Fraud Detection

1
Fraud Detection

• Through Financial Statement Analysis

2
What Causes Misstatements

• Financial statement misstatements arise primarily
  from
• Lack of competence or diligence of accounting
  personnel
• Poor internal controls
• Financial Statement Fraud
• Misappropriation of Assets

3
Financial Statement Fraud

• Definition
• Intentional misrepresentations on financial
  statements intended to deceive the users of the
  financial statements.
• Misrepresentations may be caused by
• Intentional misapplication of GAAP
• Alteration of financial records or supporting
  documentation
• Omission of significant information

4
Why is FS Fraud Committed?

• To meet company goals and objectives
• To receive performance-related bonuses
• To obtain financing (or to obtain better terms on
  financing)
• To show compliance with covenants
• To dispel negative market perceptions
• To encourage investment in securities

5
An Approach to Fraud Deterrence

• Make everyone aware of fraud signs
• Establish specific responsibilities for each
  position within the entity
• Set up and monitor internal controls
• Investigate unusual suspicious signs
• Begin formal fraud investigations only when signs
  of fraud are found

6
Risk Factors Relating to Fraudulent Financial
Reporting

• Managements characteristics and influence over
  the control environment
• Industry conditions
• Operating characteristics and financial stability
• Source SAS 82

7
Risk Factors Relating to Misappropriation of
Assets

• Susceptibility of assets to misappropriation
• Controls
• Source SAS 82

8
Fraud Signs follow risk factors

• Unbelievable performance
• Unusual ratios
• Unexplained changes
• Overly aggressive management
• Highly centralized power structure
• Poor internal controls

9
Case Handout

• Review the financial statements
• Note the following facts
• CEO is arrogant
• Dominant market share
• Aggressive marketing tactics
• High-tech firm, products changing quickly
• Do you see signs of fraud?