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FINANCIAL STATEMENT FRAUD ISSUES & EXAMPLES Angela Morelock, Partner Forensics & Valuation Services
[email protected]
Blog: www.BKDForensics.com Twitter: @Angela Morelock
FINANCIAL STATEMENT FRAUD Def. Deliberate fraud committed by management that injures investors & creditors through materially misleading financial statements
THREE TYPES OF FS FRAUD Manipulation: falsification or alteration of accounting records upon which FS is based Misrepresentation: intentional omission of significant events, transactions, etc. Misapplication of accounting principles relating to amounts, classification, manner of presentation or disclosure
FREQUENCY OF FINANCIAL STATEMENT FRAUD
©2016 by the Association of Certified Fraud Examiners, Inc.
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LOSSES FROM FINANCIAL STATEMENT FRAUD
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WHY COMMITTED? Demonstrate increased EPS so that dividends will be paid Dispel negative market perceptions Obtain financing Meet company goals Receive performance-related bonuses Increase purchase price for acquisition Meet regulatory requirements Hide asset misappropriation
TYPICAL FS FRAUDS Improper revenue recognition Inadequate disclosure Improper asset valuation Improper deferral of expenses Manipulation of accruals, reserves & estimates Understatement of liabilities Capitalizing expenses Top-side entries Related-party transactions
LIABILITY FOR FINANCIAL STATEMENT FRAUD Negligence fail to exercise professional care Gross negligence intentional failure to perform duty Fraud active participation
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MEET CAROLINE BEMBRY Medical Manager Corporation Assistant Corporate Controller Participated in a financial statement fraud two years into her career Key witness at trial
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SOME TRIAL EXHIBITS
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ETHICS
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MEET A HOSPITAL CFO Fired for smoothing earnings using contractual account as cookie jar Product of his environment Believed this was proper Failed to recognize ethical dilemma
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MANIPULATION OF NON-PROFIT HOSPITAL FINANCIALS
Subsidiary hospital of large non-profit system CFO thought revenue seemed low One quarter booked approx. $5 mil revenue to make same as last year Another quarter, earnings were great • Booked a $1 million liability against contractuals • Created a reserve for smoothing earnings
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IS SMOOTHING EARNINGS AN ACCEPTABLE PRACTICE?
SEC on Smoothing
Is it OK to be over accrued? Is it better to be over accrued than under accrued?
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What basis exists for conservatism? Is conservatism: An accounting principle? GAAP? Encouraged by any accounting standard or guidance?
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FASB CONCEPTS STATEMENT NO. 2 (AS AMENDED) QUALITATIVE CHARACTERISTICS OF ACCOUNTING INFORMATION ISSUED: MAY 1980
conservatism tends to conflict with significant qualitative characteristics, such as representational faithfulness, neutrality, and comparability (including consistency)
(para. 92)
if two amounts are not equally likely, conservatism does not necessarily dictate using the more pessimistic amount rather than the more likely one
(para. 95)
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General reserve for the unknown acceptable?
ENRONS SPECIAL PURPOSE ENTITIES
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MEET WARREN SCHMIDGALL, CFO AIPC
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SUMMARY OF PRESS RELEASE Delay in filing of 10-Q for Q3 2005 Audit committee investigation in process $60.7 million in financial statement adjustments estimated • Actual adjustments turn out to be $52.5 million
Stock price drops from $20.94 to $11.16 Stock delisted in April 2007
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METHODS TO INFLATE EARNINGS
Multiple round-trip transactions Recording fictitious $1 million receivable Capitalization of plant operating expenses Capitalization of MIS expenses Recognizing revenue on product not shipped Not recording write down of spare parts inventory
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US ATTORNEYS OFFICE NEWS RELEASE 9/15/2008
SUMMARY OF LITIGATION Criminal charges against several, including • Warren Schmidgall, CFO • Timothy Webster, CEO
Shareholder class action - $175 million • Company settled $25 million (14%) • E&Y settled $3.6 million
SEC civil actions filed against numerous individuals including many accounting personnel & Dave Watson, COO
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CAPITALIZATION OF PLANT EXPENSES Multiple capital expansion projects Adjusted plant expenses to budget & pushed excess expense into capital projects Capitalized $9.4 million of plant operating expenses, thereby increasing earnings
CAPITALIZATION OF MIS EXPENSES Multiple IT development implementation projects Adjusted MIS expenses to budget & pushed excess expense into capitalized IT projects Capitalized $5.23 million of plant operating expenses, thereby increasing earnings
DETECTING FS FRAUD Horizontal & vertical analysis (3-5 years) Ratio analysis Comparison to industry Careful examination of corporate culture & financial reporting controls Vouching to source documents Confirmations Examination of estimates Nonroutine transactions Careful examination of capitalization (operating expenses, IT projects, etc.) Scrutiny of manual journal entries Advanced data analytics
DETECTING FS FRAUD Nonroutine transactions Careful examination of capitalization (operating expenses, IT projects, etc.) Scrutiny of manual journal entries
SET A GOOD EXAMPLE
• Rationalizing can be easy we all do it • Grey areas can quickly turn black • Your gut often tells you right from wrong I knew it was wrong
.I knew that what I was doing was misleading. But I didn't think it was illegal. I thought: That's how the game is played. You have a complex set of rules, and the objective is to use the rules to your advantage. And that was the mistake I made. Andrew Fastow, Former Chief Financial Officer of Enron
WHISTLEBLOWER RETALIATION
2013 National Business Ethics Survey
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Source: AFCE Report to the Nations 2016
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DETECTION OF FRAUD SCHEMES
Source: AFCE Report to the Nations 2016
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RISKS & REWARDS OF FRAUD HOTLINES
Source: AFCE Report to the Nations 2016
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www.IntegraReport.com
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VICTIM ORGANIZATIONS
Source: AFCE Report to the Nations 2016
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Source: AFCE Report to the Nations 2016
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ACFE ANTIFRAUD CONTROLS
• Presence of antifraud controls is notably correlated with significant decreases in the cost & duration of occupational fraud schemes. Victim organizations that had implemented faster!controls experienced any of12 16 months common antifraud considerably lower losses & time-to-detection than organizations lacking these controls • Perpetrators with higher levels of authority tend to cause much larger losses. Median loss among frauds committed by Losses 44%loss less! owner/executives was $573,000, median caused by managers was $180,000 & median loss caused by employees was $60,000 ©2016 by the Association of Certified Fraud Examiners, Inc.
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THANK YOU
FOR MORE INFORMATION // For a complete list of our
offices and subsidiaries, visit bkd.com or contact:
Angela Morelock, CPA, CFE, CFF, ABV // Partner
[email protected] // 417.865.8701 910 E. St. Louis Street Springfield, MO 65801-1190
