How to Financial Statement Fraud Can Be Detected

Essay Topic:
Using quality academic references discuss how fraud can be detected.
Essay Purpose:
The purpose of this assignment is:
? to demonstrate an understanding of financial statement fraud;
? to demonstrate capability in academic research; and
? to demonstrate capability in academic essay writing.

 


Introduction

 

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Financial statement fraud can be defined as any deliberate misrepresentation of the organization’s financial condition that is accomplished via the intentional omission mount in the organization’s financial statement so as to deceive the financial statement users including the creditors and investors. ("Association of Certified Fraud Examiners - Fraud Training Education and Certification", 2016)
This illegitimate task that the management of any organization performs considerably diminishes the investor's confidence and therefore poses impacts on the economy of the world. The financial statement fraud cases have triggered the highest amount of median loss of around $1 million in spite of the comparatively low number of cases during the research investigation (ACFE, 2012). These issues impose grave danger equivalent to the exact level of any economic crime and since 2003, the financial and non-financial damages and related financial statement cases were seen to incline (PWC, 2007).  Prevention, as well as detection of financial statement fraud, has therefore become the chief concern for all the organizations worldwide. The prevention of these financial statement fraud is considered as the best method for reducing it but in the case of the failure of this prevention method, the detection of fraudulent financial reporting is very important. This paper argues the preventive as well as detection measures against the financial statement frauds and how these frauds can be detected.

 


Background

 


Fraud has a plethora of definitions along with various criminal charges like fraud, larceny, theft, embezzlement, etc. legally, the situation refers to:
Person making false statements;
Victims relying on such false statements;
Criminal benefits (Biegelman and Bartow, 2006)
Fraud can be committed either by the person inside i.e. the employee or outside the organization and sometimes even by the management. It can either benefit a single person or a particular department of the company and sometimes that whole organization itself. But the costliest and most difficult fraud for the auditor to deal with are the once committed at the senior level of management- especially if it is beneficial for the organization. When the false financial information is provided by the manager of the organization, then it is considered as the case of financial statement fraud. This type of fraud is committed with an objective of keeping the company financial reports free from the fraud and the misstatement (Zack, 2013).
Effects of the financial statement fraud
According to Rezaee (2004), the following are the potentially harmful effects of the financial statement fraud:
The integrity and quality of the financial reporting process are undermined; 
The objectivity and integrity of the accounting profession are jeopardized; 
The confidence of the market participants, as well as the capital market in the reliability of the information as per the finance, is diminished.
The capital market becomes less efficient, and the growth of the nation, as well as its prosperity, is diminished.
Other effects include litigation losses, destruction of individuals' career who were involved in the fraud, causes economic losses, encourages the high level of regulatory intervention and further causes destruction towards the normal operations.
Responsibilities of the Company to Prevent Financial Statement Fraud
This section of the paper discusses the responsibility and the role of the company towards prevention of the fraudulent financial reporting and how the frauds can be prevented. The company can prevent the financial statement fraud by exercising the following controls.

 


Internal controls

 


The primary step towards prevention of the financial statement fraud is to have a strong control over the internal accounting. The internal controls usually begin at the transaction level of the accounting and help to dictate regarding the employees and how they can complete the processes along with tasks within their organization. Allowing specific employees the authorization of various purchase orders can be a step towards the internal control. One of the methods towards the internal control can also be done outside the accounting office for strengthening the operations of the company. The employee authorizing the purchase of any of the asset must not be allowed to select where the purchase of asset must be made. This control can be enforced either by setting the dollar limits for authorizing the purchases or by using the approved vendors (Financial Statement Fraud: Prevention and Detection, 2004).
Segregation of the duties is another method for internal controlling of the accounting. This factor makes sure that there is more than one person who handles a specific financial information. The cash account is the field where the segregation is the common technique. The signing of checks, posting them in their accounting system along with the reconciling of the bank statement is done by different employees as one single employee is not allowed to do these functions altogether. This exercising of control prevents the embezzlement, and this type of segregation can easily be spread throughout the accounting department (Caplan, 1999).

 


Audits

 


The company should have their audits of their financial statements so as to test their financial information for determining the accuracy.  This step helps to understand the management regarding their weaknesses present in their accounting department as further allows them in taking a corrective measure very rapidly. The control objectiveness should be tested by the audits. Audits should review and consider the important queries like the completion of the transaction and its validity regarding the data and information, reasonability of the transactions, etc. Audits also check the internal control limitations and whether the information is being reported or not. The activities must also be tested by the audits. Further, the internal control process should also be reviewed by the audits. Some of the big enterprises having outside auditors are asked by the Securities and Exchange Commission (SEC) to attest these auditors so as to have effectiveness towards the internal controls. (Du and Roohani, 2007)
Further, the internal auditors exercise over the internal control adequacy along with the financial statement preparation. The role of these auditors is providing the first line of defense for counteracting the fraudulent financial reporting. Therefore, the companies must maintain an internal audit function for reducing the incidences of the frauds.
The auditors must additionally be professionally certified further much emphasis must be placed towards the development of the internal auditing and its standards. This method ensures that all the internal auditors are equipped with adequate technical skills for providing the company with the effective first line of defense. (Brown, 2004)
Management Review 
The management review of the financial statements that are prepared for the organization is the ultimate step towards preventing the financial statement fraud.
The Sarbanes-Oxley Act of 2002 (SOX) has asked the publicly held companies to provide the written statement to the company management for validating the accuracy and exactness of the financial statements. This method outside investors that the management of the company has seen the written financial statements and further approves of all the data and information as it is reported. (Zhang, n.d.)
The National Commission on Fraudulent Financial Reporting (NCFFR) requires the management of the company for acknowledging their responsibilities towards accuracy and exactness of their written financial statements.  These sort of acknowledgment would be beneficial towards the elimination of the perception that the independent auditors are regarded as the insurer of the financial statements and their accuracy. (Financial Statements, 2012)
Increasing the Sanctions Imposed on Perpetrators 
Reduction in the incidences of such frauds can be prevented by imposing strict sanctions on the perpetrators of the written financial statement. A recently held survey of various corporate secretaries, lawyers, auditors, financial executives and the public accountants, around 83 percent of these people recommended that a strict penalty must be assessed against the people who commit financial statement frauds. Thus, the perpetrators who are barred for the financial statement fraud from their organization reduce the recurrence of such incidences. Sometimes fines are used for punishing the people who commit such frauds.
Confidentiality between the Auditor-Client Relationship
Any kind of proposal that requires any independent auditor for reporting the errors or any irregularities in the report towards the governmental authorities most of the times foster growth and development of the relationship between the auditor and his client. These requirements further inspire even the ones who are honest clients for providing their auditor with less than complete disclosure thinking that their auditor would suspect any irregular or illegal act and can report regarding their suspicions towards the enforcement authorities. (Cahan et al., 2014)

 


Conclusion

 


There are various methods to prevent the financial statement frauds in any organization that includes the internal controlling, Confidentiality between the Auditor-Client Relationship, Increasing the Sanctions Imposed on Perpetrators, etc. that have been discussed thoroughly in the paper.

 



Reference

 


Rezaee, Z. (2004). Restoring public trust in the accounting profession by developing anti?fraud education, programs, and auditing. Managerial Auditing Journal, 19(1), pp.134-148.
Acfe.com. (2016). Association of Certified Fraud Examiners - Fraud Training Education and Certification. [online] Available at: http://www.acfe.com/ [Accessed 25 Apr. 2016].
PriceWaterHouse Coopers (2007), Survey, Economic Crime Survey: people, culture and controls, The 4th Biennial Global Economic Crime. Available at: https://register.pwc.co.uk/premium/forward.htm [Accessed 25 Apr. 2016].
Biegelman, M. and Bartow, J. (2006). Executive roadmap to fraud prevention and internal control. Hoboken, N.J.: Wiley.
Zack, G. (2013). Financial statement fraud. Hoboken, New Jersey: John Wiley & Sons, Inc.
Caplan, D. (1999). Internal Controls and the Detection of Management Fraud. Journal of Accounting Research, 37(1), p.101.
Brown, S. (2004). Fraudulent Financial Statements. CFA Magazine, 15(3), pp.60-61.
Financial Statements. (2012). Review of Income and Wealth, 58(4), pp.774-785.
Cahan, S., Godfrey, J., Hamilton, J. and Jeter, D. (2014). The Association between Client-specific Investment Opportunities and Audit Fees of Industry Specialists and Non-Specialists. International Journal of Auditing, 19(2), pp.57-71.

 

 

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