Financial Statement Fraud Investigations - Essay Example

Financial Statement Fraud Investigations Summary of Investigation The financial statements of Crazy Eddie revealed that the company is making money by practicing fraudulent activities. The reports revealed the facts that the company scheduled smuggled money as sales from foreign banks. The reports misrepresented the true value of accounts payable to creditors. The inventory was overstated and the audit reports were doctored. The company’s accounting policy recognized sales returns by crediting the respective amount and at the same time it also counted it as inventory. The inventories were shared between the various stores of the company to boost sales. Various external vendors were arranged to ship merchandises of the company claiming fake discounts. Loads of merchandises were sold to wholesalers and then the receipts were spread to individual stores of the company. These illegal money was entered and circulated between the Antar family and was parked into undisclosed foreign bank accounts. The initial reports suggest that when Crazy Eddie went public about twenty years ago, its shares were traded at $8. The company’s shares have inflated 10 times during the years due to manipulation of accounts. By showing fake sales, misrepresented inventories, doctoring and window dressing financial statements, the company was able to hide its true picture of financial position from the public. Thus, the company’s stocks looked more attractive from outside than it actually was. The sales of the company never fell since the merchandises circulated between the various stores and was treated as revenues. Such fraudulent practices helped Crazy Eddie to maintain a healthy double-digit growth and consequently inflated the company’s share prices. Due to inflated share price, the owners of the company has now appreciated share price. The most alarming part of the scam involves the doctoring of the auditor’s report. The employees of Crazy Eddie broke into auditors reports and inflated the inventory over 100 times. Fake debit memos were drawn up showing lots of sales. Due to this, the creditors got the impression that the company’s demand was unmatched and hence they extended the credit period. The payments of actual sales were made in instalments. Each instalment of a particular sale was treated as individual sales. The sharing of inventories between some forty stores helped the company conceal true facts. Scope of Examination Financial statement frauds challenge the integrity and corporate social responsibility of companies. These frauds may be malpractices in the form of intentional misrepresentation, alteration of financial reports, falsification, doctoring business documents and business transactions, deliberate window dressing and misapplication of accounting policies, inflating sales and inventories, bribes, fictitious revenues, over or under statements in financial statements, and so on. The financial statement fraud examination aims to implement integrity and CSR in all companies by encouraging transparent, reliable, and investor friendly financial statement. Financial statement examination justifies the concept of audits and establishes the confidence of society as well as all market participants. It tries to make the capital market more efficient by providing perfect information for all participants. Financial scandals not only ruin the repute of the company, it might also create negative sentiments in capital markets, affects the nation’s economic growth and prosperity. It gives the culprits one more chance to plead guilty and rectify accounting practices and malpractices. Fraud examination can help protect the company’s minority shareholders’ from potential bankruptcy or substantial economic loses. And finally it helps bring trust and public confidence in auditing profession and accounting (Nguyen, 2010, p.3). Factors that Aided Examination Some factors that aided in fraud investigation are as follows: Fictitious Revenues – Such schemes involves recognizing fake sales from phantom customers, or even fabricated sales from genuine customers. From the investigation it was apparent that Crazy Eddie’s owners wanted to hide the company’s true position from the outside world. They wanted the stocks to rise irrespective of actual happenings at the stores. They maintained double digit growth in sales by entering fake revenues which inflated their share prices. Conditional Sales – It is a condition when sale is booked but the ownership is not transferred to the purchaser. Crazy Eddie used to share inventories of different stores and also issued false entries to account payables. Thus, in this process they overstated the revenues by inflating inventory numbers. For the general public it looked as if the company’s sales were growing above industry average (Skalak, 2011, pp.231-248). Thus, the above malpractices were found out when the accounts of Crazy Eddie red flagged the facts: Unusual profit especially compared with other players in same industry; Eddie’s accounts were showing negative cash flows from operations means inability of company to generate sufficient cash to carry out daily operations. But the company’s sales and earnings were experiencing unusual growth. In fact the business money was channelled into the undisclosed personal accounts of Eddie Antar and his family members; Unusual growth in account receivables; and Significant increase in sales volume whose actual ownership was unknown Limitations of Examination Some of the fraud analysis techniques used by fraud investigators and their limitations are discussed below: Deductive fraud detection – It identifies a specific fraud but requires extensive business knowledge. Inductive fraud detection – It searches for global patterns to unveil abnormal relationships. Since it uses computer software, it is expensive, and may result in false signals. It requires information technology skill along with knowledge of auditing. Auditors depend on documents, systems and information to detect frauds but if these are skilfully doctored, the fraud may get unnoticed. Summary of Conclusions Financial statement fraud is the process of intentional misrepresentation of financial statements and disclosures in order to make abnormal profits. Financial frauds are emerging as the biggest threat to company’s corporate governance and accountability. It is also damaging the integrity of such companies as well as the directors, executives and auditors. It includes fictitious sales, inflating customer receivables, improper asset valuation, siphoning company’s money into secret personal accounts, and so on. The detection of fraud is not only responsibility of owners but all parties involved in corporate governance including internal and external auditors. References Skalak, S., Golden, T., Clayton, M., & Pill, J. (2011). A Guide To Forensic Accounting Investigation. New Jersey: John Wiley & Sons, Inc. Nguyen, K. (2010). Financial Statement Fraud: Motives, Methods, Cases and Detections. Florida: Universal Publishers. Read More