You are on page 1of 25

Fraud Examination, 3E

Chapter 13: Liability, Asset, and


Inadequate Disclosure Frauds

COPYRIGHT 2009 South-Western, a part of Cengage Learning

Learning Objectives
Identify fraudulent schemes that
understate liabilities.
Discuss the understatement of
liabilities fraud.
Describe fraudulent schemes that
overstate assets.
Understand the overstatement of
assets fraud.

Learning Objectives
List fraudulent schemes that
inadequately disclose financial
statement information.
Explain the inadequate disclosure
fraud.

Types of Financial Statement


Fraud
1. Understating liabilities
2. Overstating assets
3. Inadequate disclosure

Understatement of Liabilities
Fraud

Schemes that understate


liabilities
Understating Accounts Payable
Understating Accrued Liabilities
Recognizing Unearned Revenue as
Earned Revenue
Underrecording Future Obligations
Not Recording or Underrecording
Various Types or Debt (Notes,
Mortgages, etc.)
Omission of Contingent Liabilities

Understatement of Liabilities
Fraud

Understating Accounts Payable


Can be understated by a
combination of:
1.Not recording purchases or
recording the purchases after the
end of the year.
2.Overstating purchase returns or
purchase discounts.
3.Making it appear as if liabilities
have been paid off or forgiven
when they have not.

Understatement of Liabilities
Fraud

Understating Accrued Liabilities


Common accrued liabilities
accounts:
Salaries payable
Payroll taxes payable
Rent payable
Utilities payable
Interest payable

Understatement of Liabilities
Fraud

Recognizing Unearned Revenue


as Earned Revenue
Stock prices are affected by both
risk and return (which are based
off of earnings). As a result, the
stock price of a company reporting
smooth earnings will be
considerably higher.

Understatement of Liabilities
Fraud
Underrecording Future
Obligations

Future obligations examples include:


Warranty
Service Obligations

Understatement of Liabilities
Fraud
Not Recording or Underrecording

10

Various Types or Debt (Notes,


Mortgages, etc.)
Borrowing but not disclosing debt incurred
on existing lines of credit
Not recording loans incurred
Claiming that existing debt has been
forgiven by creditors
Claiming that debt on the companys
books is personal debt of the owners or
principals, rather than debt of the
business

Understatement of Liabilities
Fraud
Omission of Contingent
Liabilities
If likelihood of loss is reasonably
possible, the contingent liability
should be disclosed in the
footnotes to the financial
statements.

11

Understatement of Liabilities
Fraud

Ways to detect understatement


of liabilities
Abnormal analytical symptoms
Documentary symptoms

12

Understatement of Liabilities
Fraud

Abnormal Analytical Symptoms


Accounts Payable:
Balances appear too low
Cost of goods sold numbers are low

Unearned Revenues:
Payables or other accrued liabilities
are low
Income that is too smooth

13

Understatement of Liabilities
Fraud
Abnormal Analytical Symptoms
Recognition of Unearned Revenues:
Unearned liability balances appear too low
and revenue accounts appear too high

Under- or nonrecording of
services/warranty:
Balances in warranty, repurchases, or
deposits accounts appear too low

Unrecorded contingent liabilities:


Analytical symptoms are not particularly
helpful to detect unrecorded contingent
liabilities
14

Understatement of Liabilities
Fraud

Abnormal Analytical Symptoms


Unrecorded Notes/Mortgages:
Unreasonable relationship between
interest expense and recorded
liabilities
Significant purchases of assets with
no recorded debt
Recorded amounts of notes payable,
mortgages payable, lease liabilities,
pension liabilities and other debts are
too low

15

Understatement of Liabilities
Fraud
Accounting or Documentary
Symptoms

16

Photocopied records where originals


should exist.
Unusual discrepancies between the
entitys records and confirmation replies.
Transactions not recorded in a complete
or timely manner or improperly recorded
amounts.
Balances or transactions that lack
supporting documents
Missing documents.
Unexplained items on reconciliations.

Overstatement of Assets Fraud


Schemes that Overstate Assets

17

Overstatement of Assets Fraud


Overstatement of Cash, Short-Term
Investments, and Marketable
Securities Schemes
Reporting restricted cash as unrestricted
on the balance sheet
Having vendors or employees steal
significant amounts of cash over time so
that financial statements are misstated
**Cash is quite hard to overstate because
of verification from financial institutions
18

Overstatement of Assets Fraud


Overstatement of Receivables
and Inventory
Cover thefts of cash or other
assets by overstating receivables
or inventory

19

Overstatement of Assets Fraud


Overstatement of Fixed Assets
Sham purchases and sales of
assets with straw buyers.
Overstate asset costs with related
parties.
Record too little depreciation.
Collude with outside parties to
overstate assets (e.g., allocating
inventory costs to fixed assets).
20

Overstatement of Assets Fraud

21

Overstatement of Assets through


Mergers and Acquisitions or by
Manipulating Intercompany Accounts
or Transactions
Use market values rather than book
values to record assets.
Have the wrong entity be the
purchaser.
Allocate costs among assets in
inappropriate ways.
Record fictitious assets or inflate the
value of assets in intercompany accounts
or transactions

Overstatement of Assets Fraud


Overstatement of Intangible or
Deferred Assets
Startup companies can fraudulently
capitalize intangible assets like
start-up costs, advertising costs,
salaries by writing them off as
deferred charges.

22

Overstatement of Assets Fraud

23

Ways to detect overstatement of


assets
Compare changes and trends in
financial statement account balances
Compare changes and trends in
financial statement relationships
Compare financial statement balances
with nonfinancial information or things,
such as the assets they represent
Compare financial statement balances
and policies with those used by other
similar companies

Inadequate Disclosure Fraud


Disclosure Fraud Schemes
Misrepresentation about the
nature of the company or its
products
Misrepresentations or omissions in
the MD&A
Misrepresentations or omissions in
the footnotes to the financial
statements
24

Inadequate Disclosure Fraud

25

Ways to identify Disclosure Fraud


Look for inconsistencies between
disclosures and information in the
financial statements
Inquire of management concerning
related-party transactions,
contingent liabilities, and
contractual obligations
Review a companys files and
records with the SEC and other
regulatory agencies

You might also like