Financial
Statement Frauds
Red Flags of Fraud
Financial Statement Frauds
1.
2.
3.
4.
5.
Revenue/Accounts Receivable Frauds
(Global Crossing, Quest, ZZZZ Best)
Inventory/Cost of Goods Sold Frauds
(PharMor)
Understating Liability/Expense Frauds
(Enron)
Overstating Asset Frauds (WorldCom)
Overall Misrepresentation (Bre-X
Minerals)
1. Revenue Related Financial
Statement Frauds

By far, the most common accounts
manipulated when perpetrating financial
statement fraud are revenues and/or
accounts receivable.

Accounts Receivable
Revenues
(Income Assets )
xxx
xxx
Revenue-Related Transactions and Frauds
See Excel handout #1
2. Overstating Inventory

The second most common way to commit
financial statement fraud is to overstate
inventory.
Beginning Inventory
Purchases
Goods Available for sale
Ending Inventory
Cost of Goods Sold
Income
OK
OK
OK
High
Low
High
Inventory/Cost of Goods Sold Frauds
See Excel handout #2
3. Understating Liability Frauds
Not recording accounts payable
 Not recording accrued liabilities
 Recording unearned revenues as earned
 Not recording warranty or service liabilities
 Not recording loans or keep liabilities off
the books
 Not recording contingent liabilities

4. Asset Overstatement Frauds






Overstatement of Current Assets (e.g.
Marketable Securities)
Overstating Pension Assets
Capitalizing as assets amounts that should be
expensed
Failing to record depreciation/amortization
expense
Overstating assets through mergers and
acquisitions
Overstating inventory and receivables (covered
earlier)
5. Disclosure Frauds
Three Categories of Disclosure Frauds:
1. Overall misrepresentations about the nature of the
company or its products, usually made through news
reports, interviews, annual reports, and elsewhere
2. Misrepresentations in the management discussions and
other non-financial statement sections of annual reports,
and other reports
3. Misrepresentations in the footnotes to the financial
statements
RED FLAGS OF FRAUD





Changes in employee lifestyle,
habits and behaviour
Decline in employee morale
and/or attendance
Operating on a crisis basis
Unexplained variances
One employees “does it all” and
wants to control everything
RED FLAGS OF FRAUD
(continued)





Missing, altered, or perfect
documents
Invoice items do not appear
consistent
Excessive rush or emergency
transactions
Vendors with generic names and/or
Post Office Boxes as addresses
Payments made from non-original
documentation