Fraud is an intentional action to do something that is illegal or unethical. It is done to cause damage to the receiving party. Many a times fraud is also done to gain something which could be money or inside information or knowledge. Fraud is a criminal offence. It cannot be justified. Many companies have gone through the fraud and there have been cases where the fraudster has been punished.
Revenue fraud is a type of fraud which affects the revenues of a company. It is done to manipulate the accounts and earn profits. Simply overstating or manipulating the revenues can cause a revenue fraud. It is the simplest form of fraud. Over statement of revenue can make the readers believe that the company is generating adequate income and hence can make investors think that it is a worthwhile investment. There are various ways one can do revenue fraud with. Various items are shown in the income statement and balance sheet of the company. Manipulation of the accounts can lead to revenue fraud. Revenue recognition in the wrong quarter can also lead to the same. Differing expenses over a period of time can also lead to fraud cases. There are various methods of manipulation of accounts and each has a different effect on the financial statements. There have been instances where manipulation was not discovered for a long period of time and the auditors also provided an unqualified opinion of the same.
In most cases, fraud involves senior level executive who has been associated with the company for a long period of time. The executive has knowledge about the company and holds a financial position of a higher level. It helps that the executive has enough power and position to create a fraud. Along with the fraudster there is always one or two people engaged in the cause. Most commonly affected industries are finance and production units which have large base and employ a large number of people. A typical fraudster is someone aged between 35 to 40 years and is engaged in the company for more than 10 years. He holds a senior level position and involves another person in his act of fraud. It is also seen that frauds take place with companies listed on a stock exchange, this is done to manipulate the price of the shares which eventually affect the company. The owner of the company like the Global Crossing fraud, holds the manipulation of accounts and convinces the employees as well as auditors to not raise an issue. Thus making sure that it is not discovered for a long period of time. The owners of the business have the maximum power. They can ensure that no information regards the fraud goes outside of the company. Senior level executives also gain adequate power and freedom to make decisions on their own thus ensuring that the rest of the executives agree to the decisions made by them.
The most common among them is misstatement of accounts. There are various ways of manipulation of accounts. Overstatement of revenue or understatement of accounts leads to a fraud situation. The effects of both are seen on the profits and thus the company is affected as a whole. Profits have an impact on the value of shares and the shareholders as well as investors. Overstatement of revenue is done by understatement of cost of goods, capitalization of revenue expenses and manipulating the life of depreciable assets. Understatement of cost of goods will show a higher sales and higher profits. Capitalization of revenue expenses will reduce the revenues and show higher profits. Not many expenses can be capitalized, they are shown in the day to day expenses of the company. But capitalization of revenues will reduce the expense and show higher profits. Depreciation is a revenue expense and cannot be capitalized. It is charged on the overall life of the machine. If the life of the asset is manipulated, the depreciation will be affected and an increase in the life of the asset means a lesser depreciation to account for. These are the various ways revenue can be overstated. Similarly understatement of expenses leads to a higher profit. This can be done by not recording expenses, hiding liabilities and not recording lease expenses. Lease expenses should be properly recorded and document. If they are not recorded, it will lead to higher profits. Hiding liabilities or not recording expenses will also lead to overstatement of profit. Purchase prices of various raw materials can also be affected and shown at a lower rate to show higher profits. This is done to ensure that the expense are less and the revenue is growing. Many a times, the executives also change the prices in the invoices so as to leave no traces of manipulation. The accounts of previous years need to be referred in such cases . All these methods can be used to manipulate the accounts. It is difficult to recognize such acts from the financial statements of a company. Once discovered, it is difficult to find the accurate amount and its effect on the finances.
This type of fraud is commonly detected through an effective whistle blower program. Frauds have been discovered with efficient provision of a whistle blower program. The employees are given protection and they are allowed to report any questionable practices going on in the company. Majority of frauds are discovered through whistle blowers. Another technique is to observe change of auditors. 26% of companies which were involved in fraud cases changed the auditors from before the fraud and during the period the fraud was recorded. Any change in auditors should be a red signal and in depth investigation should be carried out. One technique is to question extra ordinary or complex transactions. Issues like a swap deal or insider trading should be questioned and it should be seen that how is it reported. Detailed information of such rare and complex transactions should be made available. Analyzing accounts receivable also provides information about the financial statements. Uncollectible accounts and accounts receivable should provide enough information to detect revenue frauds.
Premature revenue recognition can be detected by reviewing the sales invoice and comparing the prices on the invoice with the published prices. A company can also boost income by delaying the expense recognition. This can be detected by checking the accounts payable and reviewing the unpaid bills. One technique is to analyze any major change in the assets or liabilities of the company. Any major purchase or sale of assets should be reflected in the balance sheet, the income or expense of the same should be studied. A logical explanation of the change should be asked for. When cash flow does not match with the revenue growth, it should be questioned. Any revenue increase should be corresponding to the cash flow statement. Similarly the operating expenses should match with the expenses shown in cash outgoings. The investments made during the year should be reflected in the cash flow statement as well as the balance sheet. Both the entries should be matched. A cash flow statement provides a lot of information regarding the business transactions of the company. Any gap in the statement should be recorded and further looked into. Loans as well as borrowings provide information about the finances of the company. In case the company has been raising loans, its terms and interest rates should be noted.
One most important way to prevent fraud is an efficient system of internal control. A strong and efficient internal control system will prevent frauds to a large extent. Internal controls are means by which the various employees and departments are controlled and their acts are monitored. The company should set up internal control and make everyone aware of its existence. Bifurcation of duties among various employees leads to prevention of frauds, no one person should be allowed to complete a task from the beginning to the end. Authorization of expenses is another example, all expenses above a certain amount should be authorized by the responsible person. No payment should be allowed to be made without the authorization. Budgeting and variances is another means to prevent fraud. Maintaining a budget and sticking to it ensures that no expenses are over stated or under stated. Internal control helps maintain invoices and provides training to the employees. Internal control also makes it easier for the internal auditor as well as external auditor. Any changes in the day to day activities is recorded by the internal control. Computer based information system also generates various reports and provides adequate information about the company. The employees should also ensure that their computers are at a safe place and there are no chances of manipulation. The risks and threats to a computer system should be studied and implemented.
Variances are used to see the difference between the budgeted and the actual amounts. Budgets can be used to analyze them. Variances can be adverse and favorable. They can be used to take note of any differences in the financial statements. Variances show any significant differences noticed in the statements. The company should ensure that the senior level executives take a leave at a regular period of time. This is to ensure that he is not able to cause any manipulation. It should be noted that all employees take leaves at regular intervals. Fraud prevention also accounts for internal audit and external audit. The internal auditor should ensure the accuracy of accounts and also make sure that there is no manipulation of the accounts once they have been prepared. The external auditor should meet the audit committee once or twice in a year and ensure physical checks on assets. Surprise visits by the auditors also help prevention of frauds. Another method is continuous audit which takes place throughout the year and generates information. In case anything wrong is found in the reports, it is immediately reported and recorded. The external auditor determines if a continuous audit is a necessity or not. Large companies may require it.
Other than internal controls, there are various methods of fraud prevention. They consist of employee screening tests, code of conduct, special fraud training, internal and external audit, audit committee, fraud risk management and whistle blowing hotline system. All of these listed methods are useful in fraud prevention. Internal audit ensures that the accounts are not manipulated and external audits gives an opinion on the financial statements. Audit committee should meet at regular intervals and ensure that there is no manipulation in the statements. A code of conduct or ethics should be made available and proper training should be given to all employees regarding it. Specific training regarding avoidance of fraud should be provided. Employee screening will ensure that the employee has not committed any fraud in his previous place of employment. Background searches also provide information regarding an executive. Internal controls should be implemented in all departments of the company. Starting from purchase to sales to pay roll. There should be a policy for human resource and recruitment. Whistle blower hotline should be made available and the employees should be aware of its existence. They should be encouraged to report any questionable acts taking place in the company. Special education program regarding fraud detection and prevention should be taken by the higher level executives of the company. The most effective method is the code of ethics which should be agreed to by all employees and thus followed. Due diligence to the ethics will ensure a safe work environment. A simple document stating the code of conduct or financial ethics is not enough. What is required is a leadership and the conviction by the employees to follow ethics. Financial ethics are very important in any organization. The company should conduct an awareness program and ensure that the employees are convinced of the importance of good conduct and ethics. Red flags show a sign of a fraud but most companies avoid the information and take no steps until a fraud takes place. Red flags are signs that a fraud may be happening and the company should ensure adequate measures are taken to prevent it. According to a study, majority of companies take no action against a red sign and simply ignore it.
Various fraud cases are detected by SEC and are further investigated. This leads to awareness that no fraud case goes unreported and each one involved will be punished. SEC carries out a thorough investigation and then settles the case. KPMG produces a journal regularly on typical fraudsters and it shows that the fraud cases are only going to increase. A few examples of recent cases of fraud are given here.
A recent case of fraud is by Diamond Foods. The San Frisco based company has been asked to pay $5 million to settle charges of accounting misstatements. The top two executives lied regarding the walnut prices and increased the earnings. This was planned by the chief financial reporter of the company. This was done by pushing the payments to a future period and thus it showed higher incomes in the current period and beat the expectations of the market. This was done to increase the net revenue in the particular fiscal years. This practice led to restatement of financial reports due to which the stock price of the company also fell. The SEC also blames the former executive official of the company regarding the issue. He should have been aware of the manipulative practices going on in the company. There were two sides to the case but the company agreed to pay $125000 penalty to settle the case in addition to the $5 million to settle the civil charges. This is a common practice of manipulation of accounts followed by the company. Understating the expenses or deferring the expenses over a further period of time will ensure adequate profit for the current period. After thorough investigations by SEC, the case was settled and the company had to pay the penalty as well as the fine. Diamond Foods Inc will be under the eye of SEC and the officers will also be required to show proper conduct and ethics. In 2012, the company had to bring out the manipulations and the financial statements were restated affecting the employees and the share prices. The case is closed now after the agreement to pay $5 million for settlement.
Another fraud case involves HSBC bank which paid $2.46 billion for settlement with SEC. The lender was Household International who was a major lender for people with blemished credit histories and HSBC had agreed to buy it in Nov 2002. The suit was first filed in 2002 alleging Household International of a manipulating the financial statements and making misleading statements. This lead to inflation of the price of company’s shares. This also gave a wrong impression to the creditors and investors. HSBC still plans to appeal further with additional information discovered from the bank’s findings.
Another massive fraud case involves Robert Lynn who was sent to prison for a 15 year term over faking of financial records of the defunct soft drink maker Le -Nature. It was an $800 million fraud scheme. Tammy Jo who helped in the whole scam was also given a 5 year term along with a 5 year probation period after the release from prison. This cost the lenders around $684 million. The magnitude of the fraud was enormous and so were the representations. Hence the punishment also had to be this harsh. In the investigations, the officials found millions of dollars’ worth of gold, silver and platinum which was hidden in a room. The nature of frauds collapsed when the company was forced into bankruptcy in 2006. A court appointed official uncovered most of the fraud and investigations began. The amount involved is extremely high and also there was proof in the mansion as well as the secret room. The punished have to serve their time in prison. The main reason this was done was to show higher profits and spend the amount in the lavish lifestyle. Manipulation of accounts was the one way this could have happened. But the manipulation reached a high extent and the fraud was eventually discovered. After investigations and appeals, the court has sentenced the accused to prison.
This shows that fraud cases if reported, are always settled and no company can repeat the same scheme. Because a lot of cases go unreported, there are occurrences of fraud. SEC ensure investigations into the matter and it is settled. The accused are punished and the interest of the stakeholders are protected. Adequate attention to red flags and awareness of any questionable acts in the company will ensure that the frauds do not happen.
These are just a few examples of recent fraud cases. There have been large fraud cases in the history involving huge amount and a large number of people. Enron, Global Crossing etc. These went into bankruptcy but are doing well now. A fraud can be dealt with if discovered at the right time. For detection of fraud, timing is everything. If the fraud is not detected over a long period of time, it might be difficult for the company to function again. There will be investigations and suits against the company and it will lose faith of the employees as well as the investors. Hence discovery of fraud is important but what is equally important is the timing. Many a times the SEC keeps a close watch on the company and the frauds are discovered on time to save the economy as well as the stock market from huge effects. All companies listed in the stock exchange have an effect on the economy with the restatement of the accounts. A direct reflection can be seen in the prices of the shares of the company.
Works Cited
Dutta, Saurav K. The challenges in Forensic Accounting. 23 July 2013. <http://www.ftpress.com/articles/article.aspx?p=2101527&seqNum=3>.
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Lynch, Sarah N. Diamond Foods to pay $5 million to settle SEC fraud case. 09 Jan 2014. <http://www.reuters.com/article/2014/01/09/us-diamond-sec-accountingfraud-idUSBREA0813020140109>.
Rives, Wray. 10 steps to detecting and defecting fraudulant financial reporting. 09 Oct 2012. <http://www.cpa2biz.com/Content/media/PRODUCER_CONTENT/Newsletters/Articles_2012/CPA/Oct/FraudDetectionPrevention.jsp>.
