Detecting Accounting Fraud Before It Is Too Late - Amat Oriol
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Summary of notes and ideas
This example shows that the IFRS regulation is the one that offers higher flexibility. These data are consistent with several studies (for example, Callao and Jarne, 2010) that show that the IFRS offer more possibilities of alternative treatment and estimates compared to other accounting standards. A study by the ACCID (2017) concludes that in the IFRS there are over one hundred transactions that allow alternative accounting treatment and subjective estimates.
Legal accounting manipulation is a consequence of the rules' flexibility and is usually done through three types of transactions: Transactions that can be accounted for choosing among several alternatives. Accounting notes based on more or less optimistic estimates. Gaps in accounting regulations.
In order to assess the importance of the different types of accounting fraud, we have done a study on the affected items in 148 accounting frauds that we have identified internationally from 1980 to 2016 (see Figure 6.5). In this figure, it can be seen that of the analyzed cases, in almost all of them the manipulations modified the net result and the equity. Among the other items that have been most affected by the manipulations are sales, customers, operations with subsidiaries, and expenses.
In fact, most are discovered through anonymous complaints or by coincidence. According to Olcina (2016) and ACFE (2016), 42% of frauds are discovered after a tipoff (mostly from employees, customers, or anonymous people), 16% are discovered by the controls of the company’s management, 14% through internal audit, 3% through external audit, and the rest (25%) are discovered by chance.
The people who commit most accounting frauds are usually the chief executive of the company in collaboration with administration, accounting and financial managers. According to the Committee of Sponsoring Organizations (COSO), an international organization that fights business fraud, studies compiled by Beasley (1996) show that 72% of accounting frauds included the participation of the CEO and/or the general manager. A more recent study (ACFE, 2016) shows that executives or owners of companies commit 66% of frauds.
In the beginning the entrepreneur manages, with a lot of effort, to create an innovative and high-growth company. Soon after he is a renowned businessman and gets all types of compliments and awards. They are people with a tendency toward egocentricity and overexposure to the media. Many politicians want to be close to them (and vice versa). Success makes them drunk. Excess of diversification and acquisition of other companies that are disastrous. When the first negative results appear, instead of acknowledging them and taking measures, they opt to manipulate the accounts
WARNING SIGNS BEFORE A FRAUD OCCURS: Using the door to fraud, we can identify warning signs related to the organization, before a fraud occurs. Motivation: There may be managers interested in showing that the company is doing better than it actually is. This can be due to a number of factors: To avoid having difficulties obtaining financing. Companies with loans that have cancellation clauses. They are companies that have to accomplish certain requirements in their accounts (profits, debts, liquidity, etc.) to prevent a bank loan being rescinded in advance. In these cases, there is more pressure for the accounts to reflect that the conditions agreed on are met. Companies in which analysts and rating agencies' opinions are worsening. To avoid reprobation or dismissal, in companies that exert a strong pressure to meet certain goals or budgets that very ambitious. To receive a bonus. According to PricewaterhouseCoopers (2010), this is the main incentive to commit frauds in companies. When a manager is soon leaving the company, there might be interest in transferring problems to those who’ll take the reins in the future. A company that has to be sold in the near future
[…] sellers may be interested in offering a better image that raises the selling price. This can also happen in the IPO (initial public offering). Companies that must comply with certain conditions (of purchases, sales, profits, etc.) to continue benefiting from certain contracts or licenses. There may be managers interested in showing that the company is doing worse than it actually is: To pay less taxes; To curb the demand for wage increases or more dividends; To lower prices on dismissals; After a change in the board of directors or in the management team there may be interest in attributing problems to the previous management. In these cases, big baths are more frequent; A company that is object of tender offer. In these cases, if the shareholders that control the company are the ones who propose the tender offer, they may be interested in offering a worse image of the company to pay a lower price for the shares. Conflicts between shareholders or between members of the board of directors: In case of conflict, the group that exerts control of the company may be interested in hiding from the other side the company’s true situation
On the other hand, if the president makes the appointment, it could be people with a lower level of independence, who may favor looking the other way in case of fraud. In these cases, it is more feasible that the president or the CEO can act with more impunity. Presence of employees, former employees, or managers on the board. These are people that may have information about the fraud, but possibly don’t have enough independence to report it. A company with a high probability of unethical behaviors occurring. To evaluate this aspect, it can be checked whether it is a company that: Doesn’t have ethical or conduct code. Doesn’t have an approved document on policies in relation to frauds (from prevention to action once it has occurred). Doesn’t have a channel for anonymous complaints. Therefore, if anyone detects a problem, he may be afraid of reporting it because of the consequences it may have. Has received sanctions for breaches of the current legislation in relation to consumers or in matters of labor, environment, etc. Is known for not acting correctly with some of the interested parties (employees, shareholders, creditors, community, etc.)
Warning signs are produced if auditors issue an unfavorable opinion, or favorable but with exceptions. When the magnitude of the problems is very high and auditors don’t have enough elements to emit an opinion, then they will refuse giving an opinion.
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