FRAUD EXAMINATION

ALBRECHT, ALBRECHT, & ALBRECHT

Financial Statement
Fraud

CHAPTER 11
 Learning Objectives
1. Understand the role that financial
statements play in U.S. businesses.
2. Describe the nature of financial
statement fraud.
3. Become familiar with financial
statement fraud statistics
4. See how financial statement frauds
occur and are concealed.
 Learning Objectives
5. Understand the framework for
detecting financial statement fraud.
6. Identify financial statement fraud
exposures.
7. Explain how information regarding a
companys management and directors,
nature of organization, characteristics,
relationship with others, and financial
results can help assess the likelihood
of financial statement fraud.
 What Are Some Problems
with Financial Statements?
Misstated Cooked
Inappropriate executive loans
and corporate looting
IPO favoritism, spinning &
laddering
Excessive retirement perks
Exorbitant compensation
Loans for trading fees
Massive employee fraud
Review the Fraud Triangle.

e
ur

Ra
ss

tio
re

na
dP

liz
e
eiv

ati
rc

on
Pe

Perceived Opportunity
 What Are the Elements of
the Perfect Fraud Storm?
1. Management lacked understanding of the
causes for success of their companies
2. Moral decay occurring in the United States
and around the world
3. Misplaced executive incentives
4. Wall Streets unachievable expectations that
targeted only short-term performance
5. The large amount of debt and leverage each
of the fraudulent companies had placing
tremendous pressure on executives
 What Are the Elements of
the Perfect Fraud Storm?
6. The nature of U.S. accounting rules
7. The opportunistic behavior of some CPA firms
8. The greed by executives, investment banks,
commercial banks, and investors
9. Three types of failure by educators
1. Failure to provide sufficient ethical training
2. Failure to teach students about fraud
3. Failure to teach less about content as an end in
itself and to focus more content in the context
of helping them develop analytical skills
 Financial Statement Fraud
Statistics.
Infrequent
300 over 10 years
Costly
Last 23.7 months
Mean $25 million
CEO in 72%, CFO, COO
Computer hardware/software
78% of firms on NASDAQ
 Financial Statement Fraud
Statistics.
Most had no audit committee
Most directors were insiders
Family relationships between directors
56% audited by Big Eight or Big Six
25% changed auditors during fraud
Significant number of class action
suits
Many resignations-few served jail time
What Are the Motives for
Financial Statement Fraud?

High
Stock Competition
Prices
Increase
Personal
Wealth
Bond or To Meet
Stock Expectations
Offerings
Discuss Detecting Financial
Statement Fraud.
 Complete the Fraud
Exposure Rectangle.
Fraud Exposure Rectangle
Companys
Management
Relationship
&
with Other
1 Directors
2 Entities
The Organization Financial Results
& & Operating
Its Industry 3 Characteristics4
 Discuss Management &
Directors.
Financial Statements Requires
Managements Participation
Work ON Behalf of the Organization

Backgrounds
Motivations
Influence on
Decision Making
 Comment On & Explain
Relationships with Others.
Related Party Transactions
With Financial Institutions & Bond
Holders
Improper or Unrealistic Transactions
Auditors
Attorneys
Investors
Regulators
 Describe Questionable
Organizations & Industries.
Structures designed to hide fraud
Unduly complex organizations
Legitimate purpose for each business
segment
Active or passive board of directors
Active or passive independent audit
committee
Active, independent internal audit
Board of directors with few outsiders
Offshore activities without an apparent
business purposes
 List What to Ask About
Organization & Industry.
Is it a new business without a proven
business history?
Have recent significant changes occurred in
the nature of the organization?
Is monitoring of significant controls
adequate?
Are accounting and IT staff organized and
effective?
Is it a declining industry with increasing
business failures and declining demand?
What Approach is Taken to
Examine Financial Statements?

Non-Traditional

Examine Footnotes

Comparisons of Financial
Statement Balances with
Similar Organizations
 What Approach is Taken to
Examine Financial Statements?
Large Volumes
Of Inventory Requires Large
Volumes of Space
See if Activities Match
Between Organization &
Standard Operations
Comparisons of Financial
Statement Balances with
Similar Organizations
 Define the Acronyms.

1. COSO is Committee of
Sponsoring Organizations

2. SEC is Securities and

Exchange Commission

3. GAAP is Generally Accepted

Accounting Principles
 Match Terms &
Definitions.
10-K Quarterly report publicly traded
companies file with SEC
Government Agency responsible
10-Q for regulating stock trading &
financial Statements of Public
companies
Annual report publicly traded
AAER
companies file with SEC
Document released by SEC
when a company commits
SEC financial statement fraud
 Match Terms &
Definitions.
Financial It recommended
Statement changes in financial
Fraud statements

Intentionally
Financial misstating financial
Statements statements

Reports summarizing
Treadway cash & profits of an
Commission organization