Chapter 11 b :Financial Statement fraud Presentation Transcript
By Jaspreet Bassan
Phar-Mor Case example
Motivations for Financial Statement Fraud
Framework for detecting financial statement
Fraud Exposure rectangle
Company started in 1982 selling a variety of
household products and prescription drugs at
Idea of “Power Buying”
1985 Phar Mor had 15 stores
By 1992, 310 stores with revenue of $3billion
About 6 years later they started losing money
and engaged in creative accounting too
disguise this to maintain their appearance of
Had Finn not agreed to Micahel Monus’s
expense manipulation early on in 1985,
before the bigger frauds started, do you think
the Phar-Mor fraud would have progressed to
the extent that it did?
Support high stock price
Increase stock price
Maximize management bonus or net worth
Pressure on Management too perform
Strategic Reasoning- ability of a fraud perpetrators
likely method of concealing a fraud.
Use of game theory- Predicting behaviour based on
an individuals best response given that individuals
motivations and the individuals beliefs regarding the likely
behaviour of their opponent.
Zero-order reasoning- occurs when an auditor and
auditee consider only conditions that directly affect
themselves but not the other party. i.e. their own incentives
such as audit fees
First-order Reasoning- means that the auditor
considers conditions that directly affect the auditee.
Higher order reasoning- occurs when the auditor
considers additional layers of complexity, including how
management may anticipate the auditor’s behaviour.
What types of fraud schemes is management
likely to use to commit financial statement
What typical tests are used to detect these
How could management conceal these
How could the typical test be modified so as
to detect the concealed scheme?
• Have any of the key executives been involved with
other organizations in the past? If so of what
• Are most board members independent?
• Is the Chairperson independent from the CEO?
• Do any of members of management have criminal
• Have any members of management had
any past regulatory or legal troubles?
Is the personal worth of any of the key executives tied up in
Is management compensation performance based?
Do they have a reputation for guiding companies to higher
Are the jobs of Management at risk?
Is the organizations reported financial
Managements influence in Making Decisions
for the Organization:
Who are the key members of management and the board of
directors who have the most influence?
Do one or two people have dominant influence within the
Is the management style more authoritative or democratic?
Is the organizations management centralized or
Relationship with financial institutions
Is the organization highly leveraged through bank or other
Do the banking relationships appear normal? Or are their
unusual attributes? Such as geographical location
With what financial institutions does the organization have
significant relationships with?
Relationship with Auditors
Have frequent disputes occurred with the current or predecessor
Has auditor change occurred? If so, for what reason?
Has management placed unreasonable demands on the auditor,
including unreasonable time constraints?
Relationship with Lawyers
Has any attempt been made to hide litigation from the auditors?
Has the company been involve in litigation concerning matters
that could adversely affect the company’s financial results?
Are any other lawyer relationships questionable?
Relationship with investors
Is the organization in the process of issuing an initial or
secondary public debt offering?
Are-any investor related law suits pending?
Are any investor relationships questionable?
Relationship with Regulatory bodies
Do management show a disregard for regulatory
Are their significant disputes with tax authorities?
Has their been a history of security law violations?
Does the company have an overly complex organizational
structure involving numerous or unusual legal?
Is a legitimate business purpose apparent for each separate
entity of the business?
Is the audit committee primarily comprised of insider or
Is the audit committee passive or active and independent
Does the organization have offshore business activities
without any apparent business purpose?
Is the performance of the company similar or contrary to
other firms in the industry?
Are Unrealistic changes or increases present in
financial statement account balances?
Are the account balances realistic? Given the nature,
age, and size of the company?
Have their been significant changes in the nature of
the organizations revenues and expenses?
Does growth or profitability appear rapid?
Especially compared with that of other companies
in the same industry?
Are unrealistically aggressive sales or profitability
incentive programmes in place?
Motivations behind financial statement fraud
The use of strategic reasoning to expose
The fraud exposure rectangle
1. Management and directors
2. Relationship with others
3. Organization and Industry
4. Financial results and operating