In layman terms Financial Statement Fraud pertains to simply cooking the books. Technically Financial statement fraud is the deliberate misrepresentation of the financial condition of an enterprise achieved through the intentional misstatement or omission of amounts or disclosures in the Financial Statements.

According to the ACFE’s 2016 Report to the Nations on Occupational Fraud and Abuse, Financial Statement Fraud comprises of less than 10% of the Frauds reported in the study. In India also, the Corporate Loan frauds has been increasing at an alarming rate.  The resultant loss due to Financial Statement Frauds are huge as it affects all the users of Financial Statements at large. In India it’s impact can be simply measured by studying the case of Satyam, Kingfisher, etc.

Why people commit Financial Statement Frauds?

The main and primary reason for committing Financial Statement Fraud is make the position of the Entity look better on paper. The motivation for Financial Statement Fraud is not always involves an individual person, it is committed by a large by the company’s top level executives.  Many other reasons for committing Financial Statement Frauds are as under:

• To increase their Market Capitalisation of the listed stock.
• To show inflated Sales resulting into more earnings so that more dividend can be distributed by the company.
• To avoid wrong perception of the market.
• Major reason is to get Finance for the entity and if it is already financed to get better terms of finance.

Hence, due to situational pressures and opportunity to commit Fraud, the executives of the company are motivated to alter their face of financial statements to give a different perspective for the users of financial statements.

How are Financial Statement Frauds committed?

Financial Statement Frauds usually takes place in the following four ways:

• Overstatement of Assets to reflect a stronger company
• Overstatement of Revenue to show fictitious growth in the company
• Understatement of Expenses to inflate the profit of the company
• Understatement of Liabilities to show a better picture of the company

Entities sometimes even does the inverse of the above to get favourable conditions for loan settlement or show wrong insolvency conditions.

These result in increased net worth of the company and provides more stable picture of the company.

Financial Statement Frauds are Basically divided into following Schemes:

Fictitious Revenues:

This means recording of revenues which are not going to be recovered through creating Fake Customers, Fake Invoices for Actual Customers, Altering the amount of actual invoices of the customers, etc.

Timing Differences:

This involves not following the Matching Concept of Generally Accepted Accounting Principles like inappropriate recording of deferred revenue in on accounting period, charging of capital cost to revenue statement, etc.

Asset Valuations

This involves incorrect valuations of the Fixed Assets and creation of unnecessary revaluation reserve, also not recording the inventories as per the applicable accounting standards, etc.

Unreported Liabilities & Expenses

This involves completely removing the recognition of certain Expenses and Liabilities, such as crystallised liabilities in case of suit settlement, major expenses in Cash, etc.

Incomplete Disclosures

This includes giving incomplete disclosures of the reporting standards applicable to the company like wrong reporting of related party disclosure, contingent liabilities, etc.

How could Financial Statement Fraud Be Prevented?

• Reduce the Situational Pressures that encourage Financial Statement Fraud
• Reduce the opportunity to commit fraud by maintaining complete and accurate accounting records, etc.
• Should train the employees by conducting various training seminars.
• A proper and robust system of Internal Controls must be implemented in the entity.

In the upcoming Blog posts the means of Financial Statement Frauds will be discussed in detail along with the methods to trace the same. Follow the blog to stay updated on the same.