Financial Statement Financial Statement FraudsFrauds

Red Flags of FraudRed Flags of Fraud

Financial Statement FraudsFinancial Statement Frauds

1.1. Revenue/Accounts Receivable Frauds Revenue/Accounts Receivable Frauds (Global Crossing, Quest, ZZZZ Best)(Global Crossing, Quest, ZZZZ Best)

2.2. Inventory/Cost of Goods Sold Frauds Inventory/Cost of Goods Sold Frauds (PharMor)(PharMor)

3.3. Understating Liability/Expense Understating Liability/Expense Frauds (Enron)Frauds (Enron)

4.4. Overstating Asset Frauds (WorldCom)Overstating Asset Frauds (WorldCom)5.5. Overall Misrepresentation (Bre-X Overall Misrepresentation (Bre-X

Minerals)Minerals)

1. Revenue Related Financial 1. Revenue Related Financial Statement FraudsStatement Frauds

By far, the most common accounts By far, the most common accounts manipulated when perpetrating manipulated when perpetrating financial statement fraud are revenues financial statement fraud are revenues and/or accounts receivable.and/or accounts receivable.

Accounts ReceivableAccounts Receivable xxxxxx

RevenuesRevenuesxxxxxx

(Income Assets )(Income Assets )

Revenue-Related Transactions and Frauds

See Excel handout #1

2. Overstating Inventory2. Overstating Inventory

The second most common way to The second most common way to commit financial statement fraud is commit financial statement fraud is to overstate inventory.to overstate inventory.Beginning InventoryBeginning Inventory OKOKPurchasesPurchases OKOKGoods Available for saleGoods Available for sale OKOKEnding InventoryEnding Inventory HighHighCost of Goods SoldCost of Goods Sold LowLowIncomeIncome HighHigh

Inventory/Cost of Goods Sold Frauds

See Excel handout #2

3. Understating Liability Frauds3. Understating Liability Frauds

Not recording accounts payableNot recording accounts payableNot recording accrued liabilitiesNot recording accrued liabilitiesRecording unearned revenues as Recording unearned revenues as

earnedearnedNot recording warranty or service Not recording warranty or service

liabilitiesliabilitiesNot recording loans or keep liabilities off Not recording loans or keep liabilities off

the booksthe booksNot recording contingent liabilitiesNot recording contingent liabilities

4. Asset Overstatement Frauds4. Asset Overstatement Frauds

Overstatement of Current Assets (e.g. Overstatement of Current Assets (e.g. Marketable Securities)Marketable Securities)

Overstating Pension AssetsOverstating Pension Assets Capitalizing as assets amounts that should Capitalizing as assets amounts that should

be expensedbe expensed Failing to record depreciation/amortization Failing to record depreciation/amortization

expenseexpense Overstating assets through mergers and Overstating assets through mergers and

acquisitionsacquisitions Overstating inventory and receivables Overstating inventory and receivables

(covered earlier)(covered earlier)

5. Disclosure Frauds5. Disclosure FraudsThree Categories of Disclosure Frauds:

1. Overall misrepresentations about the nature of the company or its products, usually made through news reports, interviews, annual reports, and elsewhere

2. Misrepresentations in the management discussions and other non-financial statement sections of annual reports, and other reports

3. Misrepresentations in the footnotes to the financial statements

Changes in employee lifestyle, habits and behaviour

Decline in employee morale and/or attendance

Operating on a crisis basis Unexplained variances One employees “does it all” and

wants to control everything

Changes in employee lifestyle, habits and behaviour

Decline in employee morale and/or attendance

Operating on a crisis basis Unexplained variances One employees “does it all” and

wants to control everything

RED FLAGS OF FRAUDRED FLAGS OF FRAUD

Missing, altered, or perfect documents

Invoice items do not appear consistent

Excessive rush or emergency transactions

Vendors with generic names and/or Post Office Boxes as addresses

Payments made from non-original documentation

Missing, altered, or perfect documents

Invoice items do not appear consistent

Excessive rush or emergency transactions

Vendors with generic names and/or Post Office Boxes as addresses

Payments made from non-original documentation

RED FLAGS OF FRAUD(continued)

RED FLAGS OF FRAUD(continued)