risk of skimming offsite sales.
• An apartment manager can skim rental payments by marking occupied units as vacant, especially if they receive payments in cash.
• Skimming can occur when apartments are rented without a lease, keeping them off the books and allowing the perpetrator to skim rental payments.
• Poor collection/recording procedures enable employees to easily skim sales or receivables.
• Understated Sales Schemes involve posting a transaction but for a lower amount than collected.
• Employees working at a cash register most commonly perpetrate understated sales schemes.
• An item is sold for $100, the employee records the sale as only $80, the pockets the remaining $20.