10 Questions
What is the primary purpose of fraudulent financial reporting?
To create a false picture of the entity's financial position
Which of the following is a form of manipulation to financial statements?
Deliberate misapplication of cut-off in revenue recognition
Why may managers manipulate financial information?
To qualify for certain executive compensations
What is the term for concealing obligations and off-balance sheet finance practices?
Off-balance sheet finance practices
What is the term for undervaluing assets or understating income to make the entity look worse?
Taking a poisonous pill
Why is it unlikely for manipulations of financial statements to be detected by investors and other users?
Because auditors are not independent and are influenced by their clients
What is a common area where manipulations of financial statements occur?
During mergers and acquisitions
What is one way to detect financial statements fraud?
Reviewing general ledger verifications
Who is most likely to be affected by fraudulent financial reporting?
Investors
What is a consequence of fraudulent financial reporting for management and employees?
Loss of wages and/or staff lay-off
Study Notes
Forms of Financial Statement Manipulation
- Overstating or inflating revenues and gains through deliberate misapplication of cut-off in revenue recognition
- Understating related costs and expenses to achieve the purpose
- Inflating assets' net worth by failing to apply appropriate depreciation or failing to provide for apparent impairment losses on assets
- Concealing obligations (e.g. contingent liabilities) and off-balance sheet finance practices (e.g. leases, agency arrangements)
- Undervaluing assets or understating income to make the entity look worse than it actually is (taking a poisonous pill)
Motivations for Manipulating Financial Statements
- Qualifying for executive compensations based on certain financial performance metrics
- Self-gratification or obtaining undeserved accomplishments
- Exploiting flexibility in accounting estimates and provisions under GAAP or other country-specific financial reporting standards
- Low likelihood of detection by investors and other users and stakeholders
Detection of Financial Statement Fraud
- Performing general ledger verifications
- Reviewing transactions and identifying unusual amounts, patterns, fluctuations, and other issues in records and financial statements
- Reviewing accounting estimates for adequacy and biases
- Reviewing past or present circumstances that place undue influence or motivations on those involved to manipulate information
Parties Affected by Fraudulent Financial Reporting
- Investors: loss of investment or market share value, shrinking of the business, drop in credit ratings, and loss of reputation (goodwill)
- Management and employees: loss of wages and/or staff lay-off, legal implications such as fines by regulatory bodies or imprisonment for involved managers
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