Accounting Fraud in an Organization - Research Paper Example

Accounting Fraud in an Organization Abstract This paper is a discussion about a very common kind of fraud known as accounting fraud. First of all, an introduction to accounting is given followed by discussion about fraud in accounting. Who should be held responsible for it, has been taken into account. Then, ways and techniques to discover accounting fraud have been described. The effects of this fraud on companies and shareholders have been illustrated. Recommendations have been given about how to minimize these adverse effects. Some real life cases have been talked about so as to get a better idea how disastrous this fraud can be for individuals and companies. The paper is summarized in a concluding paragraph and APA referencing has been used properly. Introduction What is Accounting? According to Snyder (2010), “Accounting is the art of recording, summarizing, reporting, and analyzing financial transactions”. Simply put, accounting is a field that involves financial operations which record information about the financial status of a company. Accounting, when it is moral and professional at the same time, provides a lucid financial picture of a company and enables the accountants to formulate well-versed decisions that aim at securing the profit of the company. The accounting system may be as simple as involving a simple register and may be as sophisticated as a computerized system that records all financial activities providing information about every monetary detail like current business trend and future vision. Accounting deals with three types of information: operating information, financial accounting information and Managerial accounting information (MoneyInstructor, 2005). Operating information is the largest portion of accounting information. The company needs this information on a routine basis like employees’ salaries, record of loans rendered, sales, inventory, and so on. Financial accounting information enables the managers, shareholders and the like to make well-informed decisions about their investment, shares, money taken or given as loan, and etcetera. Managerial accounting information enables managers to make decisions about budget and formulate plans to supervise the financial activities. The end-result of accounting system is the financial statements that allow the organization to maintain a check and balance on the financial goings-on of the business. What is Accounting Fraud? Businesses and organizations are sometimes very much under the pressure, due to market competition may be, to make them appear profitable to the investors and clientele in order to draw them. But they need to know that practicing counterfeit accounting activities to fulfill this purpose is not only unethical but also can bring disastrous consequences. According to Will (2010), “Accounting fraud is a deliberate and improper manipulation of the recording of sales revenue and/or expenses in order to make a company's profit performance appear better than it actually is”. Companies involve in accounting fraud by over-recording the sales revenue or not recording of prepaid expenses or depreciation expenses. This is called false bookkeeping. They may also ship one-year-guarantee products to such customers about whom they are sure that they will not be able to return them back within a year, and when they do return them, the sales would have been recorded as real sales. The returned products may also not be recorded as returned to avoid having them interrupt with the sales revenue. Companies may also not record certain assets. For example, a company involved in accounting fraud may not record the sold goods so that cost is not recorded against the sales. This way, the company’s inventory would be showing goods that do not actually exist in the inventory. The company may also choose to not record asset losses or actual amount of a liability to get it understated in the balance sheet which overstates the overall profit (Will). These are some of the many types of accounting fraud in which many companies or some employees get involved to achieve their unethical evil ambitions. Accounting fraud is a very serious issue for the preparers as well as the users of financial statements. Who is Responsible? As the accounting fraud cases increase, it becomes important to know who is responsible for committing the fraud and who is responsible for its detection. The company’s management team or the preparers of the financial statements are the first who should be held responsible for accounting fraud. The head officer in the finance department, the financial manager, the internal and external auditors, all must be inquired. According to Akers and Bellovary (2006, p. 247), Even though all individuals in the financial reporting process share the responsibility for the integrity of the financial statements, different perspectives of fraud can and do affect each group’s interpretation of fraudulent activity and responsibility for the prevention and detection of fraud. Moreover, the bookkeepers and accounting clerks should also be held responsible because it is they who maintain and update the financial records and activities. Accounting clerks, like accounts receivable or accounts payable clerks, are the ones who are chiefly responsible for any intentional errors in the financial statements. How to Discover Accounting Fraud? Hiring a forensic accountant to discover accounting fraud is the most important step toward fraud detection. He will be a certified accountant expert in scrutinizing financial activities and records as a criminal would. Forensic accounting relates and applies “financial facts to legal problems” (Singleton, Singleton & Bologna, 2006, p. 44) and the evidence collected is presented to the court of law. Singleton, Singleton and Bologna affirm that it is not the methodology that is needed to detect accounting fraud; instead, it is the mind-set of the auditors that is the best detection technique. Detection does not include seeing evil everywhere and distrusting the whole body. It actually is an art that deals with critical and creative thinking and catching signs of fraud through experience and training. Thus, before calling in a forensic expert, it is important for the management of the company to observe deeply where the problem is occurring (like any unusual inventory or unusual sales) and then raising that issue to the internal and external auditors. Effects of Accounting Fraud According to the Association of Certified Fraud Examiners’ (ACFE) 2004 Report to the Nation on Occupational Fraud and Abuse (as cited in Akers & Bellovary, 2006), “fraud cost U.S. companies roughly $660 billion in 2003”. Accounting fraud affects the product markets, the shareholdres and the reputation of the company adversely. Sadka (2005) states that accounting fraud results in “inefficient pricing of debt and equity securities” because impractical hopes and prospects arise from false financial statements producing bad effects upon financial markets. Incorrect financial statements and manipulated accounting figures can enable a firm hold it eligible for loans and can also save it from bankruptcy. Fraudulent firm can also badly affect other firms related to it as cost and yield of one product is related to the cost and yield of other firms’ products. Thus, when managers increase or decrease the price of their product, this creates strain and pressure upon the overall product market. Sadka speaks of it as “accounting fraud can potentially bankrupt the entire industry, not to mention the fraudulent firm itself. The fraudulent firm is hurting3 because it is acting suboptimally and the rest of the industry suffers due to the resulting lower equilibrium price”. How to Minimize these Effects? It is important to protect one’s business from falling prey to accounting fraud. All financial activities must be documented properly and the number of people concerned with these activities must be figured out. Higher officials must keep a strict check on cash flow, liabilities and inventory to know how the accounting system is working. This is called system check that tells the financial condition of the company after the fraud has occurred. Bookkeepers or managers must not be given the right to sign on the owner’s bank account. Companies authorize bookkeepers to keep check on bank accounts and this is the real mistake. The owner must check the financial statements personally and should ask the financial manager if he encounters an unusual entry. Double-checking financial statements and bookkeepers’ accounts can give a sure check. Authorization for preparing the order and shipping must be documented. Real Life Examples of Accounting Fraud On daily basis, we come across news regarding financial wrongdoings and accounting fraud being revealed. Sulon (2001) reports that lawsuit filed against three executives at Rite Aid Corp. have been convicted of heavy duty accounting fraud which involved overstating the company’s earnings by $1.6 billion which raised the value of its stock by ninety-one percent. Accounting manipulation caused the collapse of Lehman Brothers who moved off assets worth $50 billion from balance sheets to hide their debt “while claiming the transactions as sales rather than financings”, according to WebCPA Staff (2010). In 2003, the U.S. Securities and Exchange Commission accused Penthouse International Inc.” improperly booked as revenue a $1 million upfront payment in connection with a 5-year Web site management agreement” in the quarterly report and also “changed a quarterly loss of $167,000 to a net profit of $828,000” (Reuters, 2007). Conclusion To sum up, companies indulge in accounting fraud to appear profitable to the product market or to appear in loss to the bank creditors to get loans. Simple manipulation of some accounting figures can create disastrous impact on the market. Accounting fraud may be detected in accounts receivable, accounts payable, revenue and prepaid expenses, fixed assets and inventory. Bookkeepers and financial accountants are primarily responsible for errors in financial statement. A forensic accountant may be the best person to identify and solve accounting fraud. There have been several fraudulent cases in past that compel the owners of big businesses to implement a proper system check to minimize or completely eliminate the risk of accounting fraud. References Akers, M. & Bellovary, J. (2006). What is fraud and who is responsible? Journal of Forensic Accounting, 7, 247-256. MoneyInstructor. (2005). What is accounting? MoneyInstructor.com. Retrieved May 22, 2010 from http://www.moneyinstructor.com/lesson/accountingintro.asp Reuters, (2007, May 10). Penthouse settles accounting fraud case with SEC. Reuters. Retrieved May 24, 2010 from http://www.reuters.com/article/idUSN108875120070513 Sadka, G. (2005). The Economic Consequences of Accounting Fraud in Product Markets: Theory and Evidence from the US Telecommunications Industry. Retrieved May 23, 2010 from http://www.nd.edu/~carecob/Workshops/04-05%20Workshops/Sadka.pdf Singleton, T., Singleton, A. & Bologna, J. (2006). What is forensic accounting? Fraud Auditing and Forensic Accounting. USA: John Wiley and Sons. Snyder, S. (2010). What is accounting? Microsoft Corporation. Retrieved May 22, 2010 from http://office.microsoft.com/en-us/products/HA101024451033.aspx Sulon, B. (2001, February 09). Rite-Aid executives responsible for accounting fraud, lawsuit claims. Tribune Business News. Retrieved May 23, 2010 from http://www.accessmylibrary.com/coms2/summary_0286-5836941_ITM WebCPA Staff. (2010, March 18). Regulators turned “blind eye” to Lehman’s accounting fraud. WebCPA. Retrieved May 24, 2010 from http://www.webcpa.com/news/Regulators-Turned-Blind-Eye-Lehman-Accounting-Fraud-53633-1.html Will, J. (2010). What is accounting fraud? Articlesbase. Retrieved May 22, 2010 from http://www.articlesbase.com/accounting-articles/what-is-accounting-fraud-1717680.html Read More