Fraud Examination Chapter 11 Financial Statement Fraud Albrecht

Fraud Examination Chapter 11 Financial Statement Fraud Albrecht, Zimbelman © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license

To the Student q Chapter 11 is the first of three chapters on financial statement fraud, also known as management fraud. This chapter discusses some of the numerous financial statement frauds discovered in corporate America in the last decade. q We discuss the common elements of those frauds and the conditions that led to the rash of financial statement fraud around the turn of the new millennium. Financial statement frauds almost always involve company management and are the result of pressures to meet internal or external expectations. q This chapter provides a framework for detecting financial statement fraud, which emphasizes the need to consider the context in which management is operating and being motivated. Albrecht, Zimbelman © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license

Learning Objectives q Discuss the role that financial statements play in capital markets. q Understand the nature of financial statement fraud. q Become familiar with financial statement fraud statistics. q See how financial statement frauds occur and are concealed. Albrecht, Zimbelman © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license

Learning Objectives q Outline the framework for detecting financial statement fraud. q Identify financial statement fraud exposures. q Explain how information regarding a company’s management and directors, nature of organization, operating characteristics, relationship with others, and financial results can help assess the likelihood of financial statement fraud. Albrecht, Zimbelman © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license

Financial Statement Fraud Misstatement of financial statements can result from manipulating, falsifying, or altering accounting records. Misleading financial statements cause serious problems in the market and the economy. Often result in large losses for investors, lack of trust in the market and accounting systems Albrecht, Zimbelman © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license

Elements of the Perfect Fraud Storm q A Booming Economy q Decay of Moral Values q Misplaced Incentives q High Analysts’ Expectations q High Debt Levels q Focus on Accounting Rules Rather Than Principles q Lack of Auditor Independence q Greed q Educator Failures Albrecht, Zimbelman © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license

Nature of Financial Statement Fraud q Involves intentional deceit q Involves attempted concealment q Rarely seen q Many false red flags q Conviction is very difficult Albrecht, Zimbelman © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license

Detecting Financial Statement Fraud Strategic Reasoning Questions to ask: § What types of fraud schemes is management likely to use to commit financial statement fraud? § What typical tests are used to detect these schemes? § How could management conceal the scheme of interest from the typical test? § How could the typical test be modified so as to detect the concealed scheme? Albrecht, Zimbelman © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license

Detecting Financial Statement Fraud Financial Statement Analysis Focus on the changes in reported assets, liabilities, revenues, and expenses from period to period or by comparing company performance to industry norms. Nonfinancial performance measures Research suggests that auditors, investors, regulators, or fraud examiners can benefit by using nonfinancial performance measures to assess the likelihood of fraud. Albrecht, Zimbelman © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license

Detecting Financial Statement Fraud Nonfinancial Performance Measures look for a discrepancy between the company’s financial and nonfinancial performance Example: Former Health. South CEO Richard Scrushy’s § The company’s revenues and assets were increasing while the number of Health. South facilities decreased Albrecht, Zimbelman © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license

Detecting Financial Statement Fraud q In addition to considering financial and nonfinancial data to q assess fraud risk, auditors can identify fraud risk exposures q by examining four groups of fraud exposures. Albrecht, Zimbelman © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license