Financial statement fraud

What does financial statement fraud mean?

It can be defined as intentional misstatements, and/or omission of important transactions and events in the company’s business, made in order to deceive the financial statements users, especially investors and creditors. Financial statement fraud has various forms: modification, intentional omission or unauthorized inclusion of transactions, events, accounting records or other important information reported in the financial statements.

Financial statement fraud also includes the intentional misuse of accounting principles, regulations and guidelines when assessing and making public economic events and business transactions.

Methods of financial statement fraud:

• Overstated revenues and assets
• Understated expenses and liabilities
• Concealed liabilities
• Timing differences
• Incorrect valuation of assets

Financial statement fraud does not result in direct loss or direct financial benefit for the offender. Its consequence is an indirect benefit, either in the form of better credit conditions, higher remunerations or improved financial standing of the company. However, these indirect effects ultimately cause huge losses to the companies affected.

Financial statement fraud is usually committed by middle and senior company management as only these people have access to accounting data and IT, manage company assets and approve individual transactions. As a result, this type of fraud is harder to identify and detect.

Motives

The motives for financial statement fraud include mainly the desire:

• To meet the expectations of owners, banks, creditors and financial analysts
• To obtain and keep favorable credit terms, to meet criteria set by financial institutions for obtaining/renewing a loan
• To meet performance criteria set by the parent company
• To meet the personal performance criteria necessary to receive financial bonuses
• To inflate the company value when expecting its sale, merger or acquisition
• To create “redundant” profit and transfer it to another accounting period
• To maintain the impression of constant economic growth of the company

Indicators

Indicators of financial statement fraud include:

• Rapid increase in sales or unusually high profit compared to other companies in the same industry
• Significant transactions with related parties, that took place outside the usual business
• Significant, unusual or very complex transactions, especially at the end of an accounting period
• High turnover with customers whose owners are anonymous
• Assets and liabilities, revenues or expenses based on estimates which are difficult to support by evidence
• Company bank accounts, subsidiaries or branch operations in tax havens for unclear economic reasons
• Unusual changes in the ratio between fixed assets and depreciations