As we approach the end of the calendar year for all organizations, and fiscal year for many, it’s a great time to commit to a resolution to prevent or detect financial statement fraud in the new year.
According to the Association of Certified Fraud Examiners 2022 Report to the Nations, financial statement fraud schemes were the least common of the three primary categories of occupational fraud, accounting for approximately 9% of all cases. But they’re the costliest of the schemes, with a median loss of approximately $593,000 per case.
Financial statement fraud is a deliberate alteration of a company’s financial statements in an attempt to mislead users of the financial information. Some common manipulations of earnings include:
- Recording revenue too soon
- An example would be recording future expected sales or uncertain sales, thus creating a false picture that may inflate a company’s share price
- Shifting expenses between periods
- This can cause a company’s net income to be exaggerated and costs to be understated, creating a false impression of net income
- Recording fictitious revenue
- Examples include double-counting sales, creating false customers, or even altering legitimate invoices of current customers
A unique aspect of financial statement fraud is the need to “correct” or “continue” the manipulation in the new year or subsequent period through journal entries, so it’s important for financial professionals to review entries early in the new year for odd or unusual items related to the prior year. Numerous red flags or warning signs that can help recognize financial statement fraud include:
- A spike in earnings or performance before the end of the fiscal year or period
- Increasing revenue while cash flow remains static
- Missing or altered documents
- Unexplained journal entries
When attempting to prevent financial statement fraud, it’s better to set up anti-fraud controls early to minimize the potential risk. For example, strong internal controls are a must, especially when it comes to segregation of duties. Segregation of duties related to journal entries, for instance, entails having more than one person be involved in the preparation, documentation, processing, review and authorization of significant entries, and subsequent review of the process by others, including internal audit.
Remember that even though financial statement fraud is the least common of the three primary categories, internal controls are still important because of how costly fraud can be. It’s an important resolution to prevent and detect financial statement fraud by recognizing those red flags as we head into the new year.
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