Creative accounting, tax, and financial fraud. 3rd acfe conference

CREATIVE ACCOUNTING, TAX AND
FINANCIAL FRAUD; EXPLORING THE
NEURAL NETWORKS
Prof. Godwin Emmanuel, Oyedokun
HND (Acct.), BSc. (Acct. Ed), BSc (Acc & Fin), MBA (Acct. & Fin.), MSc. (Acct.), MSc. (Bus &
Econs.), MTP (SA), PhD (Acct), PhD (Fin), FCA, FCTI, ACIB, MNIM, CNA, FCFIP, FCE, FERP,
CICA, CFA, CFE, CIPFA, CPFA, ABR, ACS, CertIFR, FFAR
godwinoye@yahoo.com
+2348033737184, +2348055863944 & 08095491026
CITN Council Member/Chairman Education Committee,
Chief Technical Consultant/President, OGE Group
Being a paper presented at the 3RD ACFE ANNUAL CONFERENCE on
Thursday, 28th November, 2019 at Ostra Hotel and Suites– Ikeja, Lagos.

CONTENTS
The Contents of the Paper shall include:
 Introduction
 Concept of Creative accounting
 Concept of Tax Fraud
 Concept of Financial Institution Fraud
 Exploration of the Neural Networks of Fraud

INTRODUCTION
 In the society of today, fraud has been revealed to be a
rampant act, with outrageous effects that cut across both
private enterprise and public entities.
 Irrespective of its prevalence, there has been development of
new technologies has also provided criminals more
sophisticated way to commit fraud and has required more
advanced techniques to detect and prevent such events.
 Economic and financial crimes in whatever form and nature
have potentially devastating impacts on economy, security and
social wellbeing of the people.
 The incessant news of financial statement fraud, tax fraud in
the world most especially in developing countries is adversely
affecting the economy, hence the need to implement neural
networks for fraud prevention and reduction.

THE CONCEPT OF CREATIVE ACCOUNTING
 Creative accounting practices are done with the motive of
making the financial statements appear better and financially
stronger on one hand or financially weaker on the other hand
depending on management’s desire.
 Amat and Gowthorpe (2004) used the word creative
accounting interchangeably to mean earnings management.
They opined that creative accounting means the
transformation of financial accounting statements using
accounting choices, estimates and other practices allowed by
accounting regulations.
 Ezeani (2012) posits that creative accounting was responsible
for various financial crises and portends a serious challenge to
the accounting profession.

THE CONCEPT OF CREATIVE ACCOUNTING (CONT)
Definitions of Creative Accounting
 “Creative accounting practices” is a term used to describe any means
that may be employed to manipulate financial data, and it includes
the aggressive choice and application of accounting principles as well
as fraudulent reporting (Mulford and Comiskey, 2002).
 Barnea(1976) defined creative accounting as the deliberate
dampening of fluctuation about “some level of earnings considered
being normal for the firm”.
 Schipper(1989) said that “creative accounting” is similar to
“disclosure management”, “in the sense of a purposeful intervention in
the financial reporting process.”

(CONT)
Manipulations and Red Flag Signaling Creative
Accounting
• There are various ways companies can maneuver their
financial reporting through the wide range of accounting
treatments allowed in GAAP as well as beyond what is set out
in accounting standards.
• Some of the methods may be considered legal, while other
techniques are totally unacceptable and illegal. The practices of
creative accounting can be summarized under five main
categories, as shown in table below:

THE CONCEPT OF CREATIVE
ACCOUNTING (CONT)
Categories of Creative Accounting Practices
Use of different accounting methods
For instance, the choice of inventory
method: a company may choose between a
first in, first out or last in, first out method
for inventories. The choices of accounting
depreciation: straight line and accelerated
depreciation methods. The company can
choose the accounting policy that conveys a
preferred image.
Subjective or estimated quantities
Certain entries in the accounts involve an
unavoidable degree of estimation, judgement,
and/or prediction. Estimation of numerous
future economic events such as expected lives
and salvage values of long term assets,
obligations for pension benefits, deferred taxes,
and losses from bad debts or asset
impairments.
Artificial transaction
Artificial transactions
can be entered both to
manipulate balance
sheet amounts and to
move profits between
accounting periods. This
is achieved by entering
two or more related
transactions with an
obliging third party
normally a bank.
Structuring of corporate
transaction
For example, business
combinations can be structured
to qualify for pooling or
purchase accounting. Lease
contracts can be structured so
that lease obligations are on- or
off- balance sheet. Equity
investments can be structured
to avoid or require
consolidation.
Timing
Genuine transactions can
also be timed so as to give
the desired impression in
the accounts. The timing
of inventory shipments or
purchases, or receivable
policies, which will affect
cost allocations and net
revenues. Selection to
make or defer
expenditures, such as
R&D, advertising, or
maintenance.

CREATIVE ACCOUNTING PRACTICE ITEM
AND THEIR CHECKLIST
Revenue
 This is the most common item to be manipulated by management
of organizations as there are too many alternative ways to
recognize it, whether through legal or illegal techniques.
Checklist

Does the company have a right of return policy?

Has there been any change in revenue recognition policy?

Was the revenue of the company recognized before the product/service
was available?

Does the company have the physical capacity to generate the reported
revenue?

CREATIVE ACCOUNTING PRACTICE ITEM
AND THEIR CHECKLIST (CONT)
Assets
These are often overvalued in an attempt to bolster
the company’s financial position and net worth.
Checklist

Has the company changed its credit policy?

Have payment terms been extended?

Has the company changed its inventory method?

Has the company reclassified its properties, plants and equipment
(PPE)?

CREATIVE ACCOUNTING PRACTICE
ITEM AND THEIR CHECKLIST (CONT)
Amortization
This is the deduction of capital expenses over a specific period of time,
usually the life of the asset. This means that amortization is related in one
way or another to the assets and revenue of a company.
Checklist

Has the company extended the amortization and depreciation period of
capitalized costs?

Is there an example of a prior-year write-down of assets that became value-
impaired?

Is there any reason to believe that normal operating expenses are converted to
reserves?

APPROACH TO MINIMIZE CREATIVE
ACCOUNTING
The following approach can be adopted:
 FRS 1- Cash Flow Statements: This approach
seeks to prevent creative accounting actions, with
the assumption that profit could easily be
manipulated according to critics of creative
accounting and as result, Accounting Standard
Board issued FRS 1, which requires most of the
companies to publish cash flow statement to
assist in avoiding figure manipulations.

ACCOUNTING (CONT)
FRS 2-Accounting for Subsidiary
Undertakings:
 This is another approach believed to prevent
creative accounting scheme.
 The adoption of the FRS 2, presented a
transparent relationship between a holding
company and its subsidiaries.

ACCOUNTING (CONT)
FRS 3- Reporting Financial Performance:
 This was noted to be a significant standard long
ago and has transformed the appearance of the
profit and loss account, by introducing a new
form of financial statements.
 Instead of concentrating on single figure profit,
the Accounting Standard Board considers
companies to disclose information which reflects
the various elements that make-up the profit.

ACCOUNTING (CONT)
FRS 4-Capital Instruments
 This standard has the objective of ensuring that
capital instruments are shown in financial
statement in such a manner, which truly reflects
the obligation of the issuer.
 Under this standard there was a clear definition as
to what must be shown as a debt, non-equity shares,
and equity shares with clear rules.

(CONT)
FRS 5-Reporting the Substance of
Transactions
This approach attempted to rectify creative
accounting by setting out definitions and
the appropriate accounting treatments,
particularly for transactions like
consignment stocks, sale and repurchase
agreements, and factoring of debts.

(CONT)
Techniques of Creative Accounting:
 Window dressing
 Changes to accounting policies or
accounting estimates
 Capitalising expenses
 Profit smoothing
 Off balance sheet finance

TAX FRAUD
Concept of Tax Fraud
 Taxes have always been the most important
source of the national budget.
 But taxpayers who mostly are ignorant of
taxation impact on the economy are constantly
looking for ways to avoid paying taxes or to
reduce the amount of tax liability.
 Tax evasion and tax fraud are current and
serious problems of various economy most
especially developing countries around the globe.
 They have a negative effect on the state budget
and on the situation of public finances.

TAX FRAUD (CONT)
 Definitions of Tax Fraud and Tax Evasion
Black’s law dictionary defines fraud as “all
multifarious means, which human ingenuity can
devise, and which are resorted to by one individual
to get an advantage over another by false
suggestions or suppression of the truth.
Lenártová (2000) defines tax evasion as a result of
targeted, legal or illegal, economic behaviour of a
taxpayer, which leads to the reduction or
elimination of tax liability or to other economic
benefit resulting from taxes.

TAX FRAUD (CONT)
 Definitions of Tax Fraud and Tax Evasion
According to Boháč, 2015, the concept of tax evasion can
be better understood as a situation in which the tax is
not determined in accordance with the law.
According to Babčák (2015), it is a complex and diverse
issue that needs to be solved through coordinated and
multilateral processes, because there is no country
within the European Union which can handle this
problem alone. He says, the concept of tax fraud can be
characterized as a form of tax evasion, while false
declarations and documents are intentionally presented.

TAX FRAUD (CONT)
Determinants of Tax Evasion
 Economic factors
 Legal factors
 Social factors
 Demographic factors

TAX FRAUD (CONT)
Forms of Tax Evasion and Tax Fraud
 Using Off-shore Accounts
 Physical entities and corporations often use off-
shore accounts to hide their income and assets
from government institutions, to avoid taxing.
 Many foreign jurisdictions offer financial secrecy
to investors who live in other countries to attract
them to “tax havens”.

TAX FRAUD (CONT)
 Corporate Tax Fraud
Tax fraud arises from the taxpayer´s active
behavior or his failure to act. This tax fraud can be
found in the following forms:
 Tax fraud related to cross-border transactions
 Fraud realized when invoicing and bookkeeping
 Other forms of fraud – for example free goods and
services, unpaid taxes, fraud realized with
advance payments

TAX FRAUD (CONT)
 Tax Fraud by Employers
Companies usually employ people on the basis of
non-employment agreements, do not pay tax and
fees according to legislation, pay in cash to avoid
taxing. In many cases, the employer exposes fake
tax return documents, does not send tax return
documents or does not inform employees about it

TAX FRAUD (CONT)
Measuring Tax Fraud and Tax Evasion
The absence of reliable information/data is one of the major
challenges militating against tax fraud and tax evasion
analysis. The table below shows data published by PwC´s
economic crime survey in 2016.

TAX FRAUD (CONT)
Tax Evasion in Nigerian Economy
In general, paying less tax or not at all than what
one is legally obliged to, described the concept of
tax evasion. Feld and Frey (2002) asserted that in
most cases tax evasion arises in a situation where a
taxpayer arranges his financial affairs in a way
that would make him not to pay or pay the least
possible amount of tax by infringing the legal rules.

TAX FRAUD (CONT)
Tax evasion is always as a result of the following:
 Failure to pay tax,
 Failure to submit returns,
 Omission or misstatement of items return
intentionally
 Claiming relief in personal income tax which do
not exist,
 Understating income,
 Documenting fictitious transactions,
 Overstating expenses and/or failure to answer
queries.

TAX FRAUD (CONT)
Tax Fraud Reduction with Neural Network
 The neural network facilitates classification of
each tax filer as fraudulent or not fraudulent,
and furthermore, it reveals a taxpayer’s
likelihood to be fraudulent.
 In other words, it does not only classify
individuals as prone to fraud or not, but also
computes each filer’s probability to commit fraud.
Hence, tax filers are classified according to their
propensity to commit fraud.

TAX FRAUD (CONT)
 Attaining the goal comes with a price due to
software availability (suitable software for these
techniques is not common), computation capacity
(network algorithms are rather complicated and
require adequate hardware for convergence), and
methodological control (Machine Learning
techniques are not trivial concerning
methodology).

FINANCIAL FRAUD
Concept of Financial Fraud
It is incontrovertible that the banking system is the
engine of growth in any economy, given its function
of financial intermediation.
Financial fraud can be broadly defined as an
intentional act of deception involving financial
transactions for purpose or personal gain.

FINANCIAL FRAUD (CONT)
Financial Fraud in Government and
Organization
Financial fraud as an entity is categorized into the
following:
 Management Fraud
 Condonable/ Staff Fraud
 Leadership Fraud

Management Fraud
The Fraud perpetrated by chief executive is
management fraud. This includes:
 Inclusion of ghost names in payroll,
 Over booking of hours worked and
 overpaying of allowances,
 Keeping inadequate records and therefore
incurring loss,
 Misappropriating unclaimed wages,
 Pilferages of currency notes from the bundles,
 Misappropriation of revenues collected.

Condonable or Staff Fraud
Condonable fraud occurs where the employee diverts
the employer’s property which was given to enhance the
performance of the employee (Mainoma, 2009). The type
of fraud is characterized by:
 Inclusion of ghost names in payroll,
 Over booking of hours worked and
 overpaying of allowances,
 Keeping inadequate records and therefore incurring
loss,
 Misappropriating unclaimed wages,
 Pilferages of currency notes from the bundles,
 Misappropriation of revenues collected.

Leadership Fraud
 This is similar to management fraud in the
private sector and undermines the entire fabric of
public accountability.
 Some common example of
management/leadership fraud includes:
 Fictitious transaction;
 Wrong project evaluation;
 Wrong project award;
 Erroneous reporting of level of project executed;
 Loans to relatives leading to bad debts.

CONCEPT OF NEURAL NETWORK
A neural network is made up of processing units
referred to as neurons and nodes which are
adjacent of the following layers:
 The input layer
 The output layer
 The hidden or intermediate layers

FRAUD DETECTION USING NEURAL
NETWORK
 Working Principle
 Neural network based fraud detection is based
totally on the human brain working principal.
Neural network technology has made a computer
capable of thinking.
 For instance when a particular consumer uses its
credit card, there is a fix pattern of credit card
use, made by the way consumer uses its credit
card.
 Using the last one or two year data, neural
network is train about the particular pattern of
using a credit card by a particular consumer.

NETWORK

NETWORK
 Fraud Detection of Neural Networks
 Matching the pattern does not mean that the
transaction should exactly match with the pattern
rather the neural network see to what extent there
exist difference if the transaction is near by the
pattern then the transaction is ok otherwise if there is
a big difference then the chance of being a transaction
illegal increases and the neural network declares the
transaction a fault transaction.
 The neural network is designed to produce output in
real value between 0 and 1.
 If the neural network produces output that is below
0.6 or 0.7 then the transaction is ok and if the output
is above 0.7 then the chance of being a transaction
illegal increases.

WHY NEURAL NETWORKS SHOULD BE
IMPLEMENTED IN FRAUD DETECTION
Neural networks, with their
remarkable ability to derive
meaning from complicated or
imprecise data, can be used to
extract patterns and detect trends
that are too complex to be noticed
by either humans or other computer
techniques.

WHY NEURAL NETWORKS SHOULD BE
IMPLEMENTED IN FRAUD DETECTION
Other advantages include:
 Adaptive learning: An ability to learn how to do
tasks based on the data given for training or
initial experience.
 Self-Organisation: An ANN can create its own
organisation or representation of the information
it receives during learning time.
 Real Time Operation: ANN computations may be
carried out in parallel, and special hardware
devices are being designed and manufactured
which take advantage of this capability.

NEURAL FRAUD MANAGEMENT SYSTEM
 The Neural Fraud Management System is a
completely automated and state-of-the-art
integrated system of neural networks, Fraud
Detection Engine, Automatic Modeling System
(AMS), supervised clustering, and system retune.
 Combined with Sentinel the Neural Fraud
Management System (NFMS) can automatically
scale the relative importance of fraud to non-
fraud, group symbols to reduce dimensionality,
and evolve over time to detect new patterns and
trend types in frauds.

(CONT)
How Neural Fraud Management System
Works

(CONT)
The Neural Networks are completely easy to learn from
patterns of legitimate behavior and adapting to the evolving
of behavior of legitimate transactions. It also adapt to
patterns of fraud transactions and adapting to the evolving of
the behavior of fraud transactions.
 Supervised Clustering uses a mix of traditional clustering
and multi-dimensional histogram analysis with a discrete
metric. The process is very fast and can make decisions in
real time.
 Statistical Analysis ranks the most important features
based on the joint distribution per transaction patterns. In
addition, it finds the optimal subset of features and
symbols with maximum information and minimum
redundancy.

(CONT)
 The Fraud Detection Engine can apply the generated
model by AMS on input data stream and output the
detection results by specified model: Neural
Networks, Clustering, and Combined.
 The Fraud Detection Engine supports both Windows
and UNIX platforms.
 Returning the basic model created by AMS to adapt to
the recent trend of both the legitimate behavior and
fraud behavior and update the model for Fraud
Detection Engine.
 The Automatic Modeling System (AMS) chooses the
important inputs and symbols, train and create
clustering and neural network models.

CONCLUSION
 The nature and threat of any kind of fraud be it occupational, tax
fraud, or financial institution fraud is universal.
 Providing individuals a means to report suspicious activity after
detection is a critical part of an anti-fraud program, Hence
implementation of Neural Networks to reduce the prevalence of
fraud in all sectors.
 However, regardless of neural networks implementation Management
of private and public sectors should actively encourage employees to
report suspicious activity, as well as enact and emphasize an anti-
retaliation policy.
 Targeted fraud awareness training for employees and managers is a
critical component of a well-rounded program for preventing and
detecting fraud.
 External audits should not be relied upon as an organization’s
primary fraud detection method.
 Over time, audits were the most commonly implemented control as
reported in various study.

Creative accounting, tax, and financial fraud. 3rd acfe conference

Recommended

Recommended

More Related Content

What's hot

What's hot (20)

Similar to Creative accounting, tax, and financial fraud. 3rd acfe conference

Similar to Creative accounting, tax, and financial fraud. 3rd acfe conference (20)

More from Godwin Emmanuel Oyedokun MBA MSc ACA ACIB FCTI FCFIP CFE

More from Godwin Emmanuel Oyedokun MBA MSc ACA ACIB FCTI FCFIP CFE (20)

Recently uploaded

Recently uploaded (20)

Creative accounting, tax, and financial fraud. 3rd acfe conference