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Financial Fraud Phenomenon and Its Major Types Problem Solution Essay


Literature Review

Financial fraud is a common phenomenon as noted earlier in this paper. Fraud is common in four major types of financial accounts that are the balance sheet that indicates the financial position of an organization at a given period, the statement showing income of an organization, the statement showing the flow of cash in the firm and the statement of the changes of equity of a given organization.

On the statement of balance of the firm, fraudsters are usually interested in altering the figures of the assets, liabilities or the equity of the firm in order to portray false information regarding the position of the firm at the period. According to DeZoort et al. (2002), the manipulation of the figures could include making the firm to look like it is doing so well yet it is not, or the opposite.

As noted by MacKinlay (1997), the common form of fraud in this case is minimization of the profit of the firm especially if the intention is personal gain. In addition, fraudsters can inflate the figures in cases where the firm is seeking more investment funds from the public and other investors so that an organization is presented as performing very well in terms of profitability (Ramamoorti, 2008).

The statement indicating the flow of cash is significant in determining the liquidity of an organization, which in turn determines the firm’s going concern. Alteration of figures on this statement could affect the presentation of the firm’s going concern to the targeted group.

For instance, the figures could be inflated to indicate a very stable condition with the firm having enough funds to meet its obligations both in the short term and immediate short term so that investors can find the firm able to survive until an unknown period in future (Palmrose, et al., 2004).

Frauds in all these financial statements affect the stakeholders of the firm in one way or another. To begin with, the figures affected could be targeting investors so that they can perceive the firm as very stable and profitable and thereby ending up investing in the firm.

On the contrary, fraud could enable the firm to earn a better reputation of better performance in terms of profits made. Lastly, Carpenter, Durtschi and Gaynor (2011, p. 13) argue that fraud could occur in an organization due to personal gains by the financial officers.

Investigation of known cases of Financial Fraud

Fraud in Atkins Trucking Corporation

Fraud took place in this corporation at the time when Jenny Baker was the CFO. She had all qualifications with the latest being regulatory accounting, which had enabled her to rise quickly through the ranks and occupy her current position. Established in 1930, the corporation had suffered greatly from the great depression of the 1930s and emerged successful after the World War II when it began gaining much growth and expansion.

Having worked from the corporation from the beginning, Wilson an internal auditor gained experience in analyzing fraud in the firm where he was then working as the internal audit director. He performed his duties diligently by undertaking data mining to establish improper expenditures in the financial statements.

He received his forensic financial accounting training while still in the firm. This type of accounting involves examination of existing relationship among financial statements’ vertical and horizontal analysis with the focus being time sensitive interdependencies (Sharma, 2004).

With his newly acquired knowledge, he examined the financial statements of Atkins for a period of ten years regarding existing relationship between vertical and horizontal relationships. The science also involved examination of the earnings manipulation that was established through the correlation of reported earnings and reported cash from the firm (Beasley, et al. 1999).

Though tedious, the examination began revealing some unusual patterns with in the first five years. Early periods indicated a correlation among the earnings with the last five years showing divergence from the correlation (Rezaee 2005, p. 291). Different unexpected results were obtained from the analysis of allowance of doubtful accounts such as increased allowance in periods of strong growth in revenue.

The findings were different from what she had heard that the firm was doing great revenue collection (The Institute of Internal Auditors, 2009). Wilson engaged the external auditors that were just in sight and they discussed the new pattern established.

It was revealed that there was some form of fraud taking place and they had to involve the management to discuss the issues, a move that flopped since the management refused to discuss the issue. Afterwards, he was intimidated by the management (Carcello, et al. 2010).

Fraud in the Monarch Group Inc

This firm was established in the 1970s in California and it was involved in the exploration of oil and gas. Just few months after its establishment, the firm changed business with all of its assets related to exploration of oil being sold (Deloitte LLP., 2008b). The firm became a developer of residential subdivisions and also their construction.

There was change of the top management after the existing CEO of the firm left sometimes later (Cohen, et al. 2004). The firm undertook a series of mergers and acquisitions with one involving the acquisition of the Alabama Resort Development, a developer of five star resorts (Beasley, et al. 2009).

All forms of acquisitions that Monarch had made were noted and included in the financial statements that were given to the board of directors and other shareholders (DeFond, et al. 2007). Later in the course of working, the CFO Knight left the firm and his place was taken by Simon Fitch who signed the year’s quarterly fillings with the SEC.

The acquisition of the ARD had been accompanied by issuance of 5 million shares of Monarch’s common stock the former owners of ARD, Nathan brothers in exchange for the 100% ownership of ARD (Buljevich & Park, 1999). Despite the disclosure of the details about the ARD acquisition, the end year reports to the SEC did not disclose the actual activities and assets of ARD (Center for Audit Quality, 2010).

Therefore, SEC suspected fraud in the activities of Monarch and began investigations. It is believed that the Nathan brothers had filed a complaint about activities of the Monarch after they were fired and it was suspected that they had obtained crucial information from the former CFO Knight who had left (Owens, 2003; Roth, 2010).

SEC had evidence of the fraudulent mortgages that Monarch had obtained. It was clear that they had acquired information from the company’s main hard drive which went missing immediately they were fired (Chris et al. 2008, p. 241).

Lessons on Fraud

It is clear from the first and second cases of Atkins Trucking and the Monarch that fraudulent activities are common among firms and could take many forms some of which involve manipulation of the financial reports (Van Peursem, 2004, p. 381). It is important that employees involved in any form of auditing beginning with internal auditors be equipped with the necessary expertise such as the forensic accounting that Wilson and Sarah had as they worked for the Atkins (Deloitte LLP., 2008a).

This could be achieved through reading and analysis of the reports using the vertical and the horizontal techniques that establish existing relationships among the statements. It is suggested that the period of analysis be five years (Kaplan, Pope & Samuels 2010, p. 314).

It is important that organizations have a good corporate culture that allows all institutions to grow but not to become too powerful. Too much dominance of the accounting department in an organization could enable the department make some malpractices a norm thereby paving way for its fraudulent manipulation of the financial statements.

According to Debreceny and Gray (2011, p. 219), internal controls play a significant part in alleviating fraud. Just like in the case of Atkins Trucking Company, control such as those that require substantiation and approval for every entry must be adhered to in order to reduce fraud cases. As noted by Fitch and Shivdasani (2007, p. 622), basic accounting rules and regulations are the foundation for openness and accountability in an organization.

While one pursues fraud, he or she is likely to be intimidated especially by the involved parties. However, Daniel et al. (2012, p. 853) point out that staying focused and shunning intimidation could help while one seek solutions elsewhere such as comparing similar situations.

Recommendations to Reduce Cases

There are various measures that an organization can undertake in curbing fraud cases such as those realized in Atkins Trucking Corporation and the Monarch. To begin with, Geiger and Smith (2010, p. 31) note that auditors need to pay attention to significant transactions in the firm’s statement.

Although most auditors examine transactions done on a routine basis, it is important to focus on transactions that are not done regularly since they fall outside the normal process of accounting. Michelman, Gorman and Trompeter (2011, p. 116) further argue that auditors should exert more efforts in identifying and analyzing non-routine activities in the reports of the firm.

Controls should be applied on all transactions as noted by Hammersley, Bamber and Carpenter (2010, p. 563) who further argue that no special class of transactions should be left since internal controls can only be effective when applied on all transactions. Similar principles should be applied to all transactions regardless of the person requesting the reports (Deloitte LLP., 2009).

Fraud can be minimized if the board can be involved in the analysis of the reports. According to Wells (2011, p. 79), it is a requirement of the Sarbanes-Oxley that experts in analyzing finances be allowed to sit on the board of most firms that are publicly traded. This could also extend to any other firm that is not traded publicly (Mark, 2009).

For instance, a board consultant could be hired with his key responsibilities being interacting with the executives on the board, understanding the way in which the firm is dong and offering advice (Dorminey, Scott, Kranacher & Riley 2012, p. 563).

Zand (1997, p. 211) posits that while revealing fraud cases, auditors experience a lot of intimidation especially from the management that comprises involved parties. It is important that auditors should not tolerate such actions since they are financial behavioral violations that should be viewed in isolation but should be considered a weakness in the firm’s control mechanisms (Bull, 2008).

Lastly, improved audit awareness and training can increase the expertise of the auditors just like in the case of Wilson in Atkinson Trucking Corporation who received forensic accounting techniques that enabled him reveal the level of fraud in the firm (External Reporting Board, 2011).

List of References

Beasley, M et al. 2009, ‘The audit committee oversight process’, Contemporary Accounting Research, vol. 26, pp. 65-122.

Beasley, M et al., 1999, Fraudulent Financial Reporting: 1987-1997: An Analysis of U.S. Public Companies, COSO, New York.

Buljevich, E & Park, Y 1999, Project financing and the international financial markets, Springer, New York.

Bull, R 2008, Financial ratios : How to use financial ratios to maximise value and success for your business, Oxford University Press, London.

Carcello, J et al. 2010, ‘CEO involvement in selecting board members, audit committee effectiveness, and restatements’, Working paper.

Carpenter, T, Durtschi, C & Gaynor, L 2011, ‘The Incremental Benefits of a Forensic Accounting Course on Skepticism and Fraud-Related Judgments’, Issues in Accounting Education, vol. 26, no. 1, pp. 1-21.

, 2010, Deterring and Detecting Financial Fraud: A platform for action. Web.

Chris, E et al. 2008, ‘Financial Statement Fraud: Insights from the Academic Literature’, A Journal of Practice & Theory, vol. 27, no. 2, pp. 231-252.

Cohen, J et al. 2004, ‘The corporate governance mosaic and financial reporting quality’, Journal of Accounting Literature, vol. 23, pp. 87–152.

Daniel, A et al. 2012, ‘Does Investment-Related Pressure Lead to Misreporting? An Analysis of Reporting Following M&A Transactions’, The Accounting Review, vol. 87, no. 3, pp. 839-865.

Debreceny, R & Gray, G 2011, ‘Data Mining of Electronic Mail and Auditing: A Research Agenda’, Journal of Information Systems, vol. 25, no. 2, pp. 195-226.

DeFond, M et al. 2007, ‘Investor protection and the information content of annual earnings announcements: International evidence’, Journal of Accounting and Economics, vol. 43, pp. 37-67.

Deloitte LLP., 2008a, Ten Things About Financial Statement Fraud, 2 ed., Deloitte Forensic, New York.

Deloitte LLP., 2008b, Ten Things About the Consequences of Financial Statement Fraud, Deloitte Forensic, New York.

Deloitte LLP., 2009, Ten Things About Financial Statement Fraud, 3 ed., Deloitte Forensic, New York.

DeZoort, F, et al. 2002, ‘Audit committee effectiveness: A synthesis of the empirical audit committee literature’, Journal of Accounting Literature, vol. 21, pp. 38–75.

Dorminey, JA, Scott, F, Kranacher, M & Riley, R 2012, ‘The Evolution of Fraud Theory’, Issues in Accounting Education, vol. 27, no. 2, pp. 555-579.

External Reporting Board, 2011, Professional and Ethical Standard 1: Ethical Standards for Assurance Providers, External Reporting Board, Wellington.

Fitch, E & Shivdasani, A 2007, ‘Financial fraud, director reputation, and shareholder wealth’, Journal of Financial Economics, vol. 86, no. 2, pp. 606-336.

Geiger, M & Smith, J 2010, ‘The Effect of Institutional and Cultural Factors on the Perceptions of Earnings Management’, Journal of International Accounting Research, vol. 9, no. 2, pp. 21-43.

Hammersley, J, Bamber, M & Carpenter, T 2010, ‘The Influence of Documentation Specificity and Priming on Auditors’ Fraud Risk Assessments and Evidence Evaluation Decisions’, The Accounting Review, vol. 85, no. 2, pp. 547-571.

Kaplan, S, Pope, K & Samuels, J 2010, ‘The Effect of Social Confrontation on Individuals’ Intentions to Internally Report Fraud’, Behavioral Research in Accounting, vol. 22, no. 2, pp. 51-67.

MacKinlay, A 1997, ‘Event studies in economics and finance’, Journal of Economic Literature, vol. 35, pp. 13-39.

Mark, N 2009, ‘A Model and Literature Review of Professional Skepticism in Auditing’, A Journal of Practice and Theory, vol. 28, no. 2, 1-26.

Michelman, J, Gorman, V & Trompeter, G 2011, ‘Accounting Fraud at CIT Computer Leasing Group, Inc.’, Issues in Accounting Education, vol. 26, no. 3, pp. 569-591.

Owens, J 2003, ‘Nonprofits without audit committees risk financial disaster’, Directorship, vol. 29, no. 7, pp. 50.

Palmrose, Z et al., 2004, ‘Determinants of market reactions to restatement announcements’, Journal of Accounting and Economics, vol. 37, pp. 59-89.

Ramamoorti, S 2008, The psychology and sociology of fraud: Integrating the behavioral sciences component into fraud and forensic accounting curricula’, Issues in Accounting Education, vol. 23, pp. 521-533.

Rezaee, Z 2005, ‘Causes, consequences, and deterrence of financial statement fraud’, Critical Perspectives on Accounting, vol. 16, no. 3, pp. 277-298.

Roth, J 2010, Best Practices: Evaluating the Corporate Culture, The Institute of Internal Auditors, New York.

Sharma, V 2004, ‘Board of director characteristics, institutional ownership, and fraud: Evidence from Australia’, Auditing, vol. 23, no. 2, pp. 105-117.

The Institute of Internal Auditors, 2009, International Professional Practices Framework Practice Guide, Internal Auditing and Fraud, London.

Van Peursem, K 2004, ‘Internal auditors’ role and authority: New Zealand evidence’, Managerial Auditing Journal, vol. 19, no. 3, pp. 378 – 393.

Wells, J 2011, Financial Statement Fraud Casebook: Baking the Ledgers and Cooking the Books, John Wiley & Sons, Hoboken.

Zand, D 1997, The leadership Triad: Knowledge, Trust, and Power, Oxford University Press, New York.

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