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Financial statement fraud detection

Financial statement fraud detection

Tuesday 07, 04 2020
According to international and Vietnamese auditing standards No. 240, in the field of finance and accounting, frauds are intentional acts of falsifying economic and financial information committed by one or more members of the Managing Board, Board of Directors, employees or the third party, having impacts on the financial statements (Vietnam Association of Certified Public Accountants, 2013).
Based on different criteria, corporate fraud is classified in various ways. In terms of fraud in the financial statements, according to Vietnamese and international auditing standards No. 240, fraudulent practice is often classified into two categories: embezzlement and fraudulent financial reporting (Vietnam Association of Certified Public Accountants, 2013).
Making fraudulent financial statements is an act of changing, falsifying accounting documents or making incorrect notes; not disclosing or knowingly omitting important information in the financial statements; knowingly applying wrongly or failing to comply with accounting principles and standards; hiding or omitting arising transactions; recording untrue operations on the financial statements to deceive the financial statements users. 

In fact, many companies listed on the stock market have committed frauds in financial statements in the last 5 years, under the form of "transforming" the business results in the financial statements by increasing revenue, reducing expenses to increase profits or increasing capital while the size of assets does not increase. These fraudulent acts represent dishonesty in reflecting accounting information while the truthfulness and accuracy of financial statements of listed companies are especially important for shareholders, as well as investors.
"Beautifying" financial statements for the purpose of attracting investments on the stock market, listed companies often use fraudulent techniques in preparing the financial statements such as increasing revenue, declining costs / omitting liabilities, wrongly recording a fiscal year, misjudging the value of assets, failing to publish fully information on the financial statements. (COSO 1999; COSO 2010; ACFE, 2014).

Revenue frauds

Faking revenue is recording unrealistic revenue in accounting books. Revenue fraud is a common form of financial statement frauds. Forms of revenue forging including making transactions with fake customers or making fake invoices for real customers but actually goods and services are not transferred. By the beginning of the following year, revenue was recorded to hide this fraud.

Recording revenue increase without accounting estimates: This fraud technique is often performed on long-term contracts to estimate the amount of work completed to record revenue. For example, long-term construction contracts have two methods of recording revenue. The first is to record revenue when the construction contract has been completed and the second is based on the contract progress. In the first method, revenue is not recorded until the project is 100% completed. Construction costs are determined when the project is completed. For the other method, revenues and expenses are measured during the project, which is often vulnerable to fraudulent implementation. The percentage of work completed is estimated by managers based on their experience and actual work completion schedule. The manager may cheat the percentage and cost of completion of a construction project to record revenue early.

Wrong accounting period

Recording transactions that occur wrongly in the accounting period is to not record of revenues or expenses at the time of arising. Revenues or expenses will be transferred from one period to the next or vice versa to increase or decrease profits as desired. The fraudulent techniques in preparing the financial statements related to the wrong record of the accounting year are as follows:

* Violation of appropriate guidelines in recording revenues and expenses:
According to GAAP, the appropriate principle in accounting is when a revenue is recorded, a corresponding expense related to the turnover of that period must also be recorded. However, at the end of the year, many companies record revenue before making transactions. Sales are recorded immediately after invoice issuance at the end of the year while goods have not been delivered yet. In the beginning of the following year, goods are delivered and the corresponding cost of this transaction is recorded. This technique helps the company to increase profit targets for the year.

* Early record of revenue:
Early record of revenue occurs when the conditions for revenue recognition are not satisfied, like the case when goods and services have not been delivered or customers only partially receive the goods and payment has not been made. For example, Britain's largest retail group – Tesco, recorded suppliers' trade commissions in financial statements in order to inflate profit of the first 6 months of 2014 to GBP 250 million.

* Record of cost at the wrong time:
This is the adjustment of business profits due to the pressure to achieve the company's goals and business plan. Expenses incurred in this period are not accounted immediately but carried forward to the next period. In addition, the technique of recording costs at the wrong time is often committed with the act of fraudulence on the principle of matching revenue and expenses.

Liabilities and costs reduction

Concealing debt and expenses is a way of committing financial statement fraud to increase the company's profits. Profit before tax increases if the total amount of expenses or liabilities is not recorded, which may significantly affect the declared profit. This technique is easier to implement and harder to detect. The most common way to conceal debt and expenses is to omit debt / expense. Those who perform this fraud believe that they can conceal fraud in the future. They often plan to cover the concealed debt with other incomes such as future gains.

Not fully disclose information

According to the accounting principles and the Securities Law, listed companies must fully and accurately disclose information in the financial statements and explain the financial statements to investors to help them have the necessary information to make righteous decision. Notes to the financial statements should present in detail the information relating to the company's business activities to avoid misunderstanding of users of financial statements. However, a lot of information is not fully disclosed in the notes to the financial statements such as contingent liabilities, events arising after reporting period, related party transactions, and changes in accounting policies.

* Events arising after reporting period:
Events arising after the date of closing the accounting book are the events that affect the financial statements having arisen between the reporting date until the date of signing the auditing report, and the events that arise after the date of signing the audit report (Ministry of Finance, 2012). 
Events arising after the close date that directly affects the financial statements including business combination, announcement of operation suspension, issuance of additional shares, debts related to the suspension of financial statements, litigation must be presented in the financial statements. Companies often conceal presentation of court rulings or judicial decisions that reduce the value of assets or do not account debts that affect the continuity of business operation.

* Changes in accounting policies:
Changes in accounting policies that may misrepresent information in the financial statements for financial statements users include accounting estimates, changes in the method of calculating inventories' prices, and the record of exchange rate differences, policy and time of capitalization, ... Each accounting policy change has different impacts on the results of the financial statements.

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