IN FINANCIAL STATEMENT Damania amp Varaiya Chartered Accountants CA Ashok Dhakar Harshit Shah 1 FEBRUARY 2016 Deliberate misstatements or omissions of amounts or disclosures of financial statements to deceive financial statement users particularly investors and creditors ID: 586588
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FRAUDS IN FINANCIAL STATEMENT
Damania & VaraiyaChartered AccountantsCA Ashok Dhakar ││ Harshit Shah
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FEBRUARY 2016Slide2
Deliberate misstatements or omissions of amounts or disclosures of financial statements to deceive financial statement users, particularly investors and creditors.
2Definition of Financial Statement FraudSlide3
More than 50% of U.S. corporations are victims of fraud with losses of more than $500,000 (Albrecht & Searcy 2001).Enron lost about $70 billion in market capitalization to investors, employees, and pensioners.
Enron, WorldCom, Quest, Global Crossing, and Tyco’s loss to shareholders was $460 billion (Cotton 2002).Other fraud costs are legal costs, increased insurance costs, loss of productivity, adverse impacts on employee morale, customers’ goodwill, suppliers’ trust, and negative stock market reactions.3Some Statistics relating to fraudsSlide4
Undermines the reliability, quality, transparency, and integrity of the financial reporting process.Jeopardizes the integrity and objectivity of the auditing profession, especially auditors and auditing firms.
Adversely affects the nation’s economic growth and prosperity.Results in huge litigation costs.4Effects of Financial Statement FraudSlide5
Encourages regulatory intervention.Raises serious doubt about the efficacy of financial statement audits .
Causes bankruptcy or substantial economic losses by the company engaged in financial statement fraud.Erodes public confidence and trust in the accounting and auditing profession.5Effects of Financial Statement FraudSlide6
Who Commits Financial Statement Fraud?
Senior managementMid and lower level employeesOrganized criminals6Slide7
Types of Frauds
VictimPreparatorEmployee embezzlement or Occupational fraudEmployersEmployeesManagement FraudStockholders, Lenders and who rely on FSTop Management
Investment ScamsInvestors
Individuals
Vendor Fraud
Organizations that buy Goods or Services
Organizations or Individuals that Sell Goods or Services
Customer Fraud
Organizations that Sell Goods or Services
Customers
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Types of fraudsSlide8
Fraud Risk
“I need to hit my monthly targets”
“Nobody really checks”
“Everyone is Doing it”
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Generally, it is noted that frauds like other crime, can be best explained by three factors: a supply of motivated offenders, the availability of suitable targets and the absence of capable guardians- control system or someone to mind the store.
Why Do People Commit Financial Statement Frauds
?Slide9
To meet or exceed the earnings or revenue growth expectations of stock market analysts.To increase the amount of financing available from asset-based loans.
To meet a lender’s criteria for granting/extending loan facilities.To meet corporate performance criteria set by the parent company.To meet personal performance criteria.To trigger performance-related compensation or earn-out payments.9
Why Senior Management Will Overstate Business Performance
?Slide10
To defer “surplus” earnings to the next accounting period. To preserve a trend of consistent growth, avoiding volatile results.
To take all possible write-offs in one “big bath” now so future earnings will be consistently higher.To reduce expectations now so future growth will be better perceived and rewarded.10Why Senior Management Will Understate Business Performance?Slide11
Playing with the accounting systemBeating the accounting systemGoing outside the accounting system
11How Do People Commit Financial Statement Frauds?Slide12
Company management is responsible for financial statements.Company’s board of directors and senior management sets the code of conduct.Company’s ethics
– “the standard by which all other employees will tend to conduct themselves”.12Responsibility of ManagementSlide13
As per Sec 143(12) of the Companies Act, 2013, if an auditor in course of his audit has reasons to believe that offence involving fraud is being or has been committed against the company by officers or employees of the company, auditor shall immediately report the matter to Central Government within such time and manner as prescribed.
If auditor does not comply with the provisions of Sub-section (12), the auditor shall be punishable with fine which shall not be less than one lakh rupees but which may extend to twenty-five lakh rupees.13Responsibility of AuditorsSlide14
Penalty for Committing FraudsAs per Sec 447 of the Companies Act,2013,
any person or company who is found to be guilty of fraud, shall be punishable with imprisonment for a term which shall not be less than six months but which may extend to ten years and shall be liable to fine which shall not be less than the amount involved in the fraud.In case of repeated default within a period of three years, the company or person who is in default shall be punishable with twice the amount of fine for such offence in addition to any imprisonment provided for that offence.14Slide15
Transaction
Activity
Information
Users
Financial
Statements
Accounting
System
Bankers
Investors
Vendors
Government
Management
Balance Sheet
Income Statement
Statement of
Owner Equity
Statement of
Cash Flows
Decisions
Loan Approval
Financial Investment
Credit Approval
Operational &
Financial Decisions
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Users of Financial StatementsSlide16
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Methods of Financial Statement FraudSlide17
Fictitious Revenues
17Slide18
18Fictitious Revenues - Example
Sr. No.ParticularsAmount (Dr.)Amount (Cr.)For example, Company “A” wishes to record 1,00,000 in fictitious sales to a non-existing customer.
1.
Accounts Receivable
A/c Dr.
To Sales A/c
1,00,000
1,00,000
2.
Fixed asset A/c
Dr.
To Cash A/c
1,00,000
1,00,000
3
Cash A/c
Dr.
To
Accounts Receivable
A/c
1,00,000
1,00,000
Thus, the cash and accounts receivable entries cancel each other.
That leaves the fictitious fixed assets and revenue, one being an asset and the other profit increase. Since fixed assets and revenues usually are significant amounts, these fictitious amounts will go unnoticed unlike cash and accounts receivable. Slide19
Recording revenues and/or expenses in improper periods
Shift revenues or expenses between two periods, increasing or decreasing earnings as desired
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Timing DifferencesSlide20
20Timing Differences - Example
CompanyFraud SchemeResult
Xerox
Overstated revenue for over 4 years by accelerating the recognition of $3 billion in revenue and inflating earnings by about $1.5 billion. Alleged scheme included the recognition of revenue on its office copier leases too early in their cycles.
Co. agreed to pay $10 million in fines and restate its income for the years 1997-2000.
SEC sued three current KPMG partners and one former partner of securities fraud in the claiming the firm fraudulently let the Co. manipulate its accounting practices to fill a $3 billion gap and make it appear to be meeting market expectations.Slide21
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Concealed LiabilitiesSlide22
22Concealed Liabilities - Example
CompanyFraud Scheme
Result
Adelphia
Communications
Misappropriation of firm assets by executives for personal use.
Concealment of $2.3 billion in loans to cover losses by founder and family members.
Declared bankruptcy in January 2002.
CEO
and family members charged with fraud.Slide23
Improper Disclosures
23Slide24
Improper Disclosures - Example24
CompanyFraud SchemeResult
Tyco
International
Misappropriation of $600 million by CEO and CFO for personal use through theft and the false sale of securities.
Company also separately sued former CEO seeking the return of more than $100 million. Suit alleges CEO gave himself unauthorized bonuses totalling $58 million and unauthorized loans of more than $43 million, and of taking personal credit for more than $43 million in charitable donations that actually were made by Tyco.
Three former executives including CEO and general counsel arrested for fraud.
CEO also charged with
avoiding payment of over $1 million in sales taxes on $13 million of artworkSlide25
Inventory valuation
Business combinationsAccounts receivableFixed assets
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Improper Asset ValuationSlide26
Improper Asset Valuation - Example26
CompanyFraud Scheme
Result
WorldCom, Inc.
Intentionally improperly capitalized billions of dollars of expenses as capital expenditures.
Former CEO facing possible charges for allegedly profiting improperly from IPOs offered by brokerages in return for investment banking business.
Declared bankruptcy, July 2002. Former finance chief and finance and accounting executives charged with securities fraud.Slide27
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Financial Statement AnalysisSlide28
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Deterrence of Financial Statement FraudsSlide29
Establish effective board oversight of the “tone at the top” created by management.Avoid setting unachievable financial goals.
Change goals if changed market conditions calls for it.Discourage excessive external expectations of future corporate performance.Remove operational obstacles blocking effective performance.29Reduce Pressure to Commit Financial Statement FraudsSlide30
Maintain accurate and complete internal accounting records.Carefully monitor the business transactions and interpersonal relationships of suppliers, buyers, purchasing agents, sales representatives, and others who interface in the transactions between financial units.
Establish a physical security system to secure company assets, including finished goods, cash, capital equipment, tools, and other valuable items. Maintain accurate personnel records including background checks on new employees.Encourage strong supervisory and leadership relationships within groups.Establish clear and uniform accounting procedures
30Reduce the
Opportunities
to Commit Financial Statement FraudsSlide31
Promote strong values, based on integrity, throughout the organization.Have policies that clearly define prohibited behavior with respect to accounting and financial statement frauds.
Provide regular training to all employees communicating prohibited behavior.The consequences of violating the rules and the punishment of violators should be clearly communicated31Reduce Rationalization of Financial Statement FraudsSlide32
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ANY QUESTIONS
?Slide33
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