FINANCIAL STATEMENT FRAUD
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Financial statement schemes are one of a large category
of frauds that fall under the heading
of Occupational
Fraud and Abuse, which is defined as “the use of one’s
occupation for personal
enrichment through the deliberate misuse or misapplication
of the employing organisation’s
resources or assets.” Simply stated, occupational frauds
are those in which an employee,
manager, officer, or owner of an organisation commits fraud
to the organisation’s detriment.
The three major types of occupational fraud are corruption,
asset misappropriation, and
fraudulent statements (which include financial statement
schemes). The following diagram
shows the complete classification of occupational fraud,
frequently referred to as the Fraud
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Tree.
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(NOTE: The discussions pertaining to accounting rules and
standards in the following
sections are generalised, and are based on accounting practices
common to many countries.
However, required accounting treatments vary among regions
and organisation types.
Therefore, it is important to consult the applicable accounting
standards governing the
organisation being examined to determine whether a particular
accounting treatment is
correct.)
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The Fraud Tree
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Financial Statement Fraud
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What Is Financial Statement Fraud?
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Financial statement fraud is the deliberate misrepresentation of the financial condition of an
enterprise accomplished through the intentional misstatement or omission
of amounts or
disclosures in the financial statements to deceive financial
statement users.
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Note that financial statement fraud, much like all types
of fraud, is an intentional act. As
stated in the International Standard on Auditing (ISA) 240,
The Auditor’s Responsibility
Relating
to Fraud in an Audit of Financial Statements, “misstatements in the financial statements can arise
from error or fraud. The distinguishing factor between error
and fraud is whether the
underlying action that results in the misstatement of the
financial statements is intentional or
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unintentional.”
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Financial statement fraud is usually a means to an end rather
than an end in itself. When
people “cook the books,” they might be doing it to “buy
more time” to quietly fix business
problems that prevent their company from achieving its expected
earnings or complying
with loan covenants. It might also be done to obtain or
renew financing that would not be
granted, or would be smaller, if honest financial statements
were provided. People who are
intent on profiting from crime might commit financial statement
fraud to obtain loans they
can then siphon off for personal gain or to inflate the
price of the company’s shares,
allowing them to sell their holdings or exercise stock options
at a profit, or even obtain
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bonus money calculated based on sales or profits. However,
in many past financial statement
fraud cases, the perpetrators have gained little or nothing
personally in financial terms.
Instead, the focus appears to have been preserving their
status as the organisations’
leaders—a status that might have been lost had the real
financial results been published
promptly.
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Financial statement fraud almost always involves overstating
assets, revenues, and profits
and understating liabilities, expenses, and losses. However,
sometimes the opposite result is
desired. For example, understating assets or revenue might
lead to a smaller tax liability for
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the company. Alternatively, a fraudster might wish to play
down over-budget results in a
good year in order to help make up for any shortcomings
during the subsequent year.
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Financial statements are the responsibility of the organisation’s
management. Accordingly,
financial statement fraud is typically committed by someone
in a managerial role who not
only has the ability to alter the financial statements,
but also has an incentive to do so. Since
fraud investigations are typically conducted or overseen
by management, financial statement
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fraud cases often persist for a long time before the whistle
is blown or the fraud is
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discovered by an external party.
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