Financial Statement Fraud

GERARD M. ZACK, CFE, CPA, CIA, is a fraud examiner and forensic accountant with more than thirty years of experience performing audits and investigating fraud. In addition to providing antifraud services to clients, he serves on the faculty of the Association of Certified Fraud Examiners, where he conducts antifraud training on financial statement fraud and other topics. He has also spoken at AICPA and IIA events.

• Foreword xiiiPreface xviiAcknowledgments xxiPART I REVENUE-BASED SCHEMES 1Chapter 1 Introduction to Revenue-Based Financial Reporting Fraud Schemes 3Revenue Recognition Principles 3Changes Proposed by FASB and IASB 5Overview of Revenue-Based Schemes 6Chapter 2 Timing Schemes 9Alteration of Records 9Shipping Schemes 10Percentage of Completion Schemes 12Improper Estimates of Revenue Recognition Period 15Multiple-Element Revenue Recognition Schemes 17Customer Loyalty Programs 22Channel Stuffing 24Bill and Hold Schemes 27Sales with Right of Return 29Improper Pushing of Current Revenue to Future Periods 30Use of Reserves as a Rainy Day Fund 32Chapter 3 Fictitious and Inflated Revenue 33Fictitious Revenue Schemes 33Sales to Related Parties 37Infl ated Revenue Schemes 41Consignment or Financing Arrangements 43Chapter 4 Misclassification Schemes 47Recording Financing Arrangements as Revenue 47One-Time Credits Reported as Revenue 49Sales Incentive Schemes 50Chapter 5 Gross-Up Schemes 57Agent versus Principal 58Barter and Round-Trip Transactions 59Phony Revenue and Expenses 61PART II ASSET-BASED SCHEMES 63Chapter 6 Improper Capitalization of Costs 65Start-Up Costs 66Research and Development Costs 67Property and Equipment 68Software Development and Acquisition Costs 71Website Costs 73Intangible Assets 75Advertising Costs 77Other Deferrals and Prepaid Expenses 79Inventory Capitalization Schemes 80Inventory Flow Assumptions 81Chapter 7 Asset Valuation Schemes 85Fictitious Assets 85Inventory Valuation Schemes 86Inflating the Basis of Property and Equipment 88Inflating the Basis of Assets Acquired in Noncash Transactions 89Assets Acquired from Related Parties 92Understating Depreciation and Amortization Expense 93Investment Property 95Improper Valuation of Investments—Financial Assets 96Loans 104Equity Method Investments 108Proportionate Consolidation 109Improper Classification or Amortization of Intangible Assets 111Impairment Losses—Nonfinancial Assets 112Investments in Insurance Contracts 115Chapter 8 Fair Value Accounting 117Fair Value Considerations 117Methods of Measuring Fair Value 118Internal versus Externally Developed Valuations 124Inputs Used in Measuring Fair Value 127PART III EXPENSE AND LIABILITY SCHEMES 129Chapter 9 Shifting Expenses to Future Periods 131Timing Schemes Involving Liabilities 131Accounts Payable 131Compensated Absences 132Contingent Liabilities 133Accrued Compensation 137Improper Use of Liability “Reserves” 138Chapter 10 Omissions and Underreporting of Liabilities 141Debt 141Guarantees 146Pension Liabilities 149Conditional Asset Retirement Obligations 152PART IV OTHER FINANCIAL REPORTING SCHEMES 155Chapter 11 Consolidations and Business Combinations 157Fraudulent Reporting Involving Consolidations 157Business Combinations 164Chapter 12 Financial Reporting Fraud as a Concealment Tool 171Financial Statement Fraud to Conceal Asset Misappropriations 171Financial Statement Fraud to Conceal Illegal Acts 174Chapter 13 Financial Statement Fraud by Not-for-Profit Organizations 177Inflating the Value of Non-Cash Contributions 179Improperly Reporting Contributions Raised for Others 179Netting the Results of Fund-Raising Events 180Improper Allocation of Costs Associated with Joint Activities 182Misclassification of Expenses 185Chapter 14 Disclosure Fraud 187Categories of Disclosure Fraud 189Common Disclosure Risks 189PART V DETECTION AND INVESTIGATION 197Chapter 15 Detecting Financial Statement Fraud 199Motives for Financial Statement Fraud 200Fraud Risk Indicators 202Internal Control Indicators 202Chapter 16 Financial Statement Analysis 209Use of Analytical Techniques to Detect Fraud 209Horizontal Analysis 210Vertical Analysis 211Budget Variance Analysis 212Chapter 17 Ratio Analysis 215Research on Ratio Analysis 216Use of Operating Ratio Analysis to Detect Financial Statement Fraud 217Another Useful Measure: Working Capital to Total Assets 225Chapter 18 Other Detection Procedures 227Analysis Utilizing Multiple Ratios 227Ratios Involving Nonfinancial Data 231Other Information and Disclosures in Financial Statements 232Understandability of Financial Statement Disclosures 234Testing of Journal Entries 235Chapter 19 Fraud or Honest Mistake? 239The “Smoking Gun” 240Witnesses 240Altered Documents 241Multiple Records 242Destruction of Evidence 242Actions That Contradict Recommendations 243Patterns of Behavior 244Personal Gain 244There’s No Other Explanation for It 244Chapter 20 Assessing (or Minimizing) Auditor Liability 245Litigation against Auditors 246Concealment from the Auditors 247Auditing Standards 248Consideration of the Risks of Material Misstatement 249Improper or Inadequate Use of Analytical Procedures 254Auditing Accounting Estimates and Fair Values 257Revenue Recognition Risks 263Insufficient Consideration of Related Party Transactions 266Auditing Disclosures in the Financial Statements 266Overreliance on the Management Representation Letter 267Appendix: Financial Statement Fraud Indicators 269Bibliography 275About the Author 277About the Website 279Index 281Index to Cases 287