Financial statement fraud is a game played by “Big Bosses”, for high stakes. The special problem for compliance professionals is that those committing financial statement frauds may have the authority to influence and disrupt compliance procedures.
Financial statement fraud exists when those responsible for preparing the financial statements of a business purposely manipulate the information to deceive the readers of the reports; mainly, to obtain a financial advantage for the company or certain employees.
Who Commits Financial Report Fraud?
- The company’s financial performance has a direct bearing on senior management promotions, bonuses, and social prestige.
- Where mid-level managers are concerned, financial statement fraud ensures positive outcomes for their careers, and can be used to hide poor performance.
- In organized crime, false financial statements can be used to get loans, boost up a worthless stock that is later sold for profit, or to laundry money from illegal activities.
Financial Statement Report Fraud: Why?
All reasons for this form of crime are routed in money. Often, the internal reward system in a company (Bonuses, Perks, Public Recognition, etc.) is based on performance that is documented in the measurable medium of sales or profit after sales. This temptation leads fraudsters to manipulate the measurement of success by fixing the numbers.
It is socially acceptable in some private and public business sectors, to falsify financial statements so that the company and employees involved look better. The immediate result sought through submitting deceptive financial reports are as follows:
- Conceal the actual company performance
- Retain or obtain credit
- For financial gain through bonuses, salary increases, stock options
- Meet company performance standards
- Support the stock price in anticipation of a merger, acquisition or sale of personal stock
- Show a pattern of growth in anticipation of offering a business for sale
Financial Statement Fraud: How is it done?
In general, there are many methods of committing financial statement fraud. Most commonly, the fraudster can use the accounting system as a tool to create the results that they want, or beat the accounting system by feeding false data into the system.
In using the accounting system as a tool to reach a desired goal - a result that generates benefits for the fraudster, the criminal might manipulate:
- Increase or decrease of earnings
- Depreciation charges
- Allowances for bad debts
- Allowances for excess or obsolete inventory
In addition, a dishonest manager might purposely report vendor invoices late to avoid expenses and liabilities being noticed. On some occasions, tricksters record legitimate sales earlier than they occurred. All of these activities change the actual values and occurrences of business transaction so that the measure of success is altered to fit the needs of the fraudster.
Managers may also beat the accounting system by feeding phony information into the system so as to cause results larger than they really achieved. False sales data might be reported regarding existing or non-existent customers. In some instances, inventories and receivables could be created and the actual documentation therefore forged to support the false inventories and receivables.
The Cost of Financial Statement Report Fraud
This form of fraud is a global problem whose effects cross international borders. The greatest cost associated with financial statement fraud is how it undermines the global finance accounting system, thus destroying the integrity of the system, while at the same time causing distrust in the financial markets. In short, employees, customers, investors, and lenders cannot depend on financial statements to help them make career and business decisions.
Detection of Financial Statement Fraud
- Unusual profitability compared to other companies in the same industry
- Large amounts of sales to unusual or unknown customers
- Negative cash flows while reporting earnings growth
- Undue involvement of managers with no financial management responsibilities in the selection of accounting procedures
- Inadequate board of director or audit committee oversight
- Reoccurring attempts of managers to justify marginal or inappropriate accounting procedures
Prevention of Financial Statement Fraud
Preventing financial statement fraud requires full commitment of managers at all levels to the principles of integrity and fair business practices. At a minimum, the following procedures should be implemented:
- Only accepted and legal forms of major generally accepted accounting procedures are used
- Use of independent accounting and tax consultants – not on long term contract
- Insist on complete transparency
- Foster a corporate climate among managers of integrity
- Avoid generating a culture of “Profit at all Cost”
- Be Careful of Tying Manager Compensation to the “Bottom Line”
Financial statement fraud is very serious, but nevertheless greatly understated. It has been reported in 2016 that executive managers caused over 30% of these types of fraud cases, while finance was responsible for roughly 23% and accounting for nearly 13% of financial statement fraud. Hence to stop financial statement fraud a cultural shift must take place in both private and government businesses. Integrity and fair play must be rewarded at the same level as profitability. Executive managers and government leaders must act at the highest levels of integrity, insist on integrity in all levels of their organizations, and motivate transparency. In short, anything done in their professional dealings should stand the test of transparency.
Bilanzfälschung - ein teures Spiel
Das Fälschen von (Finanz-)berichten wird meist von „ganz oben“ durchgeführt. Problematisch wird es für Compliance-Verantwortliche, wenn diese durch das Management beeinflusst werden. Dementsprechend ist Hartnäckigkeit und Standhaftigkeit gefordert.
Es gibt viele Gründe für eine Berichtsfälschung. Folgende ein paar Beispiele:
- Einhalten eines internen Belohnungssystems (z.B. Bonus, Gehaltserhöhung)
- Verbergen der aktuellen Firmenergebnisse um z.B. Wettbewerber, Käufer oder Kunden zu beeindrucken – zu täuschen
- Vollständige Transparenz
- Rotierende Wirtschaftsprüfer
- Etablierung einer entsprechenden Firmenkultur
- Erreichbare Ziele und Belohnungssysteme
Um Bilanzfälschungen Einzug zu leisten ist insbesondere eine kulturelle Wandlung notwendig, Fairness und Integrität müssen belohnt werden. Transparentes Handeln und Dokumentation sind notwendig und zwar auf allen Organisationsebenen.