Content uploaded by Darina Saxunova
Author content
All content in this area was uploaded by Darina Saxunova on May 13, 2018
Content may be subject to copyright.
Usefulness of Financial Statements and Annual Reports in the process
of Accounting Fraud Detection
Lenka Chorvatovičová
Comenius University, Faculty of Management, Slovakia
Lenka.Chorvatovicova@st.fm.uniba.sk
Darina Saxunová
Comenius University, Faculty of Management, Slovak republic
Darina.Saxunova@fm.uniba.sk
Abstract. Early detection and subsequent prevention of accounting fraudulent activities are basic
assumptions of healthy working economic environment. They are enforced by both governments and
audit companies. Audit procedures, however, were not originally designed to uncover accounting
frauds, but this issue has been already reflected in current audit & control procedures. The topic of
financial statement misstatement has become of great interest by academic and research community.
The main objective of this scientific paper is to present a comprehensive view on possible forms of
fraudulent activities concerning financial statements, to examine and systemize theoretical concept of
the creative accounting, aggressive accounting and fraud and to summarize or propose possible
procedures to detect accounting fraud from publicly available financial statements concentrating on
the assets misappropriation. The situation in fraud in the area of asset misappropriation is analysed and
compared globally. Unfortunately we must conclude it has been the most occurring fraud since 2000.
Keywords: accounting creativity, fraud, errors, irregularities, earnings management
1 Introduction
Deliberate misstatement of corporate financial statements has been recently brought to the attention of
broad public, media and political authorities all over the world. Such a misstatement, or in other words
accounting fraud, is a manipulation with corporate financial data in order to create false picture of its
financial health and position - leading various stakeholders (shareholders and investors, employees,
government institutions, etc.) to incorrect risk perception regarding this particular corporation.
Accounting fraud usually involves employees at highest management levels – CEOs & CFOs, top
executives and senior staff, and is particularly critical because health and stability of financial markets
largely depend on assumption of corporate financial statements being not fraudulent, but rather in line
with existing accounting principles. Recently the term of corporate social responsibility has been
introduced and its main purpose is to focus on corporate executives and chief officers and their ethical
behaviour in the best interest of stakeholders, e.g. corporate shareholders, creditors and customers, and
general public. On the other hand, economist Milton Friedman saw individual liberty as the greatest
corporate good and claimed that „the social responsibility of business is to increase profits“ and that
executive staff’s responsibility towards shareholders is to make as much profit as possible. The
management is responsible for true and fair picture of the company communicated to the users of the
accounting information via the financial statements. The main objective of accounting and preparation
of financial statements is to provide accurate information and ensure both internal and external
control. Financial statements which are audited should confirm the correctness and accuracy of
disclosed financial figures and other information in company’s accounting. It is up to company’s
employees – from office workers to top management level – to provide such information, who
however, might not always be willing to provide accurate and complete disclosure.
233
2 Creative Accounting and Fraud in Literature
Greek drama writer Sofokles knew what he was talking about, when he mentioned: Profit is sweet,
coming from the fraud though.“ (Chaline, 2008, s. 256). Fraud in general could be conveyed as a
deliberate deceit with the purpose of some form of personal gain. Accounting or financial fraud, the
intentional misstatement and disclosure of corporate financial information for one’s personal gain, has
been a continuous difficulty since many years when capitalism rose in the 20th century. Prior to 1930s
when first accounting standards were put in practice, what would be considered as accounting fraud or
misstatement nowadays, it would have been marked as an acceptable accounting in the past. History
of accounting and auditing contains long list of examples of dishonesty in disclosure of financial
information. During the 21st century we may witness major growth of the banking and finance sectors
meaning pressure on achieving profits and other financial targets have become more and more
significant than in the past. Accounting scandals (including illicit use of derivatives and special
purpose entities) have become dark part of this industry to certain extent, along with misstatement of
financial figures and frauds. Hence fraud prevention has become a part of each corporate’s accounting
processes, methodologies and internal policies. It is difficult to measure and determine its scale, and
we could only guess how many frauds go on undetected and undiscovered. According to the
Association of Certified Fraud Examiners, the main way in which an accounting fraud was discovered
were tips from whistle-blowers, followed by discovering fraud by accident, internal audit and control,
external audit, and finally by police notification.
2.1. Fraud definition
Fraudulent activities are very harmful for each company; they have a malign impact on an enterprise
development. Nor do they cause direct financial losses, but their other negatives are the loss of
business partners, deterioration of business relations, departure of best employees or collapse of the
company’s morale. According to the one of the first definitions of researchers Davia, Coggins,
Wideman and Kastantin (1992) „fraud always involves one or more persons, who, with intent, act
secretly to deprive another of something of value, for their own enrichment.“ Authors state that the
fraud involves essentially five elements presented in Table 1:
Table 1: Definition of Fraud
FIVE ELEMENTS OF THE FRAUD
Physical existence
of a person - fraud
executor.
Existence of
fraudster‘s
deliberately
harmful behaviour
Existence of
object that has
been seized by
somebody
Existence of the belief
the seized object is
only borrowed
temporarily
Existence of
benefits for a
fraudster
„There is
a perpetrator.
The perpetrator
acted with intent.
Someone has
parted with
something of
value
The person who has
parted with something
of value does not
realize at the time that
he or she has done so
The
perpetrator
has benefitted
from the act.“
Adapted by authors from the source (Davia et al., 1992)
Corporate fraud means activities undertaken by an individual or company that are done in a dishonest
or illegal manner, and are designed to give an advantage to the perpetrating individual or company.
Fraud is widely defined as a deliberate, dishonest and deceitful activity which results in direct and
indirect losses of various forms to an organisation (Saxunova, 2012) and therefore we may distinguish
two cases of fraud (focusing on the perpetrator’s intent):
a) when a fraudster acts since the first moment deliberately in order to obtain something valuable
for himself/herself, or
234
b) when a person believes that something valuable is only borrowed temporarily and will be
returned back without being noticed in the organization, but he/she fails to return it.
As defined in ISA 240.6 (Revised) the term "fraud" refers to an „intentional act by one or more
individuals among management, those charged with governance, employees, or third parties, involving
the use of deception to obtain an unjust or illegal advantage“. According to KPMG Forensic Malaysia
(KPMG, 2005) fraud is defined as „deliberate deceit planned and executed with the intent to deprive
another person of his property or rights directly or indirectly, regardless of whether perpetrator
benefits from his/her actions“. Weirich and Reinstein (Bunget, 2009) also define fraud as „intentional
deception, and they further add that it is cheating and stealing, too“. Pollick defines fraud as a
„deliberate misrepresentation, which causes one to suffer damages, usually monetary losses“ (Bunget,
2009) and as well as, he states “it involves complicated financial transactions conducted by white
collar criminals, business professionals with specialized knowledge and criminal intent”.
Fraud comprises both 1) the use of deception to obtain an unjust or illegal financial advantage and 2)
intentional misrepresentations affecting the financial statements by one or more individuals among
management, employees, or third parties. The second part actually conveys fraudulent financial
reporting which Beasley, Carcello and Hermanson (1999) characterize as „intentional material
misstatement of financial statements or financial disclosures or the perpetration of an illegal act that
has a material direct effect on the financial statements or financial disclosures.“ Mulford and
Comiskey (2002) see that as intentional misstatements or omissions of amounts or disclosures in
financial statements, done to deceive financial statement user, that are determined to be fraudulent by
an administrative, civil or criminal proceeding.“ In a simplified perspective the fraud may involve: a)
falsification or alternation of accounting records of other documents; b) misappropriation of assets or
theft; c) suppression or omission of the effects of transactions from records or documents; d) recording
of transactions without substance; e) intentional misapplication of accounting policies or f) wilful
misrepresentation of transactions or of an entity’s state of affairs“.
We may conclude that majority of authors consider fraud as intentional deed by the person and they do
not admit in their definitions the 4th feature defined by Davie et al. (1992) that perpetrator is not aware
of committing a crime first apologizing himself or herself in front of himself/herself, and promising to
return it later, but not having being seen or caught he keeps the object previously seized and by the
repetition of similar situation that tempts the perpetrator again in order to take something what does
not belong to him changes his unintentional action into intentional deed. As Slovak proverb says: the
thief is made by the opportunity.
2.2 Creative accounting
Creative accounting has been defined by many researchers e.g. from “ outright fraud” to the
“imaginative use of accounting numbers” (O’Regan, 2016, p.443). Creative Accounting is in Oxford
dictionary of English explained as „the exploitation of loopholes in financial regulation in order to
gain an advantage or present figures in a misleadingly favourable light.“ It is defined in a similar way
also by Chartered Institute of Management Accounting (2008) as „ a form of accounting which, while
complying with all regulations, nevertheless gives a biased impression (generally favourable) of the
company’s performance.“ Mulford and Comiskey (2002) add that creative accounting is perceived as
„any and all steps used to play the financial numbers game, including the aggressive choice and
application of accounting principles, both within and beyond the boundaries of generally accepted
accounting principles, and fraudulent financial reporting. Including also steps taken toward earnings
management and income smoothing.“ Gherai and Balaciu (2011) write that enterprise stake is at risk
when it indulges in practices of creative accounting. The best definition of creative accounting is
presented by O’ Regan as “the use and abuse of accounting techniques and principles to achieve
235
financial results which intentionally, do not provide a true and fair view.” (2016, p. 443). Fraud
unlike creative accounting is in Black’s Law Dictionary defined as a knowing misrepresentation of
the truth concealment of a material fact to induce another to act to his or her detriment.“ and by
Auditing Standards Board (2008)”. The main difference between creative accounting and fraud is that
creative accounting means working within the current regulatory framework. On the other hand,
committing a fraud means reporting outside current regulatory framework – it involves breaking the
law and regulatory framework violation. As per individual fraud, this may involve theft of certain
assets like cash or inventory. For management, though, fraud means preparation of misleading
financial statements with the intention to mislead certain parties.
In Romania scholars confirmed in the research that the most frequent situations of creative accounting
practices occurring were the evaluation and recognition of risk provisions, the amortization and
depreciation of assets, revaluation of tangibles, inventory and receivable accounts tested for
impairment and the least – R&D costs and financial assets. Most of the auditors (44%) consider
financial statements prepared by companies not to be transparent enough, 68% of them consider
accounting manipulation as a frequent procedure encountered in practice and 68% of the respondents
in Romania believe that the stakeholders’ interests can be affected by using creative accounting; 72 %
of the investigated auditors consider that a consolidated control can diminish the tendency to use
creative accounting (Balaciu, Bogdan Mester and Gherai, 2012). The similar problem exists in
Slovakia, Slovak companies have improved the process of financial statements, but the notes to the
financial statements are still not sufficient for the external users for appropriate interpretation.
2.3 Aggressive Accounting
Some consider aggressive accounting the same as creative accounting. There is a small difference
between them. Company’s aggressive accounting when managing its earnings uses constantly the
approach by overestimating the assets and underestimating liabilities to the maximal extent to achieve
the highest net income possible. Working under creative accounting it means for the company to use
accounting standards in order to deliver certain set of financial statements results. Creative accounting
manipulates with estimates, with the choice of the accounting methods etc. still in compliance with the
approved accounting standards to achieve either the best results possible, as aggressive accounting, but
on the other hand, or the lowest result possible or the results which are considered suitable for the
company for the particular reasons which are known to the top management. It includes deliberate
choice of such a figures to achieve specific objective – target numbers, increased earnings trend,
instead of reporting true and realistic financial view. As O’Ragan (2016, p.446) says “earnings
management and accounting scandals are linked”, earnings management is implemented to meet
market expectation of creditors and investors, to guarantee fat bonuses for management or simply just
for critics made them being silent. Thus, companies are expected to report certain levels of earnings
although many companies accomplish that by managing the numbers using aggressive and creative
accounting practices. Nowadays, it is a significant feature of many corporations’ activities.
3 Errors & Irregularities in Financial Reporting
Incorrect and not actual statement of financial information, so called accounting irregularity, can occur
due to an error or a fraud. According to Kamal Gupta (2005) an accounting error means to misstate
financial data unintentionally, examples are summarized in table 2.
On the other hand, fraudulent financial reporting, which is often considered according to Kwok (2005)
as the major kind of accounting irregularity, consists of intentional misstatement of financial
information or omission of particular financial information from financial statement in order to
mislead the users of financial statements. Such reporting can include examples as presented in table 2,
236
in the second part. Table 2 and 3 focuses on the main discrepancies between accounting error and
irregularities or frauds, as outlined by Michael Young (2013).
Table 2: Errors versus Irregularities
E
RRORS
:
Unintentional misstatements or omissions of amounts or disclosures in financial statements, such as:
a) mistakes in gathering or processing accounting data from which financial statements are prepared
b) incorrect accounting estimates arising from oversight or misinterpretation of facts
c) mistakes in the application of accounting principles relating to amounts, classification, manner of
presentation, or disclosure (Gupta, 2005)
Source: (Young, 2013, p. 21)
Table 3: Errors versus Irregularities
I
RREGULARITIES
:
Intentional misstatements or omissions of amounts or disclosures in financial statements, such as:
a) deception e.g. manipulation, falsification, or alteration of accounting records or supporting
documents from which financial statements are prepared
b) misrepresentation or intentional omission from, the financial statements of events, transactions, or
other significant information
c) intentional misapplication of accounting principles relating to amounts, classification, manner of
presentation, or disclosure (Kwok, 2005)
Source: (Young, 2013, p. 21)
4 Earnings Management
The topic of earnings management and especially the quality of earnings hasn’t stopped being a topic
for research for many years. Users of accounting information use the financial statements of the
current accounting period for forecasting future performance, future cash flows and future financial
position. If the financial statements are of a poor quality, they are not a reliable base for forecasting,
for decision making and they will mislead the users. If the company intentionally underestimates
warranty expense and defers revenue it will report a higher net income (net earnings) but the following
year or years the net income figures will be lowered, that means the net income will reverse. Earnings,
that are the consequence of using selected accounting methods in the particular fiscal year, always
reverse in the future. So earnings are of good quality if they do not reverse. Manipulation is often
referred to as earnings management. Earnings management can be described as the desire of company
management to meet their targets and forecasts.
Table 4: Earning Quality
Quality Earnings
(QE)
Scenario
The analysts’ work
Adjustments required
and implemented:
Results expected:
Low quality earn-
ings (LQE) due to
the low quality of
accounting
LQE are not detected
by the analysts
Required action not
implemented
Low quality forecasts
Low quality valuations
LQE are detected
by the analysts
Forecast can be adjusted
to anticipate the reversals
Improved quality
forecasts & valuations
High quality
earnings (HQE)
Yes/No
No action needed
High quality forecasts
High quality valuations
Source: processed by authors
It is very common that external financial analysts and agencies issue profit estimates for publicly
traded companies, and these should meet their estimates is they do not want to see their stock lose in
its value to competition in the market. Those companies which fall behind their profit targets
sometimes seek to manage their earnings, for example in a form of profit smoothing. Financial
237
markets tend to reward companies with stable and predictable profit levels, which have increasing
trend on year-to-year basis, or quarter-to-quarter basis. On the other hand, companies which profits
tent to rise and fall each period would have worse rating and corporate image. Hence such companies
might prefer to report steady period-to-period profits instead of reporting big fluctuations in their
profit levels, and their managers would use certain techniques to smooth profits. Common way is to
issue expense, revenue or profit based incentive plan. Depending on particular incentive strategy for
company sales population, their sales might be affected if they are measured on expenses, revenues or
profits. By selecting correct method a company can save its profits for worse periods and vice versa.
According to many authors, to mention at least few of them e.g. Michael Jones, (2011), Penman
(2009), Saxunova (2008 and 2014), Balaciu et al.(2012), (Ruckova, 2011) and many others the
company can potentially report increased income, for example, by the following actions:
a) Premature sales recognition
b) Increase in interest receivable
c) Inclusion of non-operating profits
d) Treatment of loans as sales
e) Swaps
Table 5: Earnings management examples - revenues
Accounting
Conservative
Liberal
Aggressive
Fraud
Revenue
recognition
manufacturing
After sale,
delivery &
acceptance
After sale is
made
Bill and hold
Fraudulent sale
Revenue
recognition
services
Services prepaid
and already
performed
Services prepaid
& partially
performed
Services agreed
to, not performed
yet
Fraudulent
scheme
Impact on NI &
Total Assets
Adapted from the source: (Giroux, 2014)
Table 6: Earnings management examples - expenses
Accounting
Conservative
Liberal
Aggressive
Fraud
Inventory
LOCOM
followed
Slow to write-
down slow
moving inventory
Obsolete inventory
still on the books
Sham rebates on
purchased inventory,
non-existent inventory
Accounts
Receivable
Conservative
credit terms
and higher
bad debt
allowance
Liberal credit
terms and bad
debt allowance
Lenient credit poli-
cies to expand sales
& reduce bad debt
by ignoring proba-
ble uncollectibles
Fake invoices on non-
existing sales (bogus
revenues),
Sales that do not allow
revenue recognition
Advertising
marketing
Expensed as
incurred
Expensed based
on some formula,
e.g. GP
percentage
Marketing costs
capitalized
Capitalized & manipula-
ted to meet profit targets,
other costs treated as
marketing & capitalized
Impact on NI
&Total Assets
Adapted from the source : (Giroux, 2014)
Legend: The size of the arrow means the size of the impact of accounting practice on the NI & TAs
238
5 Innovation in Fraudulent actions
Accounting fraud or misstatement of financial statements is intentional action of an individual or
a group to gain illegal financial advantage or to present financial information in misleading way. This
may involve: 1. Falsification or alternation of accounting records or other documents;
2. Misappropriation of assets or theft;
3. Suppression or omission of the effect of transaction from records or documents;
4. Recording of transactions without substance;
5. Intentional misapplication of accounting policies; or
6. Wilful misrepresentations of transactions or of the organization’s state of affairs.
Asset misappropriation is the most common type of fraud occurring in companies, even thought
typical amount misappropriated in such cases is smaller than amount lost in other kinds of fraud
schemes. Asset misappropriation, or in other words, theft of company assets, can involve employees at
all levels – workers, first line managers to top executives, or even third parties. If these actions are
deliberately kept in secret and not showed in company financial statements then theft is intentionally
covered. Basic ways to misappropriate company assets are stealing disposable assets (like cash or
inventory) or falsifying reimbursements for goods and services that this company have never been
delivered for the use, yet it to pay for them (fraudulent disbursements). Regarding misstatements
arising from asset misappropriation Davia et al. (1992) and Ramos (2006) identify several risk
factors, such as a) incentives/pressures, b) opportunities and c) inadequate internal control over assets.
Incentives / Pressures
1. Personal financial obligations may create pressure on management or employees with access
to cash or other assets susceptible to theft to misappropriate those assets
2. Adverse relationships between the entity and employees with access to cash or other assets
susceptible to theft may motivate those employees to misappropriate those assets. For
example, adverse relationships may be created by following:
i) Known or anticipated future employee layoffs
ii) Recent or anticipated changes to employee compensation or benefit plans
iii) Promotions, compensation, or other rewards inconsistent with expectations
Opportunities
1. Certain characteristics or circumstances may increase the susceptibility of assets to
misappropriation. For example, opportunities to misappropriate assets increase when there are
the following:
i) Large amounts of cash on hand or processed
ii) Inventory items that are small in size, or high value, or in high demand
iii) Easily convertible assets, such are bearer bonds, diamonds or computer chips
Inadequate internal control over assets
Inadequate internal control over assets may increase the susceptibility of misappropriation of those
assets. For example, the misappropriation of assets may occur because of the following shortcomings:
a) Inadequate segregation of duties or independent checks,
b) Inadequate management oversight of employees responsible for assets, for example inadequate
supervision or monitoring of remote locations,
c) Inadequate job applicant screening of employees with access to assets,
d) Inadequate recordkeeping with respect to assets,
e) Inadequate system for authorization and approval of transactions (for example in purchasing),
f) Physical safeguards over cash, investments, inventory or fixed assets,
g) Lack of timely and appropriate documentation of transactions,
h) Lack of mandatory vacations for employees performing key control functions.
239
Even though cash is primarily the target for employees’ theft, other assets such as supplies, inventory
or other kinds of equipment might be part of assets misappropriation, as well, varying from stealing
boxes of paper or small office supplies, to unauthorized usage of expensive equipment or machinery.
Taking non-cash assets into account, employees can commit several kinds of misconduct:
unauthorized use of equipment (e.g. company car or truck, computer), inventory shrinkage, fake sale
or purchase on behalf of company.
240
Figure 1: Fraud Categorisation
Source : (Report to the Nation on Occupational Fraud & Abuse, 2008 p. 7)
241
Report to the Nation on Occupational Fraud & Abuse presents general classification of asset
misappropriation in nine categories (2008, p.12). Frauds that are aimed at company incoming receipts
are included in first two categories: skimming, and cash larceny. Following five categories then
describe aiming at outgoing cash disbursements: billing schemes, checks tampering, expense
reimbursements, payroll schemes and cash register disbursements. Cash on hand misappropriations
involve the theft of cash or currency maintained onsite by the victim organization. The last category,
non-cash misappropriations, involves the theft or misuse of physical assets such as inventory or
equipment, or the misappropriation of proprietary information.
Skimming involves any situation in which company cash is stolen before it is recorded in its books
and records – for example occurring when an employee accepts cash payment from customer or
another third party, but does not record the sale or the transaction in the books. Cash larceny occurs,
on the other hand, when cash receipts were recorded into company accounting books, but the receipts
are stolen afterwards before they can be deposited. During fraudulent billing an employee causes
issuance of a payment by submitting invoices or receipts for fictional goods and services which the
company have never been delivered. Check tampering involves theft or alternation of a check which
the company issued for someone else. Situation when an employee claims fictional expense
reimbursement or inflated reimbursement is another kind of fraudulent disbursement of cash. Payroll
is any scheme when an employee falsely claims compensation and causes the company to issue such
a payment. Cash register disbursements occurs when an employee makes false entries on a cash
register in order to conceal the fraudulent removal of cash. Cash on hand misappropriation involves
theft of cash kept in company premises, and non-cash misappropriation involves misuse or theft of
non-cash assets of the organization. According to study conducted by Association of Certified Fraud
Examiners, approximately 85% of all asset misappropriation involves the theft or misuse of cash. The
chart above depicts Fraud and Abuse Classification System (adopted from the annual report by
Association of Certified Fraud Examiners), and highlights the asset misappropriation position. (see
figure 1).
6 Usefulness of Financial Statements
Certain accounting and financial statements conditions may be the warning signals that should not be
ignored by an internal or external auditor or potential investor or creditor or the company’s managers
in analyzing the financial information communicated through the financial statements. Professional
skepticism of theirs will be a threshold in judging performance of the investigated company, its
financial position and cash flows. The following symptoms should be carefully examined because they
may indicate earnings manipulation.
a) Accounting principles or estimates are suddenly changed
b) Major part of the company is surprised by the results reported
c) A decrease in profitability after a period of good profitable years
d) Sales are constant or falling
e) Sales grow in a slower pace than earnings
f) Net profit is bad, very low
g) Almost no growth, zero or even decline for profit margins
h) Analysts’ earnings expectations are met with big difficulties by the company
i) Tax reporting and financial reporting show discrepancies in expenses
j) Adjustments are made in the last quarter of the year in accounting books
For earnings manipulation it is necessary focus on the sales figures – it is necessary to monitor sales
growth, especially unusually high growth rates, then expenses related to normalised operating assets
(NOA) and affecting return on NOA (normalised assets mean five year average assets usually used by
operations in the company). Unusual and important changes resulting in different return on NOA are
242
in focus: a) gross margin ratio, advertising -to - sales ratio, G&A-to-sales ratio, R&D-to-sales ratio
and b) ratios affecting asset turnover (receivable, inventory and payable turnover and inventories to
sales ratio, account receivable to sales ratio, bad debt- to sales ratio, other asset to sales ratio, operating
liabilities to ales ratio). These figures must be monitored and compared with industry average values
and revealed discrepancies must be explained. The process of ordering is also very important and
regular checking are necessity, an accumulated order backlog indicates demand for the product which
company has not satisfied yet (book –to bill ratio is necessary to be monitored), sudden changes in
sales prices (per unit) should be checked, the investment or operational plans must be examined,
labour force changes.
A real problem for the company is when the internal auditor will finds out: a) slower sales increase as
planned, b) order backlog dropped, c) sales returns are evidently growing, the return of goods is piling
due to the customers’ dissatisfaction with the product; d) the big problem is increase in account
receivable to sales ratio leading to cash problems, e) similarly increase in inventory turnover reveals
the problem of slow sales, or it may be a sign the production is increased because there is a forecast
for the higher sale in the future, therefore the reason must be detected in order to correctly interpret the
results.
External user may have a problem to correctly interpret or sometimes he/she is unable to determine
certain ratios, because the company report only operating expenses in an aggregated amount and notes
do not provide more information how big advertising expenses, research and development expenses
(R&D), selling, general and administrative expenses (S,G&A) are etc., and therefore it is not possible
to monitor and calculate development and trend in these ratios (these expenses to sales ratios). But
internal auditor cannot have these problems as this information is available in accounting department,
and may be demanded upon request.
Possible red flags in performance shortcomings:
a) increase in advertising –to –sales ratio: low effectiveness of marketing activities for sales
increase
b) research and development expenses (R&D) should be monitored to assess product innovation
c) increase in S,G&A expenses -to-sales ratio: should be monitored if variable or fixed cost
increased, because if the sales increases fixed cost should decline.
d) low depreciation or amortization expenses mean that there will be future asset write-downs
owing to disposing assets, or incurring losses from the asset sale or restructuring expenses Too
high depreciation expenses usually leads to later gains from asset disposals.
e) provisions require the estimates, therefore accruals and also deferrals must be also monitored
if they reflect true and fair picture of the related transactions.(Penman, 2009)
7 Results and discussion
According to the PWC’s Economic Crime Survey 2016, majority of economic crime is created by
asset misappropriation. In 2014 such crimes created 67% of all economic crimes which took place in
that year, compared to 60% in 2016 which means we notice slight decrease in this trend. Asset
misappropriation is followed by Cybercrime which is the second largest category of economic crimes.
Only two years ago in 2014 39% of economic crimes were classified as cybercrimes. According to the
2016 report, nowadays in 2016 almost half of all crimes (49%) belongs to this group – this is
significant increase which we can dedicate to development of IT instruments and entire instrastructure,
and its easier availability to corporate employees and general public. Steady share of 24% in 2014 vs.
2016 among economic crimes is formed by Money Laundering. Slight decline in crime trend can be
seen in two last categories – Accounting Fraud and Bribery & Corruption. In 2014 level of accounting
fraud was 21% which decreased by 3% to 18% in 2016. Bribery and corruption category has seen
243
decrease from 20% in 2014 to 18% in 2016. Economic crime is a global problem and according to the
report, its share among all crime categories was 37% in 2014 and 36% in 2016. In general 36 out of
100 reported crimes are economic crimes. This slight decrease from 2014 to 2016 can be considered as
steady, non-progressing value.
Figure 2: Economic crime in global world in 2016 compared to 2014
Source: (PwC, 2016).
To divide this value into geographies, we have to look at the table below which depicts rate of
economic crime in various geographies.
Table 7: Economic Crime survey 2016
Region
Reported economic crime in 2016
Reported economic crime in 2014
Africa
57 percent
50percent
Western Europe
40 percent
35 percent
North America
37 percent
41 percent
Eastern Europe
33 percent
39 percent
Asia Pacific
30 percent
32 percent
Latin America
28 percent
35 percent
Middle East
25 percent
21 percent
Global
36 percent
37 percent
Source: (PwC, 2016)
The 2016 Global Economic Crime Survey 2016 conducted by PWC further outlines 14 different types
of economic crime experienced. The leaders in this category are asset misappropriation, cybercrime
and bribery & corruption. Two out of these three categories saw decrease in 2014 rates vs. 2016 rates.
Asset misappropriation category, often considered as the easiest kind of fraud to be detected, forms
64% of all economic crimes (69% in 2014). Decrease could be the result of tightening of organisation
internal controls. This could, as well, mean the shift from easier to detect crimes to more advanced IT
related crimes. This theory is supported by the fact that only economic crime category showing a
significant increase is the cybercrime category, which has now become no. 2 among all economic
crime categories. Its rate in 2014 was 24%, compared to current amount of 32% we have seen 8%
increase during period of two years. Another economic crime categories have been marked with a
decrease from 2014 to 2016: Bribery & corruption (27% in 2014 vs. 24% in 2016), Procurement fraud
(29% in 2014 vs. 23% in 2016), Accounting fraud (22% in 2014 vs. 18% in 2016) and HR fraud (15%
in 2014 vs. 12% in 2016) all have experienced declining trend. Money laundering category has been
244
unchanged through the analyzed period – 11% in 2014 and 2016 respectively. Less experienced
economic crime categories include IP infringement (8% in 2014 vs. 7% in 2016), insider trading (4%
in 2014 vs. 7% in 2016), tax fraud (steady 6% in 2014, and 2016 respectively), mortgage fraud (7% in
2014 vs. 6% in 2016), competition/ anti-trust law infringement (5% in 2014 vs. 4% in 2016),
espionage (3% in 2014 vs. 2% in 2016) and other uncategorized crimes (14% in 2014 vs. 11% in
2016).
Graph 1 below depicts trend of selected economic crime categories in 2016, 2014 and in 2011 (in such
an order they are in the brackets) with the asset misappropriation declining (64%, 69%, 72%) as a
crime leader followed by growing cyber crime ( 32%, 24%, 23%) and corruption and bribery (24%,
27%, 24%) crime closing the first three most frequently occurring crimes globally, pursued by
procurement fraud (not included in which has appeared, growing fast, in 2011 not measured at all,
(29%, 23%, - ) which is an action of not allowed lobbying and bribing authorities in order to get a state
order, followed by accounting fraud (18%, 22%, 6%), human resource fraud (12%, 15%,-) and money
laundering ( 11%, 11%, -).
Graf 1: Economic Crime Survey in 2011,2014,2016
8 Conclusion
Doubtlessly financial information from the financial statements and annual reports is very important
and valuable for the investment and credit decisions, for assessing the company’s performance and
performance of its managers. Incentives to manage income to meet earnings targets or to present
earnings looking less risky can put aside good business practices. A company’s accounting policy (e.g.
revenue recognition policy) may enable flexibility of accruing or deferring recognition of revenues,
expenses, gains or losses. Managements and accountants can “benefit from” this flexibility, but
deliberate action involving the timing of revenue recognition (and also of expenses) can complicate
the comparisons between the firms and tempts the management to engage in income smoothing (i.e.
attempts to avoid reporting peaks and troughs in revenue and /or income which the manager or
accountant thinks might give an alarming signal to financial markets). It is obvious this erodes the
quality of earnings and the quality of financial reporting. But accountants or managers are aware that
existing warning signals and indicators serve as a supporting instrument to assist in revealing practices
that may be detrimental to the organisations.
245
References
Aarens, A.A., Elder, R.J.,Beasley, M.S. 2003. ‘Essential of Auditing and Assurance Service’. Upper
Saddle River: NJ, ISBN 0-13-046303-5
Davia, H.R., Coggins, P.C.,Wideman, J.C., Kastantin, J.T. 1992. ‘Management Accountant’s Guide to
Fraud Discovery and Control’. John Wiley and Sons, Inc.: ISBN 0-471-55595-9
Chaline, E.2008. ‘Ancient Greece: Athens and Its Environs’. New York, NY: Metro Books,
Giroux, G. 2014. Accounting Fraud: Maneuvering and Manipulation Past and Present,
Business Expert Press: ISBN: 13-978-1-60649-628-2
Gupta, K. 2005. ‘Contemporary auditing’, Tata McGraw-Hill Publishing Company:
ISBN 0-07-058584-9
Gray, I., Stuart,M.: (2011).The Audit Process-principles, Practice and Cases. Cengage Learning
EMEA, Hampshire, ISBN - 978-1-40803049-3
Jones, M. 2011. ‘Creative Accounting, Fraud and International Accounting Scandals’. John
Wiley & Sons Inc.: ISBN: 978-0-470-05765-0
Kwok, B.K.B. 2005. ‘Accounting Irregularities in Financial Statements’. Gower Publishing
Limited: ISBN 0-566-08621-2
O’Regan, P. 2016. ‘Financial Information Analysis.’Routledge: Francis and Taylor Group: NY and
London. ISBN 978-0-415-69584-8
Penman, S.H. 2009. Financial Statement Analysis and Security Valuation. McGraw-Hill/Irwin.
Saxunová, D. 2014. ‚Financial statements under the us GAAP and IFRS: Theory, concepts, problems
of financial accounting.‘ - 1. vyd. - Praha: Wolters Kluwer, - 190 s. ISBN 978-80-7478-646-4
Saxunová, D. 2008. How to read the information of the financial statements. (Ako správne rozumieť
informáciám z účtovnej závierky) : Rozdiely a podobnosti v USA a v SR. - 1. vyd. -
Bratislava:Wolters Kluwer ( Iura Edition), - 210 s.
Saxunová, D., Bartková, A. 2004. ‘A New Challenge for Corporate Leaders, Managers, Accountants
and Auditors’ . In: Business Opportunities in Slovakia and Central Europe. - Bratislava: Wolters
Kluwer (Iura Edition): Bratislava, - S. 129-172. - ISBN 80-8078-056-0
Young, M. 2013. ‘Financial Fraud Prevention and Detection’. John Wiley & Sons Inc.:ISBN
978-1-118-61763-2
ACFE .2008. ‘2008 Report to the Nation on Occupational Fraud & Abuse’. available at:
http://www.acfe.com/uploadedFiles/ACFE_Website/Content/documents/2008-rttn.pdf
Beasley M S, Carcello J V, Hermanson D R. 1999. ‘文章’. Fraudulent financial reporting,
1987~1997: an analysis of US public companies . American Institute of Certified Public
Accountants,1999:1- 67. Retrieved September 30, 2016, from
http://www.oalib.com/references/17402626
Gherai, D.S. Balaciu D. 2011. ‘From Creative Accounting Practices and Enron Phenomenon
to the Current Financial Crisis ..." Accessed September 30, 2016.
http://www.oeconomica.uab.ro/upload/lucrari/1320111/03.pdf.
Mulford, Ch. Comiskey E.2002. ‘Financial numbers game detecting.’ Retrieved September 30, 2016,
from https://www.coursehero.com/file/p3dta0k/CharlesW-Mulford-Eugene-E- Comiskey2002-the-
financial-numbers-game-detecting/
Ramos, M. 2006. ‘Practitioner’s Guide to GAAS’. John Wiley & Sons Inc.: ISBN 978-
1118734032
Růčková, P. 2011. ‘Finanční analýza : metody, ukazatele, využití v praxi,’ 4. rozšírené vydanie. Praha:
Grada Publishing, 2011, S. 143
Balaciu, E. D., Bogdan, V., Mester, T. I., Gherai, D. 2012. ‘Empirical Evidences of Romanian
Auditors’ Behavior Regarding Creative Accounting Practice. In: Accounting and Management
Information Systems, Vol. 11, No. 2, 2012, s. 238
Boškin Šimunaci, T. 2005. Does the global transition imply creativity in the accounting. In: Managing
the Process of Globalisation in New and Upcoming EU Members. Koper : Faculty of
246
Management, S. 379
Brazel, J.F., Carpenter T.D.,Jenkins J.G. 2010. ‘Auditors’Use of Brainstorming in the Consideration
of Fraud: Reports from the Field.’. The Accounting Review, Vol.85.No.4, 2010, pp.1273-1301
Blidisel, R., Stirbu, D., Moraru, M., Forcane, N., Popa,A. 2009. ‘Fraud and Error’. Auditors’
Responsibility Levels., In: Annales Universitatis Apulensis Series Oeconomica, 11 (1), 2009.
pp.54-64
Bunget, O.C. 2009. ‘The role of financial auditor in detecting and reporting fraud and error’. available
at: http://mpra.ub.uni-muenchen.de/12888/MPRAPaper No.12888, posted 20.january 2009
Corporate governance: 2005. “Commissioner McCreevy outlines his views to European Forum”,
IP/05/78, January 20, 2005 , available at
http://europa.eu.int/rapid/pressReleasesAction.do?reference=IP/05/78&format=HTML&aged=0&l
anguage=EN&guiLanguage=en
ACFE, AICPA: (2010) http://www.Managing the business Risk of Fraud, Practical Guide
"Global Economic Crime Survey 2016." Global Economic Crime Survey 2016. Accessed September
30, 2016. https://www.pwcresearch.com/uc/GECS2016.
KPMG. 2005. ‘Forensic. Malaysia. Fraud survey 2004, report’. Kuala Lumpur: KPMG
Saxunová, D.,Bartková, A. 2005. ‘A New Challenge for the Corporate Leaders, Managers,
Accountants and Auditors in the Times of "Enrons Ghosts"’. In: Global Business and Economic
Development. - Montclair : Montclair State University, S. 1828- 1850.
ISBN 978-0-9747415-4-3
Saxunová, D. 2012.’Investigation of suspected fraud’.In: International Journal of Business and
Management Studies - Vol.1, No. 2 (2012), s. 347-364 [CD-ROM]
247
