FINANCIAL FRAUDS INVESTIGATION USING COMPANY BUDGETS INFORMATION

Transcription

1 FINANCIAL FRAUDS INVESTIGATION USING COMPANY BUDGETS INFORMATION Rūta Klimaitienė 1, Živilė Grundienė 2 1 Vilnius University Kaunas Faculty of Humanities, Lithuania, r.kalcinskaite@paciolis.lt 2 Vilnius University Kaunas Faculty of Humanities, Lithuania, grundiene@vukhf.lt Abstract Frauds have a large influence on every company s financial statements and activity results; it s image, competitiveness and activity continuity. Frauds reduce financial statements reliability and it s worth as significant information source. One of the main ways to implement financial frauds is pre-planning, which can be done using budgets. For some companies the budgets have become the main instrumentality for planning not only their ordinary activity, but also and financial frauds. So it is very important to found out how the information of company budgets can be used for detecting the financial frauds. Therefore the technique of financial frauds identification using company budgets information was constructed. Keywords: financial fraud, identification, management accounting, budgets. Introduction Large financial affray constantly rise because of fraud, scandals of large companies, such as Enron Corp., Waste Management, Sunbeam, Lucen, Xerox, MicroSrategy, Knowledge-Ware, Raytheon, Cendant, and Rite Aid, this brings monstrous loss for market participants. Therefore it is very important to detect financial frauds, find out fraud motivations, means, considerations (Mackevičius, 2009). Financial crime Investigation Service under the Ministry of the Interior of the Republic of Lithuania in 2008 detected 33 million Lt hidden taxes, and during pretrial investigation analysis natural persons and legal persons have voluntarily compensated 11 million Lt damage to state budget. Budget is a quantitative plan of activities and programs expressed in terms of assets, liabilities, revenues, and expenses. Budget participants will be involved in carrying out the plan. The budget expresses the organizational goals in terms of specific financial and operating objectives (Dictionary of accounting terms, 2000). The scientific literature analysis of company financial fraud issues (Loebbecke et al, 1989; Spathis Ch.; Doumpos M.; Zopounidis C., 2002; Rezaee, 2002; Howard, S., Howard, R. D., 2005; Wells, Joseph, T., 2008; Albrecht, W. Steveet, et al, 2009) and budgets issues (G. A. Welsch, R. W. Hilton, P. N. Gordon, 1988; R. H. Garrison, 1988; J. Sizer, 1989; J. K. Shim, J. G. Siegel, 1994; C. Drury, 1996; J. Hope, R. Fraser, 2003; B. Bogsnes, 2009) showed that there is a strong focus on separate analysis of these themes. But still there is a huge scientific literature gap exploring the identification of company's financial frauds using the budgets information. Besides there has not been done any research in this area. The purpose of this paper is to gain an understanding of how the financial frauds can be identified using the company s budget information. The object of this paper is the company's financial frauds. In order to achieve the purpose the authors set up the following tasks: 1) Analysis often using company financial frauds schemas; 2) To present the importance of the company budgets detecting the financial frauds; 3) Construct technique of financial frauds identification using company budgets information. Methodology and approach of this paper are carried out using latest literature of financial accounting, management accounting and financial frauds professionals. The methods used are: reviewing, systematic literature analysis, generalization and interpretation. Financial frauds common schemas Management may attempt to use constructed accounting techniques to make the company look good financially by engaging in financial statement fraud. Auditors should have a healthy skepticism when auditing financial statements. Taxonomies of financial statement fraud are also developed to identify common fraud schemes (Rezaee, 2009). Various authors distinguish these common financial frauds schemas: 960

2 Table 1. Financial frauds common schemas Eil. Nr. 1. Rezaee Improper revenue recognition Albrecht, W. Steve et al. Revenuerelated fraud Golden et al. Timing Wells (2008) Asset/Revenue overstatements and understatements Singleton (2006) Timing differences Overstatement of assets other than accounts receivable Understatement of expenses/liabilities Misappropriation of assets Inappropriate disclosure Other miscellaneous techniques Inventory and cost of goods sold frauds Understating liabilities Overstatement of asset fraud Inadequate disclosure fraud Other type of financial statement fraud Improper accounting for construction contracts Related-party transactions Revenue and receivable misappropriation Inflating the value of receivables Improperly holding open the books Other schemes and misappropriations Timing differences Fictitious revenues Concealed Liabilities & Expenses Improper disclosures Improper assets valuations Fictitious revenues Concealed liabilities Inadequate disclosures Improper asset valuation Improper revenue-recognition is the availability of acceptable alternatives for recognizing revenue and is the ease of manipulating net income using revenue and receivable (Albrecht, W. Steve et al., 2009). Most improper asset valuations involve the fraudulent overstatement of inventory or receivables. Other improper asset valuation include manipulation of the allocation of the purchase price of an acquired business in order to inflate future earnings, misclassification of fixed and other assets, or improper capitalization of inventory or startup costs (Wells, 2008). The auditor may also consider timing, particularly as it relates to the company s quarterly and year-end periods. In which periods were the sales agreements obtained? When was the product or equipment delivered? When did the buyer become obligated to pay? What additional services were required of the seller? As these questions suggest, the timing of transaction can be manipulated to accelerate revenue recognition (Singleton, 2006). Often associated with deliberate actions by management no to disclosure material financial information either within the body of the financial statements, in they related footnotes, or in its Management s Discussion and Analysis (MD&A) (Rezaee, 2009). The easiest way to identify understatement of liability fraud exposures is to identify the various transactions that involve liabilities and can be understand. In the identifying these transactions, need accurately specify the type of organization, which are dealing with, because different kinds of companies have different types of liabilities and liability-fraud exposures (Albrecht, W. Steve et al., 2009). Transaction between related parties are often difficult to audit because they are not always accounted for in manner of collusion always exists, given that the parties are, by definition, related. Internal controls, moreover, might not identify the transactions as involving related parties. While related-party transaction may involve improper revenue recognition, they may also involve other parts of the balance sheet or income statement. Inflating the value of legitimate receivables has the same impact as creating fictitious ones. Generally Accepted Accounting Principles requires accounts receivable to be reported at net realizable value the gross value less an estimated allowance for uncollectible accounts. A related scheme involves not writing off or the delaying of the writeoff of receivable that have, in fact, become uncollectible (Golden et al., 2009). Following an analysis of scientific literature, noted that the three most commonly used in financial fraud schemes are: overstatement of assets and revenues; false, inadequate, or omitted disclosures; understatements of liabilities and expenses. These schemes are made to cheat consumers of information, which are unseen true and fair situation of the company, so it is important to analyze companies budgets. The importance of the company budgets detecting the financial frauds Financial accounting is usually concerned with the external requirements of shareholders and prospective investors. The financial statements have always to detect the true and fair situation of the 961

3 company for external information users. Unfortunately, this is not always the case. The internal information users sometimes want to beautify the company performance for many reasons. And if it happens the internal information users need to get the information about the real situation of the company, because it will be not reflected in financial statements. The real situation could be seen in the budgets of the company and this information is available only for internal information users. For the other public institutions, such as the Financial crime Investigation Service, it is available only with the court permission. So these institutions are always interested to get such type of information. Planning is an inescapable part of all rational human activity. Because of its importance to organizations their planning processes have become refined and structured in order to improve their efficiency (Lucey, 1992). The main planning tools of the company activity are budgets. Budgets assist department areas such as marketing, management, personnel, production, purchasing, quality control, research, distribution, legal, and engineering. Each manager should have his own budget priorities and how he fits in. The manager must set his overall goals and find ways to accomplish them. Some objectives are profit and return on investment of maximization, improving the sales base, cost minimization, increasing production volume, generating cash flow, and improving product or service quality (Shim & Siegel, 1994) The budget is the written expression of management's plan for the future (Usry et al., 1988). Budget is a detailed plan, expressed in quantitative terms, that specifies how resources will be acquired and used during a specified period of time (Hilton, 1991). A budget is a detailed plan outlining the acquisition and use of financial and other resources over some given time period. It represents a plan for the future expressed in forma quantitative terms. The act of preparing a budget is called budgeting (Garrison, 1998). Generally speaking, budget is a financial plan of income, expenses, and profits. Everyone can agree, that the information that appears in budgets is very important for making management decisions. On the other hand, some of the problems with traditional management are directly linked to budget ant budgeting (Hope &Fraser, 2003; Bogsnes, 2009). But still, this is not the object of the paper, how the budgets of the company should be prepared. It is very important to realize that the information that is reflected in the budgets is very necessary for management decisions, because this information reflects the true and fair situation of the company. One of the great values of budgeting is that it requires managers to give planning top priority among their duties. Moreover, budgeting provides managers with vehicle for communicating their plans in an orderly way throughout an entire organization (Garrison, 1998). One of the main budgets functions is planning (Usry et al., 1988; Welsch et al., 1988; Arnold & Hope, 1990; Hilton, 1991; Lucey, 1992; Shim & Siegel, 1994; Garrison, 1998; Hope &Fraser, 2003; Mackevičius, 2003; Kalčinskas, 2007; Bogsnes, 2009). Planning is the process of developing enterprise objectives and selecting a future course of action to accomplish them. It includes establishing enterprise objectives, developing premises about the environment in which they are to be accomplished, selecting a course of action for accomplishing the objectives, initiating activities necessary to translate plans into action, and current preplanning to correct current deficiencies (Welsch et al., 1988). It follows that the budgets are obviously useful for company activity. But there is one main clause that deals with budgets. One of the main ways to implement financial frauds is pre-planning, which can be done using budgets. For some companies the budgets have become the main instrumentality for planning not only their ordinary activity, but also and financial frauds and other illegal acts. Some companies in their budgets define such indicators as: The fines, which they are considering to pay for their illegal activity in the future. The bribes, which they are considering to pay for the other business users. The illegal use of company's assets. The fair value of the company's property, which is not truly reflected in the financial statements. The fair value of the companies revenues, which are not truly reflected in the financial statements. The illegal workers. The different depreciation methods from financial accounting and etc. If the company uses budgets and misfortunes execute financial frauds or other illegal acts there is a very large probability that it will be reflected in its budgets. Because for the internal information users it is the only way to see the real companies view, for example, the real information about the products prime cost which will consist not only from variable and fixed expenditures, but also there will be included, for example, bribes or illegal workers salary and etc. Surely this information will be not reflected in the financial statements, but can be seen in the budgets of the company if illegal acts are carried out. 962

4 Principled scheme of financial frauds identification When we define often used corporate financial fraud schemes and when we distinguish corporate budgets provided useful information, we have constructed a principled scheme of financial frauds identification using company budgets information. Figure 1. Principled scheme of financial frauds identification using company budgets information In fraudulent financial statements often overstates the assets (improper asset valuation), revenues (improper revenue recognition) and reduced liabilities (improper deferral of expenses and liabilities) and expenses (improper depreciation, amortization, deletion, and write-offs). Fraudulent financial statements information can be compared to the budgets of companies that provide useful information on a true company's situation and can help identifies financial statements frauds. For example, to determine whether the company's assets and income do not overstatement, it is necessary to compare the financial statement to income and balance budgets. To verify that the company liabilities correctly recorded in the financial statements, it is necessary to compare the financial statement to the liabilities budget. To verify that the operating expenses correctly recorded in the financial statements need information from budgets of production gross expenditure, products costs, products expenditure, general and administrative expenses budgets, cash flow and other. Therefore, the workers of the Financial crime Investigation Service must have the basic knowledge about management accounting and one of the main instruments 23- budgets. They should know the role of budgets, the advantages and disadvantages of budgets, the purposes and functions of budgeting systems, the components of a master budget, the types of budget. Only in this way the principled scheme of financial frauds identification can work properly in the practice. Conclusions 1. After research analysis of literature transpires three primary and often using financial frauds schemas: overstatement of assets and revenues, false, inadequate, or omitted disclosures, understatements of liabilities and expenses. Overstatement of assets and revenues involve improper asset valuation and improper revenue recognition. False, inadequate, or omitted disclosures are intentional actions by management no to disclosure material financial information either within the body of the financial statements. Understatement 963

5 of liabilities and expenses are made improper deferral of expenses and liabilities and improper depreciation, amortization, deletion, and write-offs. These schemes are being misled users of financial statements. 2. Planning is the process of developing enterprise objectives and selecting a future course of action to accomplish them. The main planning tool of the company activity are budgets. One of the main ways to implement financial frauds is pre-planning, which can be done using budgets. For some companies the budgets have become the main instrumentality for planning not only their ordinary activity, but also and financial frauds and other illegal acts. If the company uses budgets and misfortunes execute financial frauds or other illegal acts there is a very large probability that it will be reflected in its budgets. For the internal information users it is the only way to see the real company view. 3. After the literature analysis, we have constructed a financial fraud identification principled scheme using companies budget information. This is one of the methodology/technique helps to detect financial statement fraud. The workers of the Financial crime Investigation Service must have basic knowledge about management accounting and one of the main instruments budget if they want to use this technique. References 1. Albrecht, W. S. & Albrecht, C. C. & Albrecht, Ch. O. & Zimbelmam, M. F. Fraud examination, 3rd edition. South-Western Cengage Learning 2. Arnold, J. & Hope, T. (1990). Accounting for management decisions. UK: Prentice Hall International. 3. Bogsnes, B.. Implementing beyond budgeting. United States of America: Wiley. 4. Financial crime Investigation Service under the Ministry of the Interior of the Republic of Lithuania 2008 performance report [interactive] Access via the Internet: 5. Garrison, R. H. (1988). Managerial accounting. United States of America: Business Publications, Inc. 6. Golden, W. T. & Skalak, L. S. & Clayton, M. M. A Guide to To Forensic Accounting Investigation. John Wiley&Sons. 7. Hilton, R. W. (1991). Managerial accounting. United States of America: McGraw - Hill, Inc. 8. Hope, J. & Fraser, R. (2003). Beyond budgeting: how managers can break free from the annual performance trap. Boston: HBS Press. 9. Howard, S. & Howard, R. D. (2005). Fraud 101: Techniques and Strategies for detection. Second Edition. John Wiley&Sons. 10. Kalčinskas G. (2007). Buhaterinės apskaitos pagrindai. Vilnius: Pačiolis. 11. Loebbecke, J. & Eining, M. & Willingham, J. (1989) Auditor s experience with material irregularities: Frequency, nature, and detectability, Auditing: A Journal of Practice & Theory, 9: Lucey, T. (1993). Costing. London: DP Publications Ltd. 13. Mackevičius, J. (2003). Valdymo apskaita. Vilnius: TEV. 14. Mackevičius, J. & Kazlauskienė, L.. The fraud tree and its investigation in audit. Ekonomika Nr Rezaee, Z. (2002). Financial statement fraud, prevention and detection. Jon Wiley&Sons, Inc. 16. Shim, J. K., & Siegel, J. G. (1994). Budgeting basics and beyond. United States of America: Prentice Hall. 17. Singleton, W. Tommie, Singleton J. Aaron; Bologna G. Jack; Lindquist J. Robert (2006) Fraud auditing and forensic accounting. Third Edition. John Wiley&Sons, Inc. 18. Spathis, Ch. & Doumpos M. & Zopounidis, C. (2002). Detecting falsified financial statements: a comparative study using multicriteria analysis and multivariate statistical techniques. The European Accounting Review Usry, M. F. & Hammer, L. H. & Matz, A. (1988). Cost accounting. United States of America:South - Western Publishing Co. 20. Wells, J. T. (2008). Principles of fraud examination 2nd edition. Published by John Wiley&Sons. 21. Welsch, G. A., & Hilton, R. W., & Gordon P. N. (1988). Budgeting. Profit planning and control. United States of America: Prentice Hall, Inc. 964