December 2007: Despite increasingly stringent legislation aimed at combating fraud, such as the Foreign Corrupt Practices Act and the Sarbanes-Oxley Act – and despite increased enforcement efforts by the Securities and Exchange Commission (SEC) – financial statement fraud remains a public concern.

Just what types of fraud is the SEC describing in its enforcement actions? In what industries are frauds most prevalent? Have fraud types and industry patterns changed over time?

To address these questions, and to learn how fraud schemes have evolved since the Committee of Sponsoring Organizations of the Treadway Commission produced its last comprehensive report on fraud in 1999, the Deloitte Forensic Center has, in 2007, completed an analysis of hundreds of SEC enforcement releases issued from 2000 through 2006. (Read more. )

November 2007: Financial statement fraud is the most expensive type of fraud perpetrated by an employee, with a median cost of $2 million per scheme. It occurs the least often however, with financial statement manipulation present in only 10% of all fraud schemes.

This type of fraud is generally perpetrated by upper management, as they are typically the employees with the access and the influence to manipulate financial statements. Upper management usually has the most to gain from financial statement fraud, from increased performance bonuses, to more valuable stock options, to lucrative job promotions. (Read more. )

APRIL 2007: Prior to 2001, hardly anyone in South Africa had heard of Enron. Indeed, even in the USA, its name was not widely known to the general public. Yet, in 2001, Fortune Magazine ranked it as the US’s seventh largest corporation.

During the 1990s, it had grown at a phenomenal rate. Intriguingly, if it had continued to grow at its historical rate, it would have reached number one by now in 2007.

Since 2001, the name Enron has evolved into a spectre that has haunted investors, regulators, the accountancy profession and politicians worldwide.

When Enron filed for bankruptcy in December 2001, it was the largest bankruptcy case in US history. Its demise has subsequently led to huge changes in governance and regulatory practices around the world.

But while Enron hogged the headlines, it is well worth noting that it was not the only collapse at the time. Indeed, many more occurred in the US, Europe, Asia and South Africa – often for similar reasons. Enron, however, stood out from the others because of its size and influence.

Looking back five years on, prompts one to ask if anything has changed; what lessons we have learned and whether or not Enron could happen again. ( Read more. )

What do Enron, WorldCom, Tyco, Adelphia, Global Crossing, Xerox, and Parmalat all have in common? They were all considered financial statement frauds. During the past seven years, financial statement frauds have grown dramatically in both the number occurring and the size of the losses. Fraudulent financial statements affect shareholders, lenders, creditors, and employees.

Consequently, many investors have lost confidence in the credibility of financial statements 59% of class-action securities lawsuits in US during 1997 alleged accounting abuses. This is up from 43% in 1996. In April 1998, Business Week held its Forum of Chief Financial Officers. During that forum, the CFOs revealed that 67% of them had been asked by senior company executives to misrepresent the financial results of the corporation. Of those, 12% admitted that they had in fact actually misrepresented the financial results! It is estimated that the average financial statement fraud results in a $5,000,000 misstatement on the books. What is financial statement fraud and why are so many people committing it? ( Read more. )

The focus of this series of articles is on creating an awareness of how financial statement fraud is committed, why it is committed, and ways that you can help to detect and prevent it from occurring. Part 1 created the awareness of how and why financial statement fraud is committed. This article will provide you with an overview of a systematic approach to investigating possible financial statement fraud. (Read more. )

The focus of this series is on creating an awareness of how financial statement fraud is committed, why it is committed, and ways that you can help to detect and prevent it from occurring. Part 1 of the series created the awareness of how and why financial statement fraud is committed. Part 2 provided an overview of a methodology that could be utilized to investigate suspected cases of financial statement fraud. This part discusses some of the most common schemes that are used to commit financial statement fraud and ways that they can be detected or prevented. (Read more. )

2006

SEPTEMBER 2006 — The corporate financial scandals in the early part of this decade shocked our financial markets and will be remembered for the carnage left by the likes of Enron and WorldCom: thousands of workers robbed of their retirement funds, millions of investors who lost their savings, and the havoc wreaked upon our economic and social systems. If we could only put it all behind us!

Unfortunately, the complexity embodied in financial accounting standards promotes a breeding ground for an endless variety of fraudulent schemes. ( Read more. )

JULY 2006: This is the first of two articles describing the requirements of—and implementation suggestions for—new guidance from the Auditing Standards Board (ASB). This article discusses the process of assessing risks and controls, leading to the concept of the risk of material misstatement. A subsequent JofA article will discuss how the auditor responds to the risk of material misstatement. ( Read more. )

JULY 2006: There is no statute that explicitly outlaws backdating stock-option grants, but it seems virtually impossible to backdate options and achieve the ultimate goal of putting grants in the money without first deliberately falsifying documents and then covering up the sham. At least that seems to be the conclusion reached by the Department of Justice and the Securities and Exchange Commission regarding their first case against executives charged with fraud related to backdating. (Read more. )

MARCH 2006: CPAs typically focus on uncovering items that would impact the reported earnings or the balance sheet of a company. Knowing that investors use the balance sheet and the income statement to make investment decisions, companies sometimes engage in unusual or aggressive accounting practices in order to flatter their reported figures, especially earnings. ( Read more. )

Financial statement fraud can have severe consequences. In examining financial statements, professional investigators often focus their attention on certain red flags. By familiarizing themselves with these common fraud techniques and indicators, management can minimize the impact of financial statement fraud and mitigate future risks. (Read more. )

2005

DECEMBER 2005: Bernard Ebbers, former Chief Executive of WorldCom, has finally been sentenced for his role in the collapse of WorldCom, more than two years after an internal auditor began questioning some curious accounting.

Ebbers was found guilty of orchestrating the $11-billion accounting fraud after his former chief financial officer testified that Ebbers had instructed him to hide expenses and overstate revenue in order to meet market expectations of the telecommunications company. Although the conviction was anticipated, the sentence was not. ( Read more. )

Raise the red flag. a recent study examines which SAS No. 99 indicators are more effective in detecting fraudulent financial reporting.

OCTOBER 2005: SAS No. 99 increases the number of red flags to 42, extensively revises the existing indicators, and requires auditors to consider the risk of a possible material misstatement due to fraud. One accounting Web site, AccountingMalpractice.com, describes the change as switching auditors’ focus from I believe management to I don’t believe management and strongly hints that any auditor who fails to recognize these fraud warning signs could be held negligent. ( Read more. )

Analysis ratios for detecting financial statement fraud

MARCH 2005: Detection of financial statement fraud is on the front burner. With billions of losses behind us from such companies as Enron, Tyco, and WorldCom, the numbers of cases has slowed but not stopped. Catching the deeds early is important because the average financial statement fraud costs businesses an average of $1 million, according to the ACFE’s 2004 Report to the Nation. Analysis ratios tested by an Indiana University professor show promise in identifying possible infractions and helping CFEs focus their efforts once retained to look into suspicions. Although the study is now six years old, it appears to be increasingly used to help detect signs of financial manipulations. (Read more. )

2005: This study investigates whether auditors’ attitudes towards creative accounting are associated with ethical judgement, their evaluation of the quality of financial reporting and their perceptions of factors that influence preparers of financial statements to use aggressive accounting techniques. The results of this study reveal a significant relationship between auditors’ assessments of the relevance and reliability (but not ethical judgement) of reported information and their attitudes to creative accounting. Some insight is gained into auditors’ perceptions of the factors that influence preparers to use creative accounting in South Africa. (Read more. )

2004

With the host of headline-grabbing stories dealing with financial misstatements of high-profile U.S. companies, it is increasingly likely that lawyers in Canada will play some role with an entity embroiled in a financial misstatement issue. This role may be as a director, as a business law advisor, or as a litigator. This paper is intended to provide an introductory review of the topic of financial misstatements and “earnings management.” (Read more. )

OCTOBER 2004: A forensic audit conducted by PricewaterhouseCoopers concluded that HealthSouth Corporation’s cumulative earnings were overstated by anywhere from $3.8 billion to $4.6 billion, according to a January 2004 report issued by the scandal-ridden health-care concern. HealthSouth acknowledged that the forensic audit discovered at least another $1.3 billion dollar’s in suspect financial reporting in addition to the previously estimated $2.5 billion. The scandal’s postmortem report found additional fraud of $500 million, and identified at least $800 million of improper accounting for reserves, executive bonuses, and related-party transactions. This billion-dollar-plus admission failed to garner financial media headlines, further evidence of the public’s inurement to financial reporting scandals. (Read more. )

SEPTEMBER 2004: It’s as predictable as anything about the stock market: when a company’s share price plunges, shareholders sue. But launching a successful shareholder suit — that is, one that gets settled — may soon become harder.

The U.S. Supreme Court has agreed to review a decision in a case that pits shareholders against Dura Pharmaceuticals Inc. a drug firm now owned by Ireland-based Elan Corp. At issue is a fundamental question: When fraud occurs and investors lose, how do you prove the link between fraud and loss? ( Read more. )

Further Suggestions in the Wake of Corporate Meltdowns

As we noted in our previous article in the Jan./Feb. 2000 issue of The White Paper, earnings management involves entity managers and accountants asking “How can we best report desired results?” rather than “How can we best report economic reality (the actual results)?”1 When reported results are intentionally misstated, earnings management becomes fraud. Corporate scandals including Enron, and WorldCom, and these entities’ external auditor, Arthur Andersen, are instructive on such accounting and business abuses. They also point to the critical need for further involvement of fraud examiners in assuring the verity of published financial information. (Read more. )

2004: Management can perpetrate financial reporting frauds by overriding established control procedures and recording unauthorized or inappropriate journal entries or other postclosing adjustments (for example, consolidating adjustments or reclassifications). ( Read more. )

2003

JULY 2003: Over a period of several years, the management of the Baptist Foundation of Arizona (BFA) engaged in one of the most audacious fraud schemes on record. BFA ultimately filed for bankruptcy, and thousands of elderly investors lost their life savings. How did such a massive fraud develop? What clues did the auditors overlook? BFA’s failure and the subsequent penalties provide a sobering reminder to auditors that it is important to understand the causes of fraud and even more critical to engage in effective audit procedures to detect fraud. Improving and strengthening fraud detection is at the heart of the accounting profession’s new antifraud initiatives, such as the recently issued SAS 99, Consideration of Fraud in a Financial Statement Audit. (Read more. )

JUNE 2003: In light of the accounting scandals plaguing corporate America, board members who do not understand the increasingly complex financial transactions that companies engage in are placing their firms, and possibly themselves, in serious legal and financial jeopardy, according to faculty members at Wharton and at the University of Chicago’s Graduate School of Business. (Read more. )

This paper highlights recent changes to the consequences of fraudulent conduct in the corporate accounting and securities industries. Following the Enron and Worldcom scandals, the Sarbanes–Oxley Act of 2002 has increased the penalties for fraudulent and misleading conduct. All corporate periodic reports must be personally certified by the CEOs and CFOs, who must state that the reports present fairly, in all material respects, the financial conditions and results of operation of the issuer, under penalty of up to ten years’ imprisonment and/or a fine of up to US$1m. The Act establishes a system of full disclosure of company finances and of company internal controls, including methods of calculation used in reports. Materiality is defined from the investor’s point of view. The paper also explains the Act’s effects on public accounting firms, senior employees, former employees, ‘whistleblowers’, employees who destroy documents or evidence, misleading accounting practices which artificially inflate the company’s financials, the general accounting principles and corporate lawyers. Although some of the changes have been watered down by the SEC’s implementing regulations, the effect of the Act is still dramatic and is designed to boost investor confidence in the system. (Read more. )

2003: The CPAs Handbook of Fraud and Commercial Crime Prevention describes the results of an academic study based on companies identified by the Securities and Exchange Commission (SEC) as earnings manipulators during a 10-year period. The study was conducted by Messod D. Beneish, an associate professor at the Kelley School of Business, Indiana University. The results were published in The Detection of Earnings Manipulation, Financial Analysis Journal 24 (1999); 24-36.

The purpose of the study was to develop quantitative fraud warning signs by analyzing a series of ratios that might be used as predictors of material misstatements caused by fraud. The research identified a group of financial statement variables that may be helpful in identifying material misstatements caused by fraud. These variables are: ( Read more. )

By far, the most common accounts manipulated when perpetrating financial statement fraud are revenues and/or accounts receivable; the COSO-sponsored study found that over half of all financial statement frauds involved revenues and/or accounts receivable accounts. The COSO study also found that recording fictitious revenues was the most common way to manipulate revenue accounts, and that recording revenues prematurely was the second most common type of revenue-related financial statement fraud. Other studies have found similar results. (Read more. )

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