Evaluating Financial Evidences and Early Detection of

Financial Shenanigans - A study on United Arab Emirates

Rahin Mohammed*, Lilian Gheyath Aladin Salih**

and Srinivas Inguva***

Financial shenanigans are actions that intentionally distort a company’s reported

financial performance and financial condition. Today’s tumultuous corporate and financial
markets and blinding new technologies combine to make accounting fraud much more
high impact and difficult to detect than in the past. There are many financial shenanigans
and tricks that companies have used to fool auditors and investors for decades. This
study aims at identifying 30 techniques grouped into 7 categories that companies use to
trick investors and other stakeholders in the UAE. The present study identifies some
documents that an ordinary investor can use to search for these financial shenanigans
and find out whether the company is using any of those tricks or techniques to inflate the
earnings or deflate the expenses. The main objective of the study is to find out what
financial shenanigan techniques are used in the United Arab Emirates, and what are the
techniques of early detection of financial shenanigans. The results of the findings might
contribute to the literature in the way that it addresses some key points in one context,
which has not been done before. The study also focuses on how the successful
investors, lenders and analysts read the financial reports and investigate other document
and information, searching for clues and finding out how the company actually performed
in the past and how it is likely to perform in the future.

Field of Research: Banking and Finance

1. Introduction

Financial shenanigans are actions that intentionally distort a company‟s reported

financial performance and financial conditions. Today‟s tumultuous corporate and
financial markets and blinding new technologies combine to make accounting fraud
much more high impact and difficult to detect than in the past. There are many
techniques that companies have used in order to fool investors for decades. These
investors find themselves slapped with announcements of accounting irregularities.
These irregularities are called many things, including aggressive accounting, fraudulent
financial reporting and the use of financial shenanigans or techniques to distort the
reported financial performance. All of above have similar effects-that the financial
statements which serve as a foundation for important investment and credit decision
are incorrect, improper, and worse, misleading. In UAE itself, after the recent string of
corporate scandals, people prefer to invest in emerging markets rather than investing

*Mrs. Rahin Mohammed, Graduate Student, College of Business Ajman University of Science and
Technology, Ajman, UAE, email:sarab200@hotmail.com
**Dr. Lilian Gheyath Aladin Salih, Assistant Professor, College of Business, Ajman University of
Science and Technology, Ajman, email: lilyan_gheyath@hotmail.com
***Dr.Srinivas Inguva, Assistant Professor, College of Business, Ajman University of Science and
Technology, Ajman, UAE, email: jrac.srinivas.i@ajman.ac.ae

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locally since they have lost trust. The question here is that why these investors or any
other user of the financial statements wait until the fraud is discovered and share prices
has fallen. Why they wait until the earnings come out when the damages are
irreversible. Successful investors read financial reports and other information,
searching for clues and deducing how the company actually performed in the past and
how it is likely to perform in the future to protect themselves against being torpedoed by
financial scams and gimmicks. According to studies, fraud and financial shenanigans
costs society hundreds of billions of dollars every year and as such it is very important
for investors or the other users of financial statements to know exactly the tricks and
techniques used to distort the financial reporting.

2. Rationale of the Study

The subject under research is quite a popular one today and appears frequently in the
headlines. On the international front, accounting frauds has become a topic of intense
interest not only to the business community but also to the public at large. The
accounting profession responded to the recent changes in the regulatory environment
by issuing several recent reports that provide detailed findings about the current extent
of fraudulent activities and describe key elements of programs and controls that can
reduce the incidence of such fraud. There studies make clear that the profession
realizes that it must adopt a more proactive approach to the detection and prevention of
fraud. This research study has been conducted analyze the effectiveness of detecting
accounting frauds and financial shenanigans early by investors through the useful tools
to start the search. The present study focuses light on how the number and size of
financial statement frauds are increasing and how to identify the early warning signs
that the company is in trouble or hiding a problem before the damages become
irreversible. The results of the findings might contribute to the literature in the way that it
addresses some key points in one context, which has not been done before.

3. Methodology and Sampling

The epistemology of this research is based on positivism school of thought, in which the
natural model of science is borrowed in order to test the hypothesis. The ontology of the
research is based on objectivism because the research strategy was quantitative and
hypothesis is tested based on statistical measures and evidence. The approach
followed to do this research is deductive in which first it is started with theory and then
based on it the hypotheses are developed. The data for the study is collected using a
structured questioner in order to test my hypotheses. The Purposive or judgmental
sampling is used in this study . The sample was based on the number of auditing firms
in the UAE and the sample size chosen is 50 which were determined based on its
relationship to the size of population which was relatively small. The collected data is
interpreted and analyzed to draw conclusion and suggest recommendations. The set
hypothesis of the study is that the Investors can detect financial shenanigans early, prior
to discovery of fraud.

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4. The Objectives of the Study

1. To find out specific techniques that are used to find out financial shenanigans
2. To explore the means of detecting accounting gimmicks and fraud in financial
reports.
3. To determine reasons why do shenanigans exist

5. Limitations of the Study

This is purely an area specific study conducted within the purview of UAE. This study
was conducted based on case study design. One of the main limitations of this research
design is that the findings of the research cannot be generalized to other cases.

6. Review of Literature

The majority of previous studies investigating the different risk factors associated with
financial fraud have focused on investigating misreporting as the dominant factor. After
the infamous accounting scandals, awareness increased that proper functioning of not
just the capital markets but the entire economy was dependent on the reliability and
transparency of financial statements. Several studies were conducted about problems
of illegalities in the accounting profession, famously called the „The Financial Numbers
Game‟.

According to Donald Cressey conducted research in the 1950s is an effort to determine

“why” fraud is committed. He interviewed approximately 200 embezzlers in prison. One
of the primary conclusions of his research was that virtually every fraud had three
elements in common: Pressure or motivation, Rationalization (of personal ethics); and
Knowledge and opportunity to commit the crime. Three points form the corners of what
is known as the FRAUD TRIANGLE. The majority of previous studies investigating the
different risk factors associated with financial fraud have focused on investigating
misreporting as the dominant factor.

According to the Nancy R. Jay, Atul K. Saxena, Vijaya Subrahmanyam, Ronald W.

Best, 2007, the financial scandals due to accounting fraud in corporate America have
created interest among researchers investigating possible motivations and signs for
early detection. This research has used publicly available financial information of firms
to address the basic question of whether accounting fraud is predictable and examines
the changes in variables over time to identify possible indicators of fraud. This paper
has investigated the changes in financial variables over time to determine if they can
identify accounting fraud. The findings seem to indicate that fraud may be associated
with declining performance of the firms. Discontinued operations increase and leverage
increases while bankruptcy becomes more likely. Fraud firms decrease in size and
show increases in doubtful receivables.

The Study of Jay Dawdy, published in Internal Auditor Magazine, April 2009 points out
that „Quality at the top‟ is very important. If company executives don‟t incorporate, an
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environment will exist where fraud can flourish. At WPS, the tone at the top was clearly
lacking. The CEO aggressively pushed earnings targets, and other members of man-
agement resorted to financial manipulation to meet these goals. Studies have shown
that when senior management is involved in financial statement fraud, the fraud tends to
go on longer and be more significant. This was certainly the case at WPS, and the
company suffered disastrous consequences.

7. Present Study

It can not be known in advance which companies do publish misleading information, it

is wise to be a bit suspicious of all companies and to search for early warning signs of
problems. Such signs often include:

- A weak control environment ( lack of independent members on the board of

directors or lack of competent/independent external auditor)
- Management facing extreme competitive pressure
- Management known or suspected of having questionable character

It‟ is important to be alert for above mentioned factors in following types of companies:
- Fast-growth companies whose real growth is beginning to slow
- companies that are struggling to survive
- Newly public companies
- Private companies

It is an undeniable fact that the growth of all fast-growth companies may slow at some
points in time. At that point, managers may be tempted to use accounting gimmicks. As
a result, investors should be always alert for shenanigans in all such companies.
However unless and until noticing the tricks which are used to fool and deceive
investors it is not possible to detect them. In the present research study the authors
have identified most common financial shenanigans and the most used techniques to
trick investors and other stakeholders.

8. Seven Financial Shenanigans

Recording Revenue Too Soon or of Questionable Quality
Recording Bogus Revenue
Boosting Income With One-Time Gains
Shifting Current Expenses to a Later or Earlier Period
Failing to Record or Improperly Reducing Liabilities
Shifting Current Revenue to a Later Period
Shifting Future Expenses to the Current Period as a Special Charge

According to The respondent‟s respond (50 professional auditors) Recording Revenue

too soon is the most widely used category of financial shenanigan.

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 The Most commonly Used Techniques in The UAE
Recording Revenue too
4% soon
Recording bogus revenue
4%
12% Boosting income with one-
46% time gain
10% Shifting current expenses to
later period
10% Improperly recording
14% liability
Shifting current revenue to
later period
Shifting future expenses to
current as special charge

8.1: Recording Revenue Too Soon or of Questionable Quality

Perhaps the most common financial shenanigan related to revenue recognition is

recording revenue too early, which can be either before the earning process has been
completed or before an unconditional exchange has occurred. There are six different
techniques used under shenanigan number one.

1. Recording revenue when future services remain to be provided

2. Recording revenue before shipment or before the customer‟s unconditional
acceptance
3. Recording revenue even though the customer is not obligated to pay
4. Selling to an affiliated party
5. Giving the customer something of value as an exchange for something else(
bribe)
6. Grossing up revenue.

Below are the most used techniques in the UAE under the first category of financial
shenanigan:

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 The Most widely Used Technique to Record Revenue Too soon
60% 54%
50%

40%
32%
30% Series1

20%
10%
10%
2% 2%
0%
Recording Recording Recording Selling to Giving customer
unearned revenue before revenue when affiliated party something of
revenue as customer's customer not value (Bribe)
revenue acceptence obligated to pay

8.2: Recording Bogus Revenue

Before relying on representations in financial reports, successful investors first make

sure whether those reports tell the company‟s economic story fairly and completely.
Investors should act like art dealers who try to separate real from the fakes. One
example of the “Fake” on financial statements is fictitious revenue. The Below Chart
illustrates the most widely used techniques to record bogus revenue.

Techniques for Recording Bogus Revenue

40% 40%
35%
34%
30%
25% 26%
20%
15% Series1
10%
5%
0%
Recording sales Recording cash Recording
that lacks economic received in lending investment income
substance transaction as as revenue
revenue

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8.3: Boosting Income with One-Time gains

Managers have their own way of creating something from nothing when it comes to
profits. Below are some of those easy-to-use techniques for this purpose:
Techniques used to Boost Income with One-Time
Gains

22% Boosting profits by selling

30%
undervalued asset

Including investment
48%
income as revenue

Reporting investment
income as reduction in
operating expense

8.4: Shifting Current Expenses to a later or Earlier Period

By shifting current expenses to a later period, the company can show higher income.
This trick works very well especially in the UAE, because there are no tax payment
obligations here. Below are some tricks used to boost profits by excluding expenses.
Techniques used to shift expenses to later or earlier
54% period
55% Capitalizing normal
operating costs
50% 46%
Changing A/c policies and
45% shifting expenses to earlier
period
40%
Capitalizing
Changing
normalA/c
operating
policiescosts
and shifting expenses to earlier period

8.5: Failing to Record or Improperly Reducing Liabilities

Some companies follow the policy of disclosing as little as possible about their potential
obligations and liabilities. Below are some techniques used to deflate the liabilities.

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 Techniques used to Improperly Record Liabilities
Failing to record expenses
& relate liabilities when
10% 24% future obligations remain
Reducing liabilities by
changing accounting
assumptions
66%
Releasing questionable
reserves into incime

8.6: Shifting Current Revenue to a later Period

The objective of shenanigan no. 6 is to deflate current profits and shift them to a later
period when the need for them is greater. This strategy may be more attractive in the
following two scenarios:

1. A very healthy company creates reserve for the coming years in which they
expect lower profit
2. A company that is about to be acquired, intentionally holds back revenue until
after the merger, to benefit the acquirer.
The following are two major techniques for doing so.

Techniques used to Shift Current Revenue to later

period
100%
80%
50%
20%
0% Series1
Creating reserves & releasing
Improperly
them
holding
into income
back revenue
at laterjust
period
before acquisition closes

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8.7: Shifting Future expenses to current period as a Special Charge

When companies face troubled times because of business slowdowns and other
problems, their managers may take some actions or bookkeeping steps to inflate the
income of the future years. In order to do this, they may shift future year‟s expenses into
the current period as a special charge, thereby relieving tomorrow‟s earnings of those
burdens. In other words, one of the benefits of taking special charges is that future
year‟s income will be inflated because future expenses will have already been written off
through the charge. The following are some of the techniques used to shift future
expenses to the current period:

Techniques to shift Future Expenses to Current

Period Improperly inflating the
amount included in special
34% charge
Improperly writting-off in
56%
process R&D costs from an
10% acquisition
Accelerating discretionary
expenses into current period

9. Conclusions and Recommendations

Financial shenanigans often can cause great harm to individuals, companies, and
society. On a micro level, they hurt investors, lenders, employees, and vendors; on a
macro level, they result in resources being allocated to the wrong companies. In spite of
numerous researches that are conducted in this area, yet as the businesses are
growing and becoming international and multi-national, accounting fraud is also
increasing dramatically. Accounting tricks and gimmicks can be stopped only if the
public is educated better and continues learning new techniques for detecting their
tricks. By studying and learning from the past financial reporting failures, investors,
lenders, and others can recognize early warning signs of accounting gimmicks and
fraud and consequently avoid being trapped by tomorrow's scams. Shenanigans can be
defined as actions or omissions intended to hide or distort the real financial performance
or fiscal condition of a company. In the present study seven categories of financial
shenanigans and its implication in the UAE have been studied those are aroused due to
the following reasons.

1. To fulfill the management self interest

2. To show a better company performance
3. It is unlikely that management will get caught

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Companies may use accounting tricks because they believe that they won't get caught
by auditors or regulators. The main limitation to this study is that the users of the
financial statements like investors are not bothered to investigate if the company is
using any accounting tricks to distort the financial reporting. Majority of the investments
are done based on attractive figures shown or reported by companies without actually
investigating and analyzing financial evidence to determine whether or not those
attractive figures are real or fake. The reason why Financial Shenanigans continue to be
successful is that investors, lenders, auditors, and others have not learned from
previous financial fraud. Business school educators should move away from the
antiquated and ineffective way they are training students. Rather than having students
memorize accounting rules and auditing procedures, students should be studying the
voluminous literature on financial reporting failures. In the other professions, such as
medicine and law, members are trained by learning lessons from the past.

We strongly recommend that some changes in accounting and financial statement

analysis training are needed in order to reduce the incidences of financial fraud and
detect it where and when it exists. Only when students are well familiar with Accounting
and Auditing Enforcement Releases and the previous real cases of fraud and their
lessons, then there will there be real progress in eliminating financial reporting fraud.

References

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3. Howard Schilit 2002, financial shenanigans, 2ND edn, McGraw-Hill, New York.
4. Nancy R. Jay, Atul K. Saxena, Vijaya Subrahmanyam, Ronald W. Best. July
2007 Review of Business Research, Is Accounting Fraud Predictable.
5. Internal Auditor Magazine – April 2009 – Jay Dawdy, Whirlwind of Deception.
6. The AICPA Audit Committee Toolkit 1997, New York. Fraud and the
Responsibilities of the Audit Committee.
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Longmen

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