Accounting Fraud
Business Ethic 1040 Term Report, Spring Semester 2013
Jian Yu Li
April 2013
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Accounting Fraud
INTRODUCTION
This reporting is my findings on the topic of accounting fraud in business for my Spring
Semester 2013 Business Ethic class. This is an important topic because accounting fraud can
have a huge impact on the company or other small business and it can also affect a lot of people.
After a fair amount of research, I find accounting fraud to be a universal issues that has the
power to affect everyone. This report will be focus on:

Different types of accounting fraud and how they are carried out

How accounting fraud affects business

Accounting fraud as the subject of ethical consideration
I was aided in my research through a discussion with Paige Paulson, a professor of accounting at
Salt Lake Community College, who helped me understand accounting fraud better.
My research begins with a chapter out of the text book Principles of Financial Accounting
Weygandt, Kimmel, and Kieso and with the information from the following:

http://tgg-accounting.com/blog/2011/10/common-accounts-receivable-fraud-in-smallbusinesses/

http://www.mcgoverngreene.com/archives/archive_articles/Craig_Greene_Archives/FocusEmployee_Frauds.html
http://www.nytimes.com/2008/12/20/business/20madoff.html?em&_r=0

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Findings
Looking at accounting fraud
The numbers of accounting fraud in small business or corporation is immense. Like all other
frauds, accounting fraud is committed in the attempt of increase profitability and/or personal
gains. According to businessdictionary(2013):
The intentional misrepresentation or alteration of accounting records regarding sales,
revenues, expenses and other factors for a profit motive such as inflating company stock
values, obtaining more favorable financing or avoiding debt obligations. Employees who
commit accounting fraud at the request of their employers are subject to personal
criminal prosecution and they can commit account fraud through overstating revenue,
understating expense, underreporting the existence of liability or overstating the value of
business’s assets.
Different Types of accounting fraud
There are a lot of place in business where accounting fraud can happen. Some kind of fraud are
far more easy to commit than others and require less time to commit and involve less chance of
getting caught. The most common places where the crooked boss or employee can manipulate
the records are: Cash, Accounts Receivable, Accounts Payable, Inventory, Prepaid Expense, and
Revenue.
Cash is a major part of small business’s asset but it is one of the easiest areas that accounting
fraud takes place, and it is extremely difficult to detect. One of the most common methods of
accounting fraud in cash is called “Skimming.” This occurs frequently in the retail industry
during the sales when an employee receives cash payment from customers. The reason this is
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difficult to detect is that the fraudster does not leave an audit trail and the cash is stolen before it
is documented in the organization’s record.
Accounts Receivable is the money due to the company from its customers and it is one of the
most popular areas where accounting fraud takes place, because it can be manipulated easily
through a variety of schemes and employees at any level in an organization can perform the
commission of account receivable fraud. One of the most common account receivable frauds is
“lapping”, it involves stealing customers A’s payment and applying it to customer B’s open
account receivable. This creates a “lapping” effect and covers the original theft with subsequent
customer payment and it is the most difficult fraud to detect. A company can also use Accounts
Receivable to create a fictitious account and sale; the motive behind this is to create an illusion to
have the company appear to be in better financial condition or to receive additional
compensation(The TGG Way, 2011).
Accounts Payable is money owned by a company to its creditors and accounting fraud can
happen here easily if a company lacks good internal controls. A common way Accounts Payable
fraud is perpetrated involves setting up a ‘bogus’ supplier in the accounting system, that is used
to supply fake invoices for payment and then transferring funds from the company’s bank
account to another bank account, which is usually that of an employee within the
company. Another fraud is where Accounts Payable staff use genuine suppliers to buy goods and
products from for their own personal use and pay for them with company funds (Edward James,
2010).
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Inventory is probably one of the easiest places for employees and companies to commit
accounting fraud. One of the most common schemes is appropriating inventory for personal use,
also called theft. This is rather common in the retail industry; employees can easily steal business
goods for personal use or resale. Companies can also commit inventory through manipulating
their financial statements, such as overstating the inventories, understating the cost of goods sold.
For example, if you own a company that sells only Ipads, you tell your investors, the public, and
creditors, that you have 2000 Ipads when the actually inventory is only 1000. The reason for this
is to create an effect of reporting higher profit and higher earnings to satisfy stockholders,
achieve additional compensation, or maintain bank lending covenants (Chris Hamilton, ND).
Prepaid Expense fraud can happen when a company understates current-year expenses by
claiming they are prepaid expenses. This amounts to a fraudulent claim that payments for a
certain service benefit future accounting periods when, in fact they do not. Recently a large
telecommunications company incurred significant cash expenses on maintenance of its utility
lines. It fraudulently classified most of the outlays as prepaid expense, rather than current period
expense. Since prepaid expenses are recorded as an asset rather than an expense, expenses were
understated; hence, profits were overstated (Elmaleh, 2006).
The most common financial statement fraud in accounting is the manipulation of the revenue. A
company can easily overstate its revenue and understate its expenses to make their profit seem
higher. Another method of revenue fraud is through deferred revenue. This is when the company
records the profit before it is earned. Companies can take advantage of this because it is very
difficult thing to detect. Often, the real profit falls below the company’s expectation. As most
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company transaction records are estimate, they sometimes include a projected profits as earnings
in their records (Tracy Coenen, 2013).
Madoff’s Ponzi scheme
According to the New York Times magazine, Bernie Madoff is an American, a former
stockbroker, investment adviser, and financier. Who became the executive chairman of the
National Association of Securities Dealers Automated Quotations (NASDAQ) stock market in
1990. Mr. Madoff set up his small trading firm in Wall Street and intended to make a business
out of trading in 1960 at the age of 22, and by 1989, Mr. Madoff’s firm was handling more 5
percent of trading volume on the New York Stock Exchange. Later on, Mr. Madoff became the
executive chairman of the NASDAQ (Diana Henriques, 2008).
Unlike other prominent Wall Street figures who build their fortunes during the heady 1980s and
‘90s, or become a household name among American investors (NY Times magazine, 2009). Mr.
Madoff is actually a local hero, he often donate large amount of money to charity and later on
became the money manager of choice for many prominent regional charities. And that’s when
the Ponzi Scheme begins, in the early 1990s.
According to New York Times Magazine, Mr. Madoff starts the Ponzi scheme by using the
money from the members of country clubs and charity dinners, where investors meet and asked
him to manage their life savings so they too could have a steady, solid return like many other
people who asked Madoff to manage their life savings. With charging 5 to 6 percent of investors’
returns, 2 percent higher than the standard rate, and also with the stead and solid returns, a lot of
investors asked Madoff to manage their life savings. As Mr. Madoff’s Ponzi Scheme grew, he
had to move beyond country clubs and charity dinners to bring in fresh money to pay his
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previous investors, so Mr. Madoff and his promoters set their sights in Europe, framing the
investment as membership in select clubs using the same method. As the Ponzi Scheme grew
bigger and bigger, Mr. Madoff cut a cash-gathering swath through the Persian Gulf, then South
East Asia, then finally, they were hurtling towards China with undignified speed, where people
are desperate to asked Madoff to manage their life savings. But it’s not long before the Madoff’s
Ponzi scheme come to an end.
When everyone face a financial crisis in 2008 and was reaching for cash, that the investors
starting to take out money faster than Mr. Madoff could bring fresh cash in. according to New
York Times, on December 9, 2008. Mr. Madoff told his son Mark that he planned to pay out
$173 million bonuses two months early, telling Mark Madoff that he had recently made some
profit through business operations. Then, Mark spread the news to his brother, Andrew Madoff.
The very next morning, they went to their father’s apartment to ask him how he could have
enough money to pay his staff when he didn’t have the money to pay his clients. Facing his sons’
doubts, Mr. Madoff told them that he had nothing left, that his investment fund was nothing but a
lie, it was just a big Ponzi Scheme. Madoff’s sons then reported their father to the federal
authorities. Madoff was arrested on December 11, 2008. And according to the federal
investigators, Mr. Madoff never used the money from his investors to engage in legitimate
investing activities. Also, the amount of money missing from clients’ accounts, including
fabricated gain, was almost $65 billion. The court-appointed trustees estimated that the actual
loss to investors was $18 billion; on June 29, 2009, Mr. Madoff was sentenced to 150 years in
federal prison (New York Times, 2009). Up until this point in history, it was the biggest Ponzi
Scheme that ever happened and the consequences were great; a lot of people lost their life
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savings, billions of dollars vanished in a blink of an eye, and some lost their jobs and families
and some even lost their futures due to a single man’s greed.
Accounting Fraud and Ethics
Dishonesty is one of the most unethical aspects in humanity; according to research, a person on
average lies about 20 times a day, even if they didn’t realize it. It is over looked on a daily basis
and dishonesty can be easily adapted into the business world. But the case of Madoff’s Ponzi
schemes is not ignorable, with multiple billions of dollars being stolen from people’s life savings
and ruining people’s lives. This kind of fraud is still being practiced out there in the world as we
live in today. This type of dishonesty that involves accounting fraud is practically a faceless
crime. Although it doesn’t seem likely to harm anyone and that everyone would get over it, the
world we live in today runs by money. And with people’s lifesavings being stolen, the impact on
an victim can be huge. In the case of Madoff’s Ponzi, a lot of people were forced to leave their
homes because Madoff stole their life savings.
In this case, the motive behind being dishonest is obvious, for personal gain. It is often greed that
pulls us towards dishonesty, the very same reason why businesses would do the same to their
investors: to gain profit and additional compensations. However, if it is wrong for a person to be
dishonest for personal gain, then is it not eh same with business?
Many businesses claim that they are honest when in fact they are deceptive; those who
knowingly practice deceit are unethical. Many Philosophers suggest that lying is a betrayal of
trust, of the moral code that governs our existence. In the world we live in today, people choose
to be dishonest for personal gain rather than to honor the moral code of honesty, even a wellknown philosopher agrees:
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Good people do not need law to tell them to act responsibly, while bad people will find a
way around law (Plato, 2013).
If a man is proud of his wealth, he should not be praised until it is known how he
employs it (Socrates, 2013).
On the other hand, Immanuel Kant has a different view of deceit; he claimed that lying is wrong
independent of its consequence; for example, you can save a person’s life from a person who
tries to murder him or lie to a person for personal gain. The main point is that lying itself is
wrong but the consequence can be either good or bad.
Conclusions
Before I research this topic, I was aware that accounting fraud can affect a lot of people within
the nation or the business firm itself, but the effect is even greater. The aftermath of accounting
fraud can have a huge impact on the economy and it can even affect everyone globally. We live
in the word where tons of crimes take place, so much more than in the history of the nation and
the world; these crimes are often committed in the name of person gain or profit but the cost is
often great. With thousands and even millions of people filing bankruptcy due to the greed of
others, fraud is the violation of our moral code. After all the findings, I came to the conclusion
that it is easy for people and companies to commit fraud in the name of personal gain or profit
rather than to honor the code of honesty. In the case of Madoff’s scheme just prove that, instead
of using the investor’s lifesavings to engage in a legitimate investing activities, Mr. Madoff use
that money for personal gain in the cost of other people’s lifesavings and even their futures.
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Resolutions
I understand that the world we live in today sometimes force us to be dishonest for the good of
others or to survive but we don’t want to live in a world where we all choose to be dishonest to
others for personal gain or profits. Practicing accounting fraud is a careful calculation, and
manipulate the books to gain profit or personal gain will end up betraying integrity, trust and all
the people that work so hard to make economies prosperity achievable. It is logical that no
corporation is satisfied with its own profit when there is a chance to make more, and few man
and woman can stand outside the influence of money. At the end, a corporation isn’t able to
commit accounting fraud without people; it is the people who choose to commit accounting fraud.
Although it is easy to be dishonest for profit or personal gain, the real crime is the acceptance of
being dishonest are right; like all other crime, it is possible to train the eyes and the mind to
ignore or walk away from unethical.
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