4. Understatement of Liability
Fraud
Understatement of Accounts Payable
Record payables in subsequent periods or don’t record purchases
Overstate purchase returns and purchase discounts
Record payments made in later periods as being made in earlier periods
Analytical symptoms
Accounts Payable balances that appear to high
Purchase or COGS figures that appear to low
Purchase returns or discounts that appear to high
4
5. Understatement of Liability
Fraud
Understatement of Accrued Liabilities
Not record accrued liabilities
Record accruals in a later period
Analytical Symptoms
Expenses and/or accrued liabilities appear to low e.g. payroll, rent,
interest, utilities
Income that is to ‘smooth’
5
6. Understatement of Liability
Fraud
Recognising unearned revenue as earned revenue
Record unearned revenues as earned revenues (and vice versa with
cookie jar reserves)
Analytical Symptoms
Liability balances that appear to low
Revenue accounts that appear to high
6
7. Understatement of Liability
Fraud
Under-recording future obligations
Not recording warranty (service) liabilities
Under record liabilities
Record deposits as revenues
Not recording repurchase agreements and other commitments
Analytical symptoms
Warranty, repurchase or deposit accounts that appear to low
Compare to another account
7
8. Understatement of Liability
Fraud
Not recording or under recording various types of debt
Borrow from related parties at less than an arms length transaction
Don’t record liabilities
Write off liabilities as forgiven
Claim liabilities as personal debt rather than debt of the entity
Analytical symptoms
Unreasonable relationship between interest and debt
Significant decreases in recorded debt
Significant asset purchases with no recorded debt
Liability balances that appear to low
8
9. Understatement of Liability
Fraud
Omission of contingent liabilities
Don't record probable contingent liabilities
Record contingent liabilities at to low of an amount
Analytical symptoms
Not very useful to discover unrecorded contingent liabilities
9
11. Overstatement of Asset Fraud
Overstatement of Cash, Short-Term Investments and Marketable
Securities
Record restricted cash as unrestricted
Misappropriate cash without managements knowledge
Misstate marketable securities with the aid of related parties
Overstatement of Receivables and Inventory
Overstate receivables and inventory in an attempt to cover cash theft or
theft of other assets
11
12. Overstatement of Asset Fraud
Overstatement of Fixed Assets
Leave worthless or expired assets on the books
Under reporting depreciation expense / overstate residual value /
increase the useful life
Overstate asset costs through related party transactions
Fabricating fixed assets
12
13. Overstatement of Asset Fraud
Overstatement of Assets through Merger and Acquisitions or by
Manipulating Intercompany Accounts or Transactions
Use market values rather than book values to record assets
Have the wrong entity be the purchaser
Improperly allocating book value to assets
Record fictitious assets or inflate the value of assets
Overstatement of Intangible or Deferred Assets
Capitalise costs as intangible assets where they should be expensed
13
14. Ways to Detect Overstatement
of Assets
Compare changes and trends in account balances
Compare changes and trends in financial statement relationships
Compare financial balances with non-financial information (e.g.
compare to the actual asset)
Compare financial statement balances and policies with those used
by other similar companies
14
16. Disclosure Frauds
Misrepresentation about the nature of the company or its products
Misrepresentations or omissions in the Management Discussion and
Analysis
Misrepresentations or omissions in the footnotes to the financial
statements
16
17. Ways to identify disclosure
fraud
Look for inconsistencies between disclosures and information in the
financial statements
Inquire of management concerning related-party
transactions, contingent liabilities, and contractual obligations
Review a company’s files and records with the SEC and other
regulatory agencies
17
19. Waste Management
Company: Houston-based publicly traded waste management
company
What happened: Reported $1.7 billion in fake earnings.
Main players: Founder/CEO/Chairman Dean L. Buntrock and other
top executives; Arthur Andersen Company (auditors)
How they got caught: A new CEO and management team went
through the books.
Penalties: Settled a shareholder class-action suit for $457 million. SEC
fined Arthur Andersen $7 million.
19
20. Waste Management
Asset Overstatement
Avoided depreciation charges by
increasing useful life and salvage values
Landfill development expenses
improperly capitalized
Expenses necessary to write off costs of
unsuccessful and abandoned landfill
projects not recorded
Failed to record expenses for decreases in
the value of landfills as were filled up
20
21. Waste Management
Liability Manipulation
Failed to establish sufficient reserves (liabilities) to pay for income
taxes and other expenses
Established inflated environmental reserves (liabilities) in
connections with acquisitions so that excess reserves could be
used to avoid recording unrelated operating expenses
21
23. AIG
Company: Multinational insurance corporation.
What happened: Massive accounting fraud to the tune of $3.9 billion
was alleged, along with bid-rigging and stock price manipulation.
Main player: CEO Hank Greenberg.
How he got caught: SEC regulator investigations, possibly tipped off
by a whistleblower.
Penalties: Settled with the SEC for $10 million in 2003 and $1.64 billion
in 2006, with a Louisiana pension fund for $115 million, and with 3
Ohio pension funds for $725 million. Greenberg was fired, but has
faced no criminal charges.
23
24. AIG
Investigations around two transactions between AIG and Berkshire
Hathaway’s General Re Corp
In 2005 loans worth $500 million were dressed as revenue
to boost AIGs revenue
More issues have since come to light in regards to other
accounting transactions
24
26. WorldCom
Company: Telecommunications company; now MCI, Inc.
What happened: Inflated assets by as much as $11 billion, leading
to 30,000 lost jobs and $180 billion in losses for investors.
Main player: CEO Bernie Ebbers
How he got caught: WorldCom's internal auditing department
uncovered $3.8 billion of fraud.
Penalties: CFO was fired, controller resigned, and the company filed
for bankruptcy. Ebbers sentenced to 25 years for fraud, conspiracy
and filing false documents with regulators.
26
27. WorldCom
Internal Audit uncovered massive fraud
$3.8 billion of line expenses incorrectly recorded as capital
investments
Further $3.3 billion of profits incorrectly recorded. This was
done through manipulation of reserves
By the end of 2003 estimated that assets were overstated
by $11 billion
27
29. Satyam
Company: Indian IT services and back-office accounting firm.
What happened: Falsely boosted revenue by $1.5 billion.
Main player: Founder/Chairman Ramalinga Raju.
How he got caught: Admitted the fraud in a letter to the company's
board of directors.
Penalties: Raju and his brother charged with breach of
trust, conspiracy, cheating and falsification of records. Released
after the Central Bureau of Investigation failed to file charges on
time.
29
30. Letter to the BOD
The balance sheet carries as of September 30, 2008
Inflated (non-existent) cash and bank balance of Rs 5,040 crore (as
against Rs 5361 crore reflected in the books)
An accrued interest of Rs 376 crore which is non-existent
An understated liability of Rs 1,230 crore on account of funds arranged by
me
An over stated debtor position of Rs 490 crore (as against Rs 2651
reflected in the books)
This gap amounted to about $1.6 billion in total
30
31. Letter to the BOD
The gap in the balance sheet has arisen purely on account of
inflated profits over a period of last several years
Started as marginal, and continued to grow
Justifies his actions
Nether himself or the Managing Director sold shares
Did not take a dollar /rupee nor profit from the fraud
None of the board members not their immediate family knew about the
companies fraudulent financial position
31
32. “
”
It was like riding a
tiger, not knowing how to
get off without being
eaten
32
33. Satyam’s Auditor - PWC
PwC India was the auditor of Satyam
Two audit partners on trial
Two audit managers have been banned for life
After the scandal 10% of PwC partners walked out, with many
staff expected to follow
PWC India was fined $6million for:
Failing to act as a watchdog
Failing to follow most basic auditing standards
Routinely neglecting quality control
33
37. References
AICPA (2003). Fraud at Waste Management. AICPA. Retrieved from
www.aicpa.org/InterestAreas/AccountingEducation/.../wastemanage.ppt
Albrecht, W.S; Albrecht, C.O; C.C. Albrecht and Zimbelman, M.F. 2012. Fraud
Examination. Australia: South Western Cengage Learning
Callahan, D. (Nov, 2010). AIG: Before the Crash, There Was the Fraud.
Retrieved from www.cheatingculture.com/accounting-fraud/2010/11/8/aig-
before-the-crash-there-was-the-fraud.html
Desai, M. (Sept, 2013). Satyam scam: US finds PwC 'India' guilty. Indian
Express. Retrieved from www.indianexpress.com
Doval, P., (Feb, 2012). ICAI bans PW India's top auditor for life in Satyam
case. Times of India. Retrieved from www.timesofindia.indiatimes.com
37
38. References
JJ, (Mar, 2007). WorldCom Scandal: A Look Back at One of the Biggest
Corporate Scandals in U.S. History. Yahoo. Retrieved from
www.voices.yahoo.com/
McKenna, F. (May, 2011). Satyam: Not The Only Case PwC Worried About.
Forbes. Retrieved from www.forbes.com
Raju, R (Jan, 2009). Satyam Chairman B Ramalinga Raju’s statement to the
Board. Retrieved from www.hindu.com/nic/satyam-chairman-
statement.pdf
SEC (2002). Waste Management Founder, Five Other Former Top Officers
Sued for Massive Fraud. SEC. Retrieved from
www.sec.gov/news/headlines/wastemgmt6.htm
Tran, M., (Aug, 2002). WorldCom accounting scandal. The Guardian.
Retrieved from www.theguardian.com
38
Editor's Notes
There are 6 main understatement of liability frauds, we will have a look at each one in turn.
Understatement of Accounts PayableAccounts AffectedInventory, accounts payableFraud SchemesAs aboveAnalytical symptomsAs aboveE.g. Text book has a case where a $28 million unrecorded liability was discovered by auditors. Management had altered purchasing records, bank statements and correspondence with vendors to make it look as though the amount had been paid. Will result in cost of goods sold and accounts payable balances being to low
Understatement of Accrued ExpensesAccounts AffectedPayroll tax expense, salary expense, various expenses, salaries payable, payroll tax payable, various accrued liabilitiesCommon fraud schemesAs aboveAnalytical SymptomsAs aboveWill result in net income being overstated and liabilities being understated
Recognising unearned revenue as earned revenueAccounts affectedAccounts receivable, sales revenue, unearned revenueFraud schemesAs aboveAnalytical symptomsAs aboveNeed to use a lot of judgement to determine if revenue is recorded before it is earned. Need to analyse documents such as contracts, sale agreements and other revenue related documentationDoes anybody know what a cookie jar reserve is?Like a cookie jar that has money stored in it, it represents a stash of accounting earnings that can be used to bolster perceived performance of the company in the futureXerox, Sunbeam and W.R. Grace & Co have all been charged by the SEC for the use of cookie jar provisions to manipulate earnings.Xerox had $396 million of cookie jar reserves which they released into there earnings between 1997 and 2000.If a company manipulates the time of revenue recognition, it is easy for the value of liabilities to be over or under stated.
Under-recording future obligationsAccounts affectedWarranty (service) expense, warranty or service payableFraud schemesAs aboveAnalytical symptomsAs aboveTo help determine if the accounts are actually to low, compare to other accounts e.g. Compare warranty to sales accountFor example, if a car is sold might be sold with a three year warranty. This obviously needs an associated warranty provision.The value of this provision can be understated by not recording any amount or recording an amount that is to low.All money back guarantees (Warehouse) the value of this liability could be severely understated if the provision is not estimated correctly.
Not recording or under recording various types of debtAccounts affectedCash, notes payable, mortgagesCommon fraud schemesAs aboveAnalytical SymptomsAs aboveEnron – kept a lot of debt of books
Omission of contingent liabilitiesAccounts affectedLoss from contingencies, contingencies payableCommon fraud schemesAs aboveAnalytical symptomsAs aboveIf a loss is probable then the contingency needs to be recorded in the notes, however if the loss is remote then no not disclosure needed.Company is able to under estimate the probability of occurrence, then do not need to disclose in the annual report.
5 keys ways in which this is done
Overstatement of Cash, Short-Term Investments and Marketable SecuritiesGenerally considered hard to overstate cash as bank balance can easily be confirmed. However remember the Parmalat case where the bank balance was forged. Also the Satyam case where fictitious cash balances exceeding $1 billion were recorded (we will look at this case later) Accounts InvolvedCash, Marketable Securities, and other short term assetsCommon Fraud SchemesAs aboveTransfer troubled assets to another entity and then record as an investment or receivable. Such was the case with Enron.Overstatement of Receivables and InventoryAccounts InvolvedAccounts Receivable, InventoryCommon Fraud SchemesAs aboveE.g. Phar-Mor case. One of the reasons that inventory was overstated was to off set the cash that Mickey Monus had taken out of the business to support a now-defunct World Basketball Team.
Overstatement of Assets through Merger and Acquisitions of by Manipulating Intercompany Accounts or TransactionsAccounts InvolvedAny assetCommon Fraud SchemesAs aboveOverstatement of Intangible or Deferred AssetsAccounts InvolvedVarious deferred charges and intangible assets accountsCommon Fraud SchemesAs aboveIn some cases it is justified to capitalise expenditure, other cases it is clearly fraudulent.Common for management to argue that these costs are part of the development phase and should be capitalised.
As aboveMost annual reports contain statements from the management including the management discussion and analysis, historical performance charts, announcements of new products & strategic decisions, plans and goals for the future. Management could outright lie during these disclosures or not make these disclosures at all. key notes to help investors make informed decisions may by omitted or misstated. For example, related party transactions, contigient liabilities, contractual obligations, contingent assets that will never be realised etc
Background to the company
Background to the company
Background to the company
Suspicion that WorldCom deliberately inflated reserves to be able to dip into them to boost revenues to meet targets
Background to the company
Two audit partners on trial.One partner (S. Gopalakrishnan) is not able to get bail so remains in prisonICIA banned the other audit partner (SrinivasTalluri) for life, and imposed maximum financial penaltyThe two managers banned for life were banned for “serious and gross negligence” in conducting the audit 170 partners in total at PwC India. With partners walking out it indicates serious problems for the firm. PWC India was fined $6million, accused of routinely neglecting quality control, and violated its most fundamental duty to act as public watchdog and comply with the most elementary accounting standards
