Financial Statement Fraud. An Aronson LLC Webinar Presented by Michael J. Kresslein October 5, 2016

Transcription

1 Financial Statement Fraud An Aronson LLC Webinar Presented by Michael J. Kresslein October 5, 2016

2 Housekeeping The recording of the webinar along with a copy of the slides will be sent to you within the next few business days For any technical inquiries, please use the support tab on the lower right hand side of the interface 2

3 Today s Learning Objectives Can I Rely on an Audit to Detect Fraud? Financial Statement Fraud Schemes How you too can have the eye of a Forensic Accountant 3

4 Financial Statement Fraud Represents a small (but growing?) percentage of fraud cases: o 9.6% of cases surveyed in 2016 ACFE Report to the Nation (9.0% in 2014; 7.6% in 2012) BUT, it involves the largest loss o Median Loss of $975,000 (compared to $120,000 from asset misappropriation) in cases surveyed in 2016 ACFE Report to the Nation 4

5 Role of Outside Accountants Three Levels of Reporting: Audit: the highest level of assurance Review: moderate level of assurance Compilation: no expression of assurance 5

6 Role of Outside Accountants Audit: Examination resulting in a statement of opinion by an independent CPA on the fairness of the financial statements taken as a whole. Auditor must corroborate amounts and disclosures in financial statements through test of accounting documents, physical inspection, third party confirmations, or other procedures. Auditor must understand internal control structure. 6

7 Role of Outside Accountants Review: Engagements in which inquiry and analytical procedures are performed. CPA expresses limited assurance that they are not aware of any material modifications necessary to conform to GAAP. Does NOT contemplate understanding internal controls, assessing control risk, tests of accounting records and responses to inquiries, or other audit procedures. Does NOT provide assurance that accountant will become aware of all significant matters that would be disclosed in an audit. 7

8 Role of Outside Accountants Compilation: Presentation of financial information in the form of financial statements that is the representation of management without any expression of assurance or opinion on them. Accountant not required to make any inquiries or perform procedures to corroborate information. Accountant not required to be independent. 8

9 Assurance for What? Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. 9

10 Assurance for What? What if the Company has audited financial statements? Is the financial statement audit designed to detect fraud? SAS 99 - Consideration of Fraud in a Financial Statement Audit Does NOT require full fraud examination in financial statement audit. Requires auditors to consider how and where financial statements might be susceptible to material misstatement due to fraud. Requires auditors to assess identified risks, gather information, evaluate the company s programs, communicate with management, and document all activities conducted to consider fraud ACFE Report to the Nation: of all U.S. companies studied that were victims of fraud (of any type), 74.2% had external audits of their financial statements. 10

11 Reasons for Financial Statement Fraud Make company look more profitable, to mislead: o Investors o Buyers of a business o Banks (for purpose of borrowing) o Regulators o Other Insiders (e.g., for job security, higher salary/bonus) Conceal other fraud, i.e. asset misappropriation. o 14% of financial statement frauds, according to COSO study 11

12 Common Schemes Improper Revenue Recognition ofictitious revenues ooverstatement of revenues orecording revenue prematurely o Other Timing Differences 12

13 Common Schemes Overstatement of Assets ofictitious assets ooverstatement of existing assets oimproper capitalization of expenses Understatement of Expenses or Liabilities 13

14 Common Schemes Results of COSO Studies Method Used to Misstate Financial Statements 1999 a 2010 b Improper Revenue Recognition 50% 61% Recording fictitious revenue 26% 48% Recording revenue prematurely 24% 35% No description/"overstated" 16% 2% Overstatement of Assets 50% 51% Overstatement of existing assets/capitalizing expenses 43% 46% Recording fictitious assets or assets not owned 12% 11% Understatement of Expenses/Liabilities 18% 31% Misappropriation of Assets 12% 14% Inappropriate Disclosure (with no line item effects) 8% 1% Other Miscellaneous Techniques 20% 20% Disguised Through Use of Related Party Transactions N/A 18% a The 1999 study involved 204 companies reporting fraud from b The 2010 study involved 347 companies reporting fraud from

15 Detection Tools: Financial Statement Analysis Horizontal Analysis: Changes over time are expressed as a % of the prior period Vertical Analysis: Line items expressed as % of total (revenues or assets) Ratio Analysis: Expresses relationships of amounts in financial statements as a % 15

16 Detection Tools: Horizontal Analysis Company XYZ Income Statement 20X5 $ Chg % Chg 20X4 $ Chg % Chg 20X3 Revenues % % 100 Cost of Sales % % 70 Gross Profit % % 30 Oper. Exp % % 10 Oper Inc % % 20 Interest 3 0 0% 3 0 0% 3 Pre tax Earnings % % 17 Taxes % % 5 Net Income % % 12 Company XYZ Balance Sheet (at year end) 20X5 $ Chg % Chg 20X4 $ Chg % Chg 20X3 Cash 20 (1) 5% % 20 A/R % % 25 Inventory % % 40 Other Assets % 8 0 0% 8 Current Assets % % 93 Fixed Assets, Net % % 40 Total Assets % % 133 A/P % % 22 Accrued Exp % % 10 ST Debt 8 0 0% 8 0 0% 8 Current Liabilities % % 40 LT Debt 22 (8) 27% 30 (8) 21% 38 Total Liabilities 69 (4) 5% 73 (5) 6% 78 Common Stock 8 0 0% 8 0 0% 8 Retained Earnings % % 47 Total Equity % % 55 Total Liab. & Equity % %

17 Detection Tools: Vertical Analysis Company XYZ Income Statement 20X5 % 20X4 % 20X3 % Revenues % % % Cost of Sales 60 54% 65 61% 60 60% Gross Profit 52 46% 41 39% 40 40% Oper. Exp % 20 19% 18 18% Oper Inc % 21 20% 22 22% Interest 3 3% 3 3% 3 3% Pre tax Earnings 27 24% 18 17% 19 19% Taxes 8 7% 5 5% 6 6% Net Income 19 17% 13 12% 13 13% Company XYZ Balance Sheet (at year end) 20X5 % 20X4 % 20X3 % Cash 19 15% 18 15% 15 13% A/R 26 20% 25 21% 25 22% Inventory 36 28% 26 22% 25 22% Other Assets 9 7% 8 7% 8 7% Current Assets 90 69% 77 65% 73 65% Fixed Assets, Net 40 31% 42 35% 40 35% Total Assets % % % A/P 17 13% 18 15% 17 15% Accrued Exp. 5 4% 7 6% 8 7% ST Debt 4 3% 4 3% 4 4% Current Liabilities 26 20% 29 24% 29 26% LT Debt 19 15% 24 20% 31 27% Total Liabilities 45 35% 53 45% 60 53% Common Stock 6 5% 6 5% 6 5% Retained Earnings 79 61% 60 50% 47 42% Total Equity 85 65% 66 55% 53 47% Total Liab. & Equity % % % 17

18 Detection Tools: Ratio Analysis Liquidity Ratios o Current Ratio o Net Working Capital Profitability Ratios o Gross Profit Margin o Return on Assets 18

19 Detection Tools: Ratio Analysis Efficiency Ratios o A/R Turnover o Days Sales Outstanding o Inventory Turnover Others o Rate/Volume Analysis 19

20 Detection Tools: Recording Revenue Prematurely Balance Sheet A/R Balance Income Statement Sales Returns and Allowances Terms of Contracts Statement of Cash Flows Cash flow from operations 20

21 Detection Tools: Fictitious Revenue Balance Sheet A/R Transactions? Income Statement Investments Statement of Cash Flows Cash flows from Operations Ratios A/R Turnover 21

22 Detection Tools: Overstatement of Assets Balance Sheet Capitalized costs Deferred costs Estimates Income Statement Deletion of Expenses 22

23 Other Red Flags Draft Financial Statements Late Auditor s Report Audit Report Qualifications Reportable Conditions or Material Weaknesses Turnover in Management Change in Accounting Methods or Estimates Deferred Taxes Reserve for Bad Debts Disclosures in Footnotes Payables to Assets Increasing Suspicious Journal Entries and Adjustments 23

24 Kresslein, Michael, JD, CPA, CFE, CVA Director, Financial Advisory Services Michael J. Kresslein is a Director in Aronson LLC's Financial Advisory Services Group, where he specializes in fraud investigations and commercial disputes. With more than 20 years of experience, he combines forensic accounting, legal and investigative skills to assist his clients with a wide range of forensic and litigation matters, including calculating commercial damages for litigation; conducting investigations regarding embezzlements, accounting improprieties and other matters; and providing expert testimony. Prior to joining Aronson, Michael litigated cases through trial and has substantial experience in all phases of litigation. He is very skilled at drafting expert/investigative reports and in working closely with attorneys to analyze disputes. Highlights include directing a substantial part of the Lehman Bros. bankruptcy examination; nearly three years working on RICO litigation arising out of the Bank of Credit and Commerce International (BCCI) global banking scandal; investigating embezzlement and accounting scandal at Italian-based Parmalat; extensive experience investigating and evaluating tax shelters; litigating or providing expert services for many other cases, including calculating economic damages or otherwise involving accounting scandals, securities fraud, embezzlements and Ponzi schemes; and serving as General Counsel to a technology company. Michael is a CPA in Maryland, Virginia, and the District of Columbia, a Certified Fraud Examiner and Certified Valuation Analyst and licensed attorney. He received a bachelor's degree in business administration from Georgetown University and earned his juris doctorate from the University of Maryland School of Law. Michael has also taught financial accounting as an Adjunct Professor at Georgetown University and has presented seminars on calculating commercial damages, fraud and forensic accounting, and related topics mkresslein@aronsonllc.com 24

25 Contact Information

26 Thank you for attending! Reminder: The powerpoint slides and a recording of the presentation will be ed to you within the next few business days. 26