How Do People Commit Financial Statement Fraud?
Regardless of method, there are three general ways in which fraudulent financial statements can be produced. By being aware of these three approaches, those who investigate financial statement fraud can be alert for evidence of attempts to manipulate the accounting and financial reporting process, or to go outside it. Financial statement frauds may involve more than one of these three methods, though they will commonly start with the first method and progressively add the other two methods as the fraud grows. The three general methods are as follows:
1. Playing the accounting system. In this approach, the fraudster uses the accounting system as a tool to generate the results he wants. For example, in order to increase or decrease earnings to a desired figure, a fraudster might manipulate the assumptions used to calculate depreciation charges, allowances for bad debts, or allowances for excess and obsolete inventory. To avoid recognizing expenses and liabilities, vendor invoices might not be recorded on a timely basis. Genuine sales might be recorded prematurely. Transactions recorded in the accounting system have a basis in fact, even if they are improperly recorded. There is a documentary trail to support the results reported in the financial statements, though the assumptions shown in some of those documents may be questionable.
2. Beating the accounting system. In this approach, the fraudster feeds false and fictitious information into the accounting system to manipulate reported results by an amount greater than can be achieved by simply “playing the accounting system.” Fictitious sales may be recorded to legitimate or phony customers. Inventory and receivables figures may be invented, with documents later being forged to support the claimed numbers. Senior financial management might determine allowances for bad debts and for excess and obsolete inventory without regard to the formulae or methods historically used in the entity to determine these amounts. Journal entries might be disguised in an attempt to conceal their fraudulent intent (e.g., splitting big round-sum adjustments into many smaller entries of odd amounts), or transactions may be hidden through use of intercompany accounts to conceal the other side of a transaction. Some transactions recorded in the accounting system may have no basis in fact and some that do may be improperly recorded. There will be no documentary trail to support certain transactions or balances unless the fraudster prepares forged or altered documents to help support this fraud.
3. Going outside the accounting system. In this approach, the fraudster produces whatever financial statements he wishes, perhaps using just a typewriter or a personal computer. These financial statements could be based on the results of an accounting and financial reporting process for an operating entity, with additional manual adjustments to achieve the results desired by the fraudster. Alternatively, they could just be printed up using phony numbers supplied by the fraudster. In some cases, the fraudster may go back and enter false data in the accounting system to support the phony financial statements. In other cases, he may not bother or there might be no accounting system. So not all transactions may be recorded in an accounting system and some or all transactions may have no basis in fact. To catch this type of fraud, it is usually necessary to start by tracing the published financial statements back to the output of the accounting system. As in the previous situation, there will be no documentary trail to support certain transactions or balances reported in the financial statements unless the fraudsters prepare forged or altered documents to help support this fraud.
For More Information:
Business Fraud Techniques
Regardless of method, there are three general ways in which fraudulent financial statements can be produced. By being aware of these three approaches, those who investigate financial statement fraud can be alert for evidence of attempts to manipulate the accounting and financial reporting process, or to go outside it. Financial statement frauds may involve more than one of these three methods, though they will commonly start with the first method and progressively add the other two methods as the fraud grows. The three general methods are as follows:
1. Playing the accounting system. In this approach, the fraudster uses the accounting system as a tool to generate the results he wants. For example, in order to increase or decrease earnings to a desired figure, a fraudster might manipulate the assumptions used to calculate depreciation charges, allowances for bad debts, or allowances for excess and obsolete inventory. To avoid recognizing expenses and liabilities, vendor invoices might not be recorded on a timely basis. Genuine sales might be recorded prematurely. Transactions recorded in the accounting system have a basis in fact, even if they are improperly recorded. There is a documentary trail to support the results reported in the financial statements, though the assumptions shown in some of those documents may be questionable.
For More Information:
Business Fraud Techniques
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