Ch 11 - Accounting Principles & Fraud Flashcards
Financial statement fraud
A type of fraud whereby an individual or individuals purposefully misreport financial information about an organization in order to mislead those who read it.
Overstatements
Type of financial statement fraud in which an individual exaggerates a companys assets or revenues to meet certain objectives.
Understatements
Type of financial statement fraud in which an individual minimizes a companys liabilities or expenses to meet certain objectives.
Comparability and consistency
Secondary, qualitative characteristics that state that a company’s information must be presented with the same consistent method from year to year in order for it to be useful for analytical purposes in decision making.
Relevance and reliability
Primary qualitative characteristics of financial reports as they relate to usefulness for decision making. Relevance implies that certain information will make a difference in arriving at a decision. Reliability means that the user can depend on the factual accuracy of the information.
Periodicity
A time period assumption which deems that economic activity be divided into specific time intervals, such as monthly, quarterly, and annually.
Full disclosure
A standard for financial reporting that states that any material deviation from generally accepted accounting principles must be explained to the reader of the financial information. Any potential adverse even must be disclosed in the financial statements.
Who commits financial statement fraud?
- Senior Management
- Mid- and Lower-Level Employees
- Organized Criminals
Who commits financial statement fraud: Senior Management
◾ Conceal true business performance
◾ Preserve personal status/control
◾ Maintain personal income/wealth
Who commits financial statement fraud: Mid- and Lower-Level Employees
Generally related to their department to conceal true performance or to earn higher bonuses
Who commits financial statement fraud: Organized Criminals
Obtain loans fraudulently, provide misinformation for the stock market
How do people commit financial statement fraud?
◾ Playing the accounting system
◾ Beating the accounting system
◾ Going outside the accounting system
What is playing the accounting system?
The use of the accounting system as a tool to generate desired results.
Ex. Manipulating assumptions used to calculate depreciation charges, allowances for bad debts, or allowances for excess and obsolete inventory to increase or decrease earnings.
Ex. To avoid recognizing expenses and liabilities, vendor invoices might not be recorded on a timely basis. Genuine sales might be recorded prematurely.
What is beating the accounting system?
Feeding false and fictitious information into the accounting system to manipulate reported results by an amount greater than can be achieved by simply “playing the accounting system.”
Ex. Fictitious sales may be recorded to legitimate or phony customers.
Ex. Inventory and receivables figures may be invented, with documents later being forged to support the claimed numbers.
Ex. Senior financial management might determine allowances for
bad debts and for excess and obsolete inventory without regard to the formulae or methods historically used in the entity to determine these amounts.
Ex. Journal entries might be disguised in an attempt to conceal their fraudulent intent (e.g., splitting big round-sum adjustments into many smaller entries of odd amounts), or transactions may be hidden through the use of intercompany accounts to conceal the other side of a transaction.
What is going outside the accounting system?
The fraudster produces whatever financial statements he wishes. These financial statements could be based on the results of an accounting and financial reporting process for an operating entity, with additional manual adjustments to achieve the results desired by the fraudster.
Alternatively, they could just be printed up using phony numbers supplied by the fraudster. In some cases, the fraudster might go back and enter false data in the accounting system to support the phony financial statements. In other cases, he may not bother, or there might be no accounting system. So not all transactions may be recorded in an accounting system, and some or all transactions may have no basis in fact.
