The document discusses several key aspects of corporate fraud including: 1) The legal definition of fraud which requires a deliberate misrepresentation that causes damages. 2) Common types of accounting irregularities used to commit fraud such as aggressive accounting, earnings management, and fraudulent financial reporting. 3) The main cash flow cycles in a business - sales, expenses, payroll, inventory, and capital expenditures - and how fraud can occur in each cycle. 4) Warning signs that a corporate fraud may be taking place such as bypassing low bidders and a lack of controls over spending.

1. Diagnosis to detect manipulation
of items
Aju joy

2. Definition
• Simply stated, corporate fraud is cooking
books to show better earnings and profits.
The cost of fighting fraud is very
high, especially in high profile cases, such as
frauds occurring in Fortune 500 companies.
• Legally, a fraud must include seven elements: a) A deliberate
misrepresentation about b) a material point, c) which is
false, d) but which the victim believes, e) intentionally or
recklessly, and f) acts upon it, g) thus causing significant

3. Not all deceptions are frauds. To meet the legal definition of a
fraud, there must be damage, usually in terms of money, to the victim.
Under the common law, there are four general requirements for a fraud
to exist:
• A material false statement [(a), (b) and (c) above],
• Knowledge that the statement was false when it
was made, [(d) and (e) above],
• Reliance on the false statement by the victim [(f)
above], and
• Damages the victim as a result [(g) above] (

4. Accounting irregularities
• Aggressive Accounting: Intentional choice and application of accounting principles, in
accordance with GAAP or not, done in an effort to achieve desired results, typically, higher
current corporate earnings.
Examples: Recording revenues too soon or of questionable quality; recording bogus
revenues; recognizing revenues on disputed claims against customers; paying fictitious
consulting or other fees to customers that were to be repaid to the company as licensing
fee; shifting current expenses or sales to a later date; shifting future expenses or sales to
the current period as a special charge, and influencing auditors.

5. Earnings Management: The active manipulation of earnings toward a
predetermined target, which may be set by management, a forecast made by
analysts, or an amount that is consistent with a smoother and more sustainable
earnings stream.
•Income Smoothing: A form of earnings management designed to flatten peaks and valleys
from an actual earning series, including steps to reduce and “store” profits during good years
for use during slower years.
Fraudulent Financial Reporting: These are deliberate misstatements or omissions
of amounts or disclosures in financial statements, done to deceive financial
statement users. Administrative, civil or criminal proceedings can determine such
statements as fraudulent.

6. Creative Accounting Practices: This is a general euphemistic term for any of the
above accounting malpractices or irregularities. Typical creative accounting
practices include recognizing premature and fictitious revenues, aggressive
capitalization and extended amortization policies, misreported assets and
liabilities, massaging income statements, and deceptive cash-flow reporting.
Insider Trading: This is buying or selling some or all of one’s stock holdings, or
facilitating such transactions for others, because of insider information that one has
privileged access to as a corporate insider. There are legal as well as illegal insider
trading activities that can be undertaken by corporate insiders.

7. Common Sources of Corporate Fraud
To understand how fraud occurs within businesses one must understand how the
various cycles (e.g., operation cycle, cash cycle) work within an accounting system.
Concretely, accounting profession recognizes five cash flow cycles:
•Sales and accounts receivable
•Payment/expense and accounts payable
•Human resources and payroll
•Inventory and storage/warehousing, and
•Capital expenditures

8. Sales and Accounts Receivable:
The fundamental concept of any business is to design new products and services, distribute, market and sell them, and collect
revenues. Revenues from sales appear on the income statement, and corresponding accounts receivable from credit appear on the
balance sheet. Cash sales directly affect the cash balance, which also appears on the balance sheet. In order to minimize fraud
and financial risk in this cash cycle, various checkpoints are:
Marketing department: Identifying and soliciting customers, processing customer orders and fulfilling them exactly (e.g., timely
sorting, packaging and shipping of products) - this is the marketing and sales function.
Accounting department: costing products, pricing products, sending invoices, guidelines for credit, approving credit, collecting
receivables, record keeping and assessing bad debts - this is the credit function.
Finance department: collecting cash, cashing checks, banking cash and financing production and marketing - this is the financial
function.
In minimizing fraud, keep these three functions separate. Accordingly, custody of data and customers, authorization of credit, and
recordkeeping should be separate functions. That is, separate the credit function from the sales function, thereby avoiding
granting credit to an unsuitable potential customer in order to force a sale. Similarly, sales recording and receipt of cash should be
separated so that skimming of cash may be minimized.

9. Human Resources and Payroll: Any business systems need employee skills. This HR cycle
includes identifying skills, recruiting, developing, promotion, and retention of employee
talent, performance appraisal, and other related matters. Cash, payroll and taxes payables
appear on the balance sheet, while salaries/payroll, tax, travels, training and entertainment
appear in the income statement. Fraudulent practices prevalent in the HR cycle are ghost
employees, falsified hours and overtime; false expense reports (e.g., padding); false
medical claims; false sick leave; improper
recruiting, hiring, firing, wages, salaries, promoting, appraising, and personnel
development.

10. Inventory and warehousing management: This purchase cycle includes
ordering, transportation, logistics, receiving goods and reports, processing
requisitions, control over requisitions, storage, warehousing, continuous inventory
records, shipping documents, JIT inventory management, inventory
costing, FIFO, LIFO, theft, spoilage, and other related functions. From an
accounting perspective, inventory appears on the balance sheet, and cost of goods
sold (CGS) in the income statement. Fraudulent practices prevalent in the
inventory management function include overstocking, creating artificial
shortages, creating production bottlenecks, overstating inventory as bank
collateral, improper use of FIFO or LIFO, theft, spoilage, and the like.

11. Capital Expenditures: This fifth part of the accounting cycle is also known as the capital acquisition
and repayment cycle or the financing cycle. It includes borrowing of funds, payment of interest, debt
structure of the company, debt amortization, issuance of stock, stock repurchases, and the like.
Several of these items feature in the financial statements, such as cash, liabilities (e.g., debt,
mortgages), capital and retained earnings on the balance sheet, and interest paid and received,
among others on the income statement.

12. New medicines:
forensic accounting enables the investigative auditor to assess financial transactions in
relation to various authorities such as the Criminal Code, an insurance
contract, institutional policies, or other guidelines for conduct and reporting.

13. Warning Signs of Corporate Frauds
Opportunity is the most controllable condition for fraud. Fraud thrives in organizations
that have little respect for controls. Frauds occur more likely where controls are weak
rather than absent. Typical warning signs of corporate frauds in your corporation are
when the following routinely happen:
Low bidders are bypassed on technical grounds;
Open public bidding of suppliers is non-existent;
Frequent use of one or two suppliers;
Reputable suppliers shy away from submitting bids;
Frequent entertainment of employees by few vendors;
Lifestyles of employees are inconsistent with their official income levels;
Employees’ reluctance or refusal to go on leave;

14. Analysis of long lived assets:
1. Plant and machinery, land and buildings
2. Investments long term
3. Good will
Usually created Allocated to income
Long-lived asset
because the company statement expense (or
account:
purchased: income) via:
depreciation or
Property, plant &
tangible property impairment (i.e. abrupt
equipment
loss in value)
the securities of another
Investments gain/Loss or impairment
company
another company, but
paid more than fair value amortization or
Goodwill
(The excess over fair impairment
value is goodwill)

15. investments
Method Value of Investment on the Balance Sheet Cash Dividends and Investment Income When Used
The investment is carried at its historical cost;
Only actual (cash) dividends are recognized by the The "ready market price" is available or the
Cost holding gains/losses are recognized only when
parent. Income is not recognized company intends to hold the investment until sale.
the asset is sold.
The investment is marketable (has a readily
The market value of the asset is updated each
Cash dividends are recognized; income may or available price) and is either used for trading
Market period, which creates holding period gains and
may not be recognized. purposes and is "available for sale" by the trading
losses.
company.
The investment is carried at its historical cost; The parent company has a "significant influence"
Equity The parent's share of income - including any cash
holding gains/losses are recognized only when over the investment. This generally applies when
Method dividends received - is recognized.
the asset is sold. the parent owns 20-50% of the investment.

16. Goodwill is created when one company (the buyer) purchases another company (the
target). At the time of purchase, all of the assets and liabilities of the target
company are re-appraised to their estimated fair value. This includes even intangible
assets that were not formerly carried on the target's balance sheet, such as
trademarks, licenses, in-process research & development, and maybe even key
relationships.
At one time, goodwill was amortized like depreciation. But as of 2002, goodwill
amortization is no longer permitted. Now, companies must perform an annual test of
their goodwill. If the test reveals that the acquisition's value has decreased, then the
company must impair, or write-down, the value of the goodwill. This will create an
expense, which is often buried in a one-time restructuring cost, and an equivalent
decrease in the goodwill account.