Homework guide Please read the following note on fraud to broaden your understanding of the topic and to guide your responses. [More guide] Fraud Fraud is a deception deliberately practiced in order to secure unfair or unlawful gain (adjectival form fraudulent; to defraud is the verb). As a legal construct, fraud is both a civil wrong (i.e., a fraud victim may sue the fraud perpetrator to avoid the fraud and/or recover monetary compensation) and a criminal wrong (i.e., a fraud perpetrator may be prosecuted and imprisoned by governmental authorities). Defrauding people or organizations of money or valuables is the usual purpose of fraud, but it sometimes instead involves obtaining benefits without actually depriving anyone of money or valuables, such as obtaining a driver’s license by way of false statements made in an application for the same (Nigrini 2011). Financial Statement Fraud Financial statement fraud is one of the biggest challenges in the modern business world. This is when corporations engage in certain practices designed to hide or maneuver the accounts of a corporation to help it continue to remain attractive to investors. To counter financial statement frauds, especially in the aftermath of the Enron scandal in 2001-2002, the US Congress introduced the Sarbanes Oxley Act, the compliance with which is mandatory for US corporations. A financial statement fraud may be actionable under both the False Claims Act and the Dodd Frank Act as well. You may have suffered a financial statement fraud or may have original information about a financial statement fraud, which means that you may be able to bring either a financial statement fraud lawsuit or a whistleblower lawsuit depending on the facts peculiar to your case. The most common occurrence of financial statement fraud is when losses are underplayed or deliberately hidden by corporations. Financial statement fraud comprises deliberate misstatements or omissions of amounts or disclosures of financial statements to deceive financial statement users, particularly investors and creditors, outright falsification, alteration, or manipulation of material financial records, supporting documents, or business transactions, material intentional omissions or misrepresentations of events, transactions, accounts, or other significant information from which financial statements are prepared, deliberate misapplication of accounting principles, policies, and procedures used to measure, recognize, report, and disclose economic events and business transactions and also intentional omissions of disclosures or presentation of inadequate disclosures regarding accounting principles and policies and related financial amounts. There are massive issues that emanate from financial statement fraud. Financial statement fraud undermines the reliability, quality, transparency, and integrity of the financial reporting process and jeopardizes the integrity and objectivity of the auditing profession, especially aud.

1. Homework guide
Please read the following note on fraud to broaden your
understanding of the topic and to guide your responses. [More
guide]
Fraud
Fraud is a deception deliberately practiced in order to secure
unfair or unlawful gain (adjectival form fraudulent;
to defraud is the verb). As a legal construct, fraud is both a civil
wrong (i.e., a fraud victim may sue the fraud perpetrator to
avoid the fraud and/or recover monetary compensation) and a
criminal wrong (i.e., a fraud perpetrator may be prosecuted and
imprisoned by governmental authorities). Defrauding people or
organizations of money or valuables is the usual purpose of
fraud, but it sometimes instead involves obtaining benefits
without actually depriving anyone of money or valuables, such
as obtaining a driver’s license by way of false statements made
in an application for the same (Nigrini 2011).
Financial Statement Fraud
Financial statement fraud is one of the biggest challenges in the
modern business world. This is when corporations engage in
certain practices designed to hide or maneuver the accounts of a
corporation to help it continue to remain attractive to investors.
To counter financial statement frauds, especially in the
aftermath of the Enron scandal in 2001-2002, the US Congress
introduced the Sarbanes Oxley Act, the compliance with which
is mandatory for US corporations. A financial statement
fraud may be actionable under both the False Claims Act and
the Dodd Frank Act as well. You may have suffered a financial
statement fraud or may have original information about
a financial statement fraud, which means that you may be able
to bring either a financial statement fraud lawsuit or a
whistleblower lawsuit depending on the facts peculiar to your
case.
The most common occurrence of financial statement fraud is

2. when losses are underplayed or deliberately hidden by
corporations. Financial statement fraud comprises deliberate
misstatements or omissions of amounts or disclosures of
financial statements to deceive financial statement users,
particularly investors and creditors, outright falsification,
alteration, or manipulation of material financial records,
supporting documents, or business transactions, material
intentional omissions or misrepresentations of events,
transactions, accounts, or other significant information from
which financial statements are prepared, deliberate
misapplication of accounting principles, policies, and
procedures used to measure, recognize, report, and disclose
economic events and business transactions and also intentional
omissions of disclosures or presentation of inadequate
disclosures regarding accounting principles and policies and
related financial amounts.
There are massive issues that emanate from financial statement
fraud. Financial statement fraud undermines the reliability,
quality, transparency, and integrity of the financial reporting
process and jeopardizes the integrity and objectivity of the
auditing profession, especially auditors and auditing
firms. Financial statement fraud diminishes the confidence of
the capital markets, as well as market participants, in the
reliability of financial information and as a consequence makes
the capital markets less efficient. In the bigger picture it
adversely affects the nation's economic growth and prosperity,
results in huge litigation costs, destroys careers of individuals
involved in financial statement fraud and causes bankruptcy or
substantial economic losses by the company engaged
in financial statement fraud. It causes devastation in the normal
operations and performance of alleged companies and erodes
public confidence and trust in the accounting and auditing
profession. Ultimately financial statement fraudtranslates to
massive stockholder losses and debts to creditors, not to
mention emotional trauma to employees who lose their jobs and

3. retirement funds.
Financial statement fraud may be committed by the senior and
mid-level management of a corporation to fraudulently enhance
the financial health of a business and enrich one's own net
worth. Senior management may indulge in fraudulent cover-ups
to exceed the earnings or revenue growth expectations of stock
market, to comply with loan agreements, to increase the amount
of financing available from asset-based loans and to meet a
lender's criteria for granting/extending loan facilities. They may
also fudge the statements to create a rosy picture for the
shareholders.
Financial Statement Fraud Red Flags
Financial statement red flags provide a general overview of the
warning signs investors should take note of. They do not
necessarily indicate an undoubted occurrence of financial
statement fraud, but merely signal that further in-depth research
must be conducted to assess the validity of the corporate
documents. Creditors would find such information useful to
ensure that loans are not provided to firms operating with an
elevated amount of risk. Investors, on the other hand, may want
to take note of the following factors to discover new
shorting opportunities. Government regulators, however, aim to
catch and punish fraud to ensure the transparency and reliability
of the financial markets.
Five basic types of financial statement fraud exist:
1. fictitious sales
1. improper expense recognition
1. incorrect asset valuation
1. hidden liabilities and
1. unsuitable disclosures
Effectively spotting these fraudulent disclosures involves
keeping an open eye for the most common financial statement
fraud red flags:
1. Accounting anomalies, such as growing revenues without a

4. corresponding growth in cash flows. Sales are much easier to
manipulate than cash flow but the two should move more or less
in tandem over time.
1. Consistent sales growth while established competitors are
experiencing periods of weak performance. Note that this may
be due to efficient business operations rather than fraudulent
activity.
1. A rapid and unexplainable rise in the number of day's sales in
receivables in addition to growing inventories. This suggests
obsolete goods for which the firm records fictitious future sales.
1. A significant surge in the company's performance within the
final reporting period of fiscal year. The company may be under
immense pressure to meet analysts' expectations.
1. The company maintains consistent gross profit margins while
its industry is facing pricing pressure. This can potentially
indicate failure to recognize expenses or aggressive revenue
recognition.
1. A large buildup of fixed assets. An unexpected accumulation
of fixed assets can flag the usage of operating expense
capitalization, rather than expense recognition.
1. Depreciation methods and estimates of assets' useful life that
do not correspond to the overall industry. An overstated life of
an asset will decrease the annual depreciation expense.
1. A weak system of internal control. Strong corporate
governance and internal controls processes minimize the
likelihood that financial statement fraud will go unnoticed.
1. Outsized frequency of complex related-party or third-party
transactions, many of which do not add tangible value (can be
used to conceal debt off the balance sheet).
1. The firm is on the brink of breaching their debt covenants. To
avoid technical default, management may be forced to
fraudulently adjust its leverage ratios.
1. The auditor was replaced, resulting in a missed accounting
period. Auditor replacement can signal a dysfunctional
relationship while missed accounting period provides extra time
to "fix" financials.

5. 1. A disproportionate amount of managements' compensation is
derived from bonuses based on short term targets. This provides
incentive to commit fraud.
1. Something just feels off about the corporation's business
model, financial statements or operations.
Financial Statement Fraud Detection Methods
Spotting red flags can be extremely challenging as firms that
are engaged in fraudulent activities will attempt to portray the
image of financial stability and normal business operations.
Vertical and horizontal financial statement analysis introduces a
straightforward approach to fraud detection. Vertical analysis
involves taking every item in the income statement as a
percentage of revenue and comparing the year-over-year trends
that could be a potential flag cause of concern. A similar
approach can also be applied to the balance sheet, using total
assets as the comparison benchmark, to monitor significant
deviations from normal activity. Horizontal analysis implements
a similar approach whereby rather than having an account serve
as the point of reference, financial information is represented as
a percentage of the base years' figures. Likewise, unexplainable
variations in percentages can serve as a red flag requiring
further analysis.
Comparative ratio analysis also allows analysts and auditors to
spot discrepancies within the firm's financial statements. By
analyzing ratios, information regarding day's sales in
receivables, leverage multiples and other vital metrics can be
determined and analyzed for inconsistencies. A mathematical
approach, known as the Beneish Model, evaluates eight ratios to
determine the likelihood of earnings manipulation. Asset
quality, depreciation, gross margin, leverage and other variables
are factored into the analysis. Combining the variables into the
model, an M-score is calculated; a value greater than -2.22
warrants further investigation as the firm may be manipulating
its earnings while an M-score less than -2.22 suggests that the
company is not a manipulator similar to most other ratio-related

6. strategies, the full picture can only be accurately portrayed once
the multiples are compared to the industry and to the specific
firm's historical average.
References
Francine McKenna (2012). The SEC and Accounting Fraud
Enforcement: No "There" There. Retrieved February 15, 2014;
from http://www.forbes.com/sites/francinemckenna/2012/11/29/
the-sec-and-accounting-fraud-enforcement-no-there-there/
COSO (2011). Guidance on Fraudulent Financial Reporting.
Retrieved February 16, 2014;
from http://www.coso.org/FraudReport.htm
Nigrini, Mark (2011). Forensic Analytics: Methods and
Techniques for Forensic Accounting Investigations. Hoboken,
NJ: John Wiley & Sons Inc. ISBN978-0-470-89046-2.
SEC (2012). Financial Statement Fraud. Retrieved February 16,
2014;
from https://www.sec.gov/News/PressRelease/Detail/PressRelea
se/1365171624975#.UwE3bmJdXBc
Fraud
Please respond to the following:
-- From the e-Activity, determine the main reasons why several
members of top management in Phar-Mor perpetrated the
financial statement fraud. Next, recommend one (1) strategy
that the auditors might have taken to detect or prevent the fraud.
Provide a rationale to support your recommendation.
-- From the case study, analyze the financial data as presented.
Next, choose at least one (1) pattern within the data that appears
to be inconsistent, and propose one (1) strategy that one could
use to audit this pattern. Provide a rationale to support your
response. [250 words][1 – 2 references]