Financial Statement Fraud

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After reading this chapter, you will be able to:

  • Identify the most common ways financial statements are fraudulently manipulated.
  • Recognize some of the common red flags of financial statement fraud.
  • Understand why traditional independent audits fail to detect fraud most of the time.

Financial statement fraud is the most costly type of fraud committed at companies. Although financial statement fraud is present in only about 10% of internal fraud cases, the median cost of a financial statement fraud is $2 million.

Financial Statement Fraud schemes include:

  • Revenue overstatement
  • Understating expenses
  • Overstating assets
  • Understating liabilities
  • Improper use of reserves
  • Mischaracterization as “one-time” expenses
  • Misapplication of accounting rules
  • Misrepresentation or omission of information

Why Financial Statement Audits don’t find fraud:

  • Detecting fraud is not a primary objective of financial statement audits
  • Auditors use sampling techniques and do not (and cannot) examine every transaction
  • Employees committing fraud take proactive actions to conceal their crimes