Financial Statement

     Financial Statement Fraud




Ten Things About Financial Statement Fraud


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...)


Financial Statement Manipulation: The Schemes


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...)


Enron lessons learned


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...)


Financial Statement Fraud Part 1


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...)


Financial Statement Fraud Part 2


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...)


Financial Statement Fraud Part 3


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...)




Financial Statement Complexity: A Breeding Ground for Fraud


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...)


Assessing and Responding to Risks in a Financial Statement Audit


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...)


When Is Backdating a Crime?


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...)


Accounting Shenanigans on the Cash Flow Statement


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...)


Recognizing Financial Statement Fraud Red Flags


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...)




It's official white collar crime no longer pays!


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,, 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...)


Formulas for detection


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...)


Determinants of auditors’ attitudes towards creative accounting


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...)




Financial (Mis)Statements


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...)


Anatomy of a Financial Fraud


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...)


Does Fraud Equal Loss?

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...)


Earnings Management Revisited


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...)




Lessons from the Baptist Foundation fraud


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...)


Fraud and its discontents


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...)


The criminalisation of securities fraud


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...)


Example Analytical Ratios as Predictors in Financial Statement Fraud


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...)


Fraudulent Financial Transactions


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...)


Also in this article:

  • Fraud Involving the Understatement of Liabilities

  • Overstatement-of-Asset Fraud

  • Inventory and Cost of Goods Sold Fraud



Why management fraud is unstoppable


DECEMBER 2002: Management fraud is unstoppable because no controls, past or present, exist to completely control management's actions. Management controls internal control, and can generally do as it pleases, including overriding controls whenever they prevent management from attaining its objectives. (Read more...)


The three Cs of Fraudulent Financial Reporting


OCTOBER 2002: Assessing an organization's conditions, corporate structure, and the choices it makes can help reveal the motivations, opportunities, and rationalizations behind the commission of financial statement fraud. (Read more...)


Avoid your own Enron


APRIL 2002: Most of us don't make loans to the Enrons of the world, but in the wake of the largest bankruptcy in U.s. history, what can we learn to protect ourselves and our banks? Actually, quite a lot, because many of the factors that led to the Enron debacle are common among companies of all sizes. Although there are many more, here is a short list of things to watch for that aren't related to the size of the company. (Read more...)


The Enrons of Russia


APRIL 2002: Readers of Russian newspapers were not at all surprised by recent stories about Enron. During the ’90s, Russian energy companies were notorious for cooking their books, defrauding their shareholders and using political connections to cover shadowy deals. (Read more...)


Enron: The Way Ahead (speech)


APRIL 2002: So I'd like to begin my remarks to you tonight with a story about the sea. Specifically, about a captain who is sailing his ship through rough seas at night. In the distance he sees the flashing light of another ship, which is approaching pretty fast.

He quickly sends a signal and the message ... "Ship approaching on course: change direction immediately 10 degrees south"

The reply comes instantly ..."Collision imminent. Turn 10 degrees north." The captain signals in frustration. "This is the captain speaking. Turn 10 degrees south."

And the reply again. "This is the first officer. Turn 10 degrees to the north."
Completely desperate now, the captain signals, "I am a battleship." The reply comes back, "I am a lighthouse."

This story provides an interesting perspective for my remarks on Enron tonight... and what we in the accounting profession are doing to avoid an Enron in Canada. (
Read more...)


The Enron Collapse: An Overview of Financial Issues


MARCH 2002: Only months before Enron Corp.’s bankruptcy filing in December 2001, the firm was widely regarded as one of the most innovative, fastest growing, and best managed businesses in the United States. With the swift collapse, shareholders, including thousands of Enron workers who held company stock in their 401(k) retirement accounts, lost tens of billions of dollars.


Investigations of wrongdoing may take years to conclude, but Enron’s failure already raises financial oversight issues with wider applications. Why didn’t the watchdogs bark? This report briefly examines the accounting system that failed to provide a clear picture of the firm’s true condition, the independent auditors and board members who were unwilling to challenge Enron’s management, the Wall Street stock analysts and bond raters who missed the trouble ahead, the rules governing employer stock in company pension plans, and the unregulated energy derivatives trading that was the core of Enron’s business. (Read more...)


Financial Statement Fraud


The opinion of investors and lenders on red flags


FEBRUARY 2002: There is increasing international concern about the escalation in fraudulent financial statement reporting and the difficulties in detecting and proving such fraud.


A major obstacle to addressing the problem of financial statement fraud promptly, is related to the difficulty of identifying the fraud soon after its occurrence. Because it is often a management fraud, it is well hidden from auditors, investors and other stakeholders and it is usually only discovered by chance or once the company is in financial difficulty, which may result in a takeover or insolvency. It is therefore important to attempt to manage the risk of fraud by using early warning signals such as ‘red flags’. (Read more...)





JUNE 2001: To stay ahead of financial statement fraud, fraud examiners must step up to a new level of analytical comprehension and intellect to uncover the latest devious techniques.


Financial statement fraud is "a new kid on the block," and the intent to conceal and take advantage by false suppression of the truth of assets, liabilities, cash flow, sales and profitability is creating a new level of risk for corporate America. Fraud examiners must have a new level of analytical comprehension and intellect to uncover the devious techniques. (Read more...)


Timing is of the Essence


MAY 2001: When companies get desperate to show earnings or reduce losses, sometimes they resort to fraudulent timing differences to show phony profits. By recognizing these often simple schemes CPAs can usually detect material financial statement frauds early, before they become catastrophic. (Read more...)


Follow Fraud to the Likely Perp

Why the CEO goes bad


MARCH 2001: As CPAs it is important to understand both the methods and motivations at play when otherwise ethical executives participate in fraudulent financial statement schemes. According to a 1999 study by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), in three-quarters of fraud cases the chief executive officer is directly involved. So try to trade places—in your mind—with the CEO of any public company. Imagine:


The market analysts have been pestering you, the CEO of the company, and your brother, the CFO, for advance information on the upcoming quarterly earnings announcement. They are predicting your company will earn 75 cents per share, just as in the last 9 quarters. But you know something they don't: The company will be lucky to earn half that amount. Because the product recently introduced isn't selling well, profits are going to take a big hit. When that happens, the stock price is bound to tumble. You wouldn't and couldn't tell the analysts this terrible news.


You've always considered yourself honest and ethical. Everyone in the company looks up to and admires you. Ironically, if the real truth about the earnings becomes public knowledge, many of the people who think so well of you will likely lose their jobs. You could go, too. And all of this is your fault. You believed in the new product line so much that you gambled the company's whole future on it.


What do you do? The choice seems obvious. The lesser of two evils would be to fix the numbers before the quarterly report goes out. "Good grief, this is terrible," you think to yourself. "But if we can just get past this quarter." (Read more...)




Preventing fraudulent financial reporting


DECEMBER 2000: Detecting financial fraud is difficult, even for the best auditors. To arm auditors with the tools to detect and prevent fraud, a study by the Committee of Sponsoring Organizations (COSO) has identified six key areas:

  • Types of companies engaged in fraud and employees involved;

  • Nature of the frauds;

  • Ineffective audit committees and board governance;

  • Industry-specific traits;

  • Incentives for fraud due to ownership, financial condition, and market expectations; and

  • Audit firms.

(Read more...)


Earnings Management and the Abuse of Materiality


SEPTEMBER 2000: Take your pick of fraudulent financial reporting schemes. One of these gimmicks, manipulating reported income through “earnings management” techniques, draws its share of attention in the financial press. A company can effect earnings management practices in a variety of ways. One of the most popular vehicles for earnings management, however, stems from a misuse or misunderstanding of the proper application of materiality, a concept central to the preparation and audit of all financial statements. (Read more...)



JANUARY 2000: Have you heard the one about the company that needed to hire a chief corporate accountant? In the last interview session each finalist was given financial information and asked, "What are the net earnings?" All applicants but one dutifully computed the net earnings but none of them got the job. The candidate who landed the position answered the question by replying, "What do you want your net earnings to be?" (Read more...)





Exposing Financial Statement Fraud


The forms and faces of financial statement fraud are many, various--and often disastrous.


DECEMBER 1999: STEVE MCMILLAN, GENERAL Auditor for a medium-sized financial services holding company, had recently joined the organization after an eight-year career in public accounting. He and Karen Johnson, one of the company's audit managers, were discussing a meeting they had had with the CEO earlier that day.


The CEO had begun the meeting by acknowledging that most internal auditors are not usually concerned about fraudulent financial reporting. "However, I'm taking this issue seriously," he continued. "I want to be sure that this company cannot be accused of managing earnings or fraudulent financial reporting of any kind." (Read more...)


Hocus-Pocus Accounting


OCTOBER 1999: EC Chairman Arthur Levitt decried what he termed "accounting hocus-pocus" and called for coordinated efforts to uncover it. He targeted the practice by some companies of improperly boosting reported earnings by manipulating the recognition of revenue. Among the most common methods of doing this are the bill-and-hold transaction and a long list of sham transactions involving shipping, billing and/or related-party involvements. Both the SEC and the AICPA seek to increase independent auditors' awareness of problems associated with these practices.


Public companies feel pressure to report quarterly earnings that meet or exceed analysts' expectations—after all, failure to meet those expectations can hurt companies' stock prices. This pressure can lead to practices that sometimes include fraudulent overstatement of quarterly revenue. Any of the improper and unusual revenue-transaction methods used to misstate quarterly revenue also can be used to change annual results. Auditors need to be alert to the whole gamut of warning signs that revenue-recognition fraud may be present. (Read more...)




Fraudulent Financial Reporting: 1987-1997 - An Analysis of U.S. Public Companies


Fraudulent financial reporting can have significant consequences for the organization and for public confidence in capital markets. Periodic high profile cases of fraudulent financial reporting raise concerns about the credibility of the U.S. financial reporting process and call into question the roles of auditors, regulators, and analysts in financial reporting. (Read more...)





The Fraud Investigator fighting fraud through prevention, detection and deterence