MLR

Financial statement fraud – a rare but costly scheme

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Although only 9 percent of occupational fraud cases involve financial statement fraud, organizations may find the financial impact of this fraud classification surprising and troubling.

executive in handcuffs

The median loss from financial statement fraud was $1 million among the nearly 1,500 cases of occupational fraud investigated by Certified Fraud Examiners and analyzed in the Association of Certified Fraud Examiners’ 2014 Report to the Nations on Occupational Fraud and Abuse.

Financial statement fraud is one of three main occupational fraud classifications. The others are asset misappropriations and corruption.

The Report to the Nations defines financial statement fraud as a scheme involving one or more employees who “intentionally” cause “a misstatement or omission of material information in the organization’s financial reports.” It breaks down financial statement fraud into two broad categories, asset/revenue overstatements and asset/revenue understatements.

Overstatements include timing differences, fictitious revenues, concealed liabilities and expenses, improper asset valuations, and improper disclosures. Understatements include timing differences, understated revenues, overstated liabilities and expenses, and improper asset valuations.

Organizations should be aware that perpetrators of fraud often combine more than one scheme. When considering financial statement fraud, the ACFE report reveals that almost 76 percent of cases involve another form of occupational fraud, with slightly more than 51 percent of such schemes combined with corruption.

Another disturbing statistic in the report is the length of time before detection of a financial statement fraud. In both the 2012 and 2014 biannual reports, from the time a financial statement fraud was committed until it was discovered was 24 months. The median duration until detection for all types of frauds was 18 months.

By industry, financial statement fraud occurs most frequently in manufacturing companies (13.8 percent), followed by oil and gas companies (12.2 percent). The list below provides additional industries in order of frequency:

  • Construction – 11.6 percent
  • Transportation and warehousing – 10.4 percent
  • Banking and financial services – 10.2 percent
  • Education – 10 percent
  • Health care – 8 percent
  • Religious, charitable or social services – 7.5 percent
  • Services (other) – 6.7 percent
  • Retail – 6.5 percent
  • Government and public administration – 5 percent
  • Insurance – 3.2 percent

Within organizations, executives and members of upper management were by far the most frequent perpetrators of financial statement fraud, seen in 26.3 percent of cases, the report said. Other departments are listed below in order of frequency:

  • Finance – 17.4 percent
  • Sales – 9.6 percent
  • Accounting – 8.3 percent
  • Operations – 4.9 percent
  • Purchasing – 4.2 percent

When trying to prevent financial statement fraud specifically, organizations should watch for certain behaviors that can be considered red flags, according to the ACFE. In general, perpetrators of this classification of fraud are “more likely to be under excessive organizational pressure compared to those who engaged in corruption or asset misappropriation.”

Employees who are participating in financial statement fraud are most likely to exhibit the following warning signs:

  • Living beyond their means
  • Having control issues; an unwillingness to share duties
  • Experiencing excessive pressure from within the organization
  • Showing a “wheeler-dealer” attitude
  • Having financial difficulties

Another aspect of the report’s fraud overview shows that almost 11 percent of the fraud cases perpetrated by men were financial statement fraud. Women participated in this type of fraud in only 6 percent of the cases. The study found no obvious reason for the disparity between genders.

Women involved in financial statement fraud exhibit the same red flags as those listed above, with the addition of divorce or family problems as another important warning sign. Having financial difficulties was a more significant behavioral red flag for women (43.5 percent of cases) than for men (27.4 percent of cases). But women were far less likely than men to have a wheeler-dealer attitude – 10.2 percent of cases compared to 22.7 percent.