ACCOUNTEX Conference September 6, 2017 Concealing Fraud in Financial Statements Allan Bachman, CFE Education Manager [retired] Association of Certified Fraud Examiners Austin, Texas Agenda Overview and Definitions What Constitutes Financial Statement Fraud? Magnitude of the Problem Committee of Sponsoring Organizations of the Treadway Commission (COSO) ACFE 2016 Report to the Nations Types of Financial Statement Fraud Gunning Fog Index (time permitting) Agenda Overview Types of Financial Statements Financial Statement Fraud Misleading Financial Statements Definitions Fraud & Fraud Triangle 1
Financial Statement Types Balance sheet Statement of income or statement of revenues and expenses Statement of retained earnings or statement of changes in owners equity Statement of cash flows Notes to financial statements Financial Statement Fraud The deliberate misrepresentation Of the entity s financial condition Accomplished through the intentional misstatement or omission of amounts or disclosures To deceive financial statement readers and users Misleading Financial Statements Financial statements are materially misleading (fraudulent) when the presentation contains: fictions, improper valuations, inappropriate transaction timing, omissions, or false statements that are important enough to affect decisions made by users of the statements. 2
What is Fraud? Wrongful or criminal deception intended to result in financial or personal gain. 7 The Fraud Triangle Opportunity The chance to take advantage of an organization Motivation Perceived un-shareable financial need Rationalization The explanation as to why? 8 Fraud is Hidden Its very nature makes it difficult to measure actual fraud losses. Until discovered, there is no way to know. A tip of the iceberg potential to all of these statistics. 9 3
Financial Statement Fraud Typically involves one or more of the following: Overstating assets, revenues, and profits Understating liabilities, expenses, and losses Outcomes of Financial Statement Fraud Stock price decline Impact on reputation of entity and those involved Lost jobs Lost pensions Lawsuits against company and auditors Potential corporate deathblow Why Financial Statement Fraud Occurs Meet financial analysts expectations. Encourage investment in company stock. Demonstrate increased earnings, allowing increased dividend or distribution payouts. Cover inability to generate positive cash flows. Dispel negative market perceptions. Obtain financing or more favorable terms. Receive higher purchase prices for acquisitions. 4
Why Financial Statement Fraud Is Committed Keep up with competitors. Demonstrate compliance with loan covenants. Meet internal company goals and objectives. Receive performance-related bonuses or otherwise inflate executive compensation. Increase stock value for acquisitions involving stock swaps. Smooth reported earnings. Why Financial Statement Fraud Is Committed Most frauds are committed to make the organization appear more profitable. Some understate assets and revenues for more funding (i.e., government contracts). Revenues might be understated to avoid taxes or to create a cushion for the future. Often does not involve personal gain. Opportunities The absence of, or improper oversight by, the board of directors or audit committee Weak or nonexistent internal controls Unusual or complex transactions Financial estimates requiring significant subjective judgments 5
RTTN Executive Summary Typical organization loses 5% of revenues as a result of fraud. Total losses by cases examined exceeded $6.3 billion. The average loss per case was $2.7 million Direct loss does not include indirect losses It cannot be determined what the actual global losses due to fraud actually are. 19 How Occupational Fraud Is Committed Most frauds originated in the accounting department (16.6%). 75% of frauds were committed in one of these departments: Accounting, Operations, Sales, Customer Service, Purchasing, Finance, Executive/Upper Management 20 How Occupational Fraud Is Committed 21 7