Frauds type of accounting. By Priyanshu Jain

1. What is an Accounting Fraud?
When a person engages in accounting fraud, they are intentionally manipulating accounting
records to make the company’s financial picture seem better than it actually is. Furthermore, it
involves an employee, accountant, or the organization itself misleading investors and
shareholders. When someone is found guilty of committing accounting fraud, they are subject to
criminal prosecution.
Secondary sources from the internet have been used to make the presentation

2. Common types of Fraudulent Accounting
There are several types of accounting fraud that tend to be most prevalent. These can include:
• Overstating revenues: To improperly inflate revenues, a company may post sales before they
are made or prior to payment. They may not make proper provisions for returns, or sales
made to related parties may not be properly recorded as revenues. Furthermore, keeping the
books open for a few days past month-end in an effort to rake in additional sales transactions
in the prior month is an overstatement of revenues.
• Understating expenses: When understating expenses, a company may fail to accrue expenses
for services consumed within the month but not yet billed to the business. They may
improperly keep certain liabilities “off the books,” capitalize standard operating expenses, or
fail to report accounts payable.
• Misrepresentation of assets: Overstating the value of capital assets or not properly recording
depreciation expenses are forms of accounting fraud. Furthermore, companies that overstate
assets like accounts receivable and inventory are committing accounting fraud.
Secondary sources from the internet have been used to make the presentation

3. How do you spot accounting fraud?
Here are some red flags that accountants should have on their radar in their day to day:
• Seeing a company report an increase in revenues at the very end of the year.
• Reversals of revenue transactions at the beginning of the following year is a red flag. For
instance, there are returns, discounts, etc., being provided and not recorded, or not recorded
in a timely manner, resulting in inflated revenues.
• If a company’s revenues are growing but the cash flows are not growing, that could be a red
flag.
• If an industry is struggling and an entity within that industry is not being impacted, that could
give reason for a closer look.
• Any unusual Q4 trends are worth investigating.
Secondary sources from the internet have been used to make the presentation

4. Red Flag
A red flag is a warning or indicator, suggesting that there is a potential problem or threat with a
company's stock, financial statements, or news reports. Red flags may be any undesirable
characteristic that stands out to an analyst or investor. Red flags tend to vary. There are many
different methods used to pick stocks and investments, and therefore, many different types of
red flags. So a red flag for one investor may not be one for another. There is no fixed method of
identifying red flags. Based on how you are researching the company and the way you examine
historical and current data will define how you identify potential problems.
Proper due diligence must be exercised before investing in a stock.
Let’s first understand, what exactly is the meaning of Due Diligence and how to do it?
Due Diligence: When you analyze the financials of a company, it is important to confirm the facts
under consideration. The process of reviewing the financial records to confirm this is called due
diligence. Here are some important steps to help you exercise due diligence while investing in
stocks:
• Analyze the company’s market capitalization: This can help you understand the volatility of the
stock price and the size of its customer base. So, a large-cap company will have less volatility in
the stock price since it will have a stable revenue stream and a large & diverse customer base.
Secondary sources from the internet have been used to make the presentation

5. Red Flag
Due Diligence (Cont.):
Here are some important steps to help you exercise due diligence while investing in stocks:
• Look at trends in profits and revenues: When you look at the income statement of a company,
you can check its revenues and profits. While looking at the current quarter’s profits is
important, it is necessary to look at the trends over multiple quarters or years. This will give
you a perspective on the company’s performance.
• Competitive Analysis: Compare the profits and revenues of the company with 2/3 close
competitors. Also, assess how the industry is doing.
• Financial Ratios: Look at the Profit to Earnings ratio (P/E), Price to Book ratio (P/B), Debt to
Equity ratio (D/E), etc.
• Management Analysis: Analysing the management of the company is important since the
growth of the company is determined by the decisions made by the management team.
• Balance Sheet: Analyze the company’s balance sheet and to understand the company’s assets
and liabilities along with the available cash.
Secondary sources from the internet have been used to make the presentation

6. Red Flag
Due Diligence (Cont.):
Here are some important steps to help you exercise due diligence while investing in stocks:
• History of the stock price: Look at the long-term and short-term trends in stock price and
compare them with the profits generated by the company. This can help you choose a stock
based on your risk tolerance.
• Stock Dilution: Is the company issuing shares frequently to raise funds? If you observe this
trend, then you must consider the possibility of stock dilution.
• Assess Risks: Look at all the risks associated with the investment – capital market risks,
liquidity risks, regulatory risks, etc.
Secondary sources from the internet have been used to make the presentation

7. Red Flag
Identifying Red Flags in the Financial Analysis of a Company.
Let’s begin with looking at some obvious and easily recognizable red flags that should make you
stop and rethink your decision of investing in the company.
• Revenues that have been decreasing consistently over time
• A D/E ratio that is consistently increasing
• Cash flows that are volatile
• Extreme fluctuations in the market price of shares
• Any lawsuit against the company that is still pending resolution
Apart from the ones mentioned above, here are some accounting red flags that you must check
while analyzing the financial statements of the company:
• Over-attractive Financial Results: Do the financial results of the company seem over-attractive
or inconsistent? If yes, then you should investigate further and look for consistency in
performance or a valid reason for a sudden boost in the financial results.
Secondary sources from the internet have been used to make the presentation

8. Red Flag
Identifying Red Flags in the Financial Analysis of a Company.
• Unusual Accounting Policies: Sometimes, companies can adopt unusual accounting practices
and/or methods making it difficult for you to compare their performance with their
competitors. These practices may relate to over/under-estimation of assets, valuation of the
inventory, reserves creation, expenses relating to the development of the business, etc.
• Changes in Financial Reporting: Analyze trends in the balance sheet and profit and loss ratios.
So, if you see an increasing debt-to-equity ratio, then it can indicate a potential problem in the
operation of the company. Some large adjustments made late in the year to make amends to
the errors and/or inaccurate data
• Anomalies in the Financials: When you look at the financial statements of a company and find
anomalies – numbers that are higher or lower than expected, then it should serve as a red
flag. If you find such anomalies, then look at some aspects including:
- Take a look at the profit and loss statement. You might see the ‘Other Expenses’ category
very high
- A sudden surge in the value of fixed assets or intangibles – way above expectations
indicating that costs are being capitalized
Secondary sources from the internet have been used to make the presentation

9. Red Flag
Identifying Red Flags in the Financial Analysis of a Company.
• Complex Transactions: Sometimes, you might come across transactions that seem highly
complex – with internal or external parties. These may seem like transactions that don’t have
a sound economic standing. Such transactions are often used to deceive. Hence, you must
treat them as red flags and spend some more time analyzing them.
• Performance-linked Bonuses: In some companies, the compensation of the management team
is tied to the performance of the company. Hence, senior management has a huge incentive to
manipulate the results. Sometimes, the management team is awarded bonuses for the short-
term performance of the company. This could lead to decisions that are not beneficial for the
company in the long-term. Pay close attention to this aspect too.
• Gross Profit Margin Increasing but Sales are Declining: If you see that the company has a trend
of increasing profit margins, then you might be inclined to give it a pass. However, it is
important to remember that the gross profit margin should never be looked at in isolation.
Always ensure that you look at the sales figures and overheads.
• Rising Debtors or Inventory: Finally, analyze the debt and inventory to assess the reasons
behind an increase in them. Usually, an increase in inventory or debt is a sign of possible bad
debt.
Secondary sources from the internet have been used to make the presentation

10. What are ways to prevent accounting fraud?
Knowing the red flags to watch for is important, but it is ideal to prevent fraud before it happens.
For companies, this involves setting the proper tone at the top, stressing their code of ethics, and
ensuring proper internal controls are in place.
Internal controls are there to prevent not just fraud but errors as well. Internal controls — if they
are well thought out, well implemented, well tested and adjust to different conditions — they will
certainly catch a lot.”
Secondary sources from the internet have been used to make the presentation

11. Let’s look at some of the Accounting Frauds
• WorldCom (2002): This accounting scandal occurred in the year 2002. WorldCom was a
telecommunication company. The name of WorldCom has not changed; it is MCI, Inc. now.
The fraud happened due to the inflated assets of the company. Then CEO Bernie Ebbers didn’t
report the line costs by capitalizing, and he also inflated the company’s revenues by recording
fake entries. As a result, 30,000 people lost their jobs, and investors lost around $180 billion.
The internal audit team of WorldCom found out $3.8 billion fraud. After the fraud was
discovered, WorldCom filed for bankruptcy, and Ebbers got a sentence of 25 years.
Secondary sources from the internet have been used to make the presentation

12. Let’s look at some of the Accounting Frauds
• Enron (2001): This accounting scandal happened in the year 2001. Enron, a commodity and
energy-based service company, was in trouble for removing a massive amount of debt from its
balance sheet. As a result, the shareholders of Enron lost $74 billion. Many employees lost
their jobs. Many investors and employees lost their retirement savings. It is one of the most
cited accounting scandals of all time. It was the work of then CEO Jeff Skilling and former CEO
Ken Lay.
Secondary sources from the internet have been used to make the presentation

13. Let’s look at some of the Accounting Frauds
• Waste Management Company
(1998): This accounting scandal
happened in the year 1998.
Waste management company
reported around $1.7 billion in
fake earnings. They deliberately
increased the time period of
depreciation period of their
plant, equipment, and property.
While the new CEO, A. Maurice
Meyers, and his team members
went through the books of
accounts, they found out about
this unprecedented scenario.
Secondary sources from the internet have been used to make the presentation

14. Let’s look at some of the Accounting Frauds
• Satyam (2009): Ramalinga Raju, the founder and chairman of Satyam Computer Services,
admitted to falsifying the company's accounting for many years in 2009. This disclosure
surprised investors, workers, and regulators, ruining Satyam's and the Indian business
community's image. The Satyam scam was a methodically planned effort to defraud
stakeholders. Raju and a small group of accomplices increased sales, earnings, and cash levels,
providing a false sense of financial accomplishment. Forging bank statements, faking invoices,
and inflating customer numbers were all part of the fraudulent operations. Auditors tasked
with protecting shareholders' interests failed to discover the anomalies, showing the failure of
corporate governance processes. Following the incident, the Indian government intervened to
avert Satyam's collapse and preserve stakeholders' interests. Tech Mahindra finally purchased
the firm, kicking off a lengthy path to recovery.
Secondary sources from the internet have been used to make the presentation