News
Financial Deceit and Fraud in the Preparation of Financial Statements and Reports
26-Oct-2021
By: Dr. Hussam Addin Ahmad Khalil – IASCA Member
Managements of companies are responsible for the preparation of financial statements and the disclosure of their contents. However, some managements in some companies manipulate or commit fraudulent activities while using the accounting standards (IFRS). Moreover, the managements in some companies do manipulate regarding the understanding of the application of accounting standards or policies, or sometimes they use fabricated accounting methods (false ones) to prepare the financial statements of companies. Such managements adopt such methods and defend them.
However, the manipulation of financial reports or financial statements allows managers, companies, or senior managers to present a false and unrealistic picture of the financial position of their companies (i.e., presenting a false position instead of the real one in the company’s financial statements).
Financial and administrative corruption, in the managements of giant companies, banks, and stock markets, has become the feature of this era. All countries were affected, the developed, the poor, whether, in the West or the East, all suffered from corruption. However, in the industrial developed countries, corruption took a legal form based on the legislative loopholes that characterized the pre-financial crisis period, when those countries witnessed booms, profits, stock and bond exchanges, along with the establishment of new companies...etc.
In this article, we address some types of fraud, but not exhaustively.
Types of Fraud
Employee Fraud
In general, employee fraud is about embezzlement and theft of the company’s funds, accompanied by making intentional errors in the accounting journals and the entries of the accounting records by those who are responsible for such activities in order to disguise the thefts and embezzlements. Of course, all business entities rely on the robustness and strength of their internal control systems, as they use these systems to reduce potentially fraudulent activities. Therefore, the external audit function is highly dependent on the assessment of internal controls, which were developed by the employees of the entity and tailored to match the nature of the business. External auditors should determine the weak points in internal control systems, and report them to managements; the outcomes of the evaluation process will be used as a basis to the audit plan that should be implemented in the entity. Moreover, it is expected that the auditor will detect the fraudulent activities out of her/his experience and professional skills, and this requires the auditor to be aware of the methods of fraud. In addition, auditors should maintain professional skepticism while performing their jobs as auditors. Many large and medium-sized companies have established internal audit departments associated with managements to audit the accounting procedures that are carried out in companies on a timely basis, and to maintain the application of the internal control system related to documentary accounting procedures, and inform the senior management of any breaches of these policies and procedures. This has led to the reduction of the employee fraud.
The Jordanian market has witnessed the emergence of some professional companies that perform internal auditing for medium-sized and small companies, depending on their skilled cadres to carry out this job. These trained and skilled cadres are directly connected to managements or owners, as they can report to them directly and discuss the breaches or the recommendations about the development of accounting policies and the appropriate application methods of such policies. For example, many companies merge the cashier and the accountant professions, which gives the accountant the opportunity to enter the records and receive cash without supervision. This often leads to a shortage of cash on the part of the accountant, as the accountant is the one who receives, records, and makes banks and cash settlements.
On the other hand, many companies assign the jobs of selling and cash collection to one person, which often leads to hiding collected amounts from management for long periods.
Moreover, the absence of companies’ control over inventory, and their reliance on periodic count of inventory without having class cards and documents that prove the output, input, and the receipt of goods along with the absence of the methods to dully conforming the goods received from suppliers, will eventually lead to intended shortage in goods by the employees of the company (goods theft).
I will address in successive articles the manipulation of financial statements. The following list includes some forms of embezzlement and manipulation by employees:-
Cash embezzlement
The embezzlement of cash is committed in several ways, including:
• Embezzlement of cash sales value.
• Embezzlement of customer collections.
• Recognition of fictitious purchase invoices.
• Manipulation of payrolls (wages and salaries).
• Falsification of cash exchange documents or petty cash.
The following is a brief explanation of the forms of this embezzlement:
• Embezzlement of cash sales value.
A salesperson sells goods for cash and debits them at the expense of a customer whom the salesperson selects for a certain period, then the salesperson uses the cash and proceeds of sales, and does not add them to the company’s fund for a period to be determined by the salesperson.
A salesperson sells a commodity at a certain price and records its value on the invoices at a price lower than the recorded selling price, then he/she keeps the difference between the two prices for her/his benefit.
A salesperson sells goods with a bonus, recognizes the bonus on invoices, does not deliver the bonus totally or partially, and seizes the difference, and sells it illegally.
• Embezzlement of customer collections.
This embezzlement takes many forms, including:-
(1) Recognition of the misappropriated amount in the form of an allowable deduction:
This means that the amount paid by the customer will not be recorded in the cash journal, either totally and/or partially, and that the amount will not be added to the company’s fund, as it will be embezzled, and the balance of the customer's debit account will be settled as if the customer was granted an allowable discount in the value of that balance, for example:
In a company that sells electrical appliances, a client’s receivables account amounts to (JD10000), the salesperson or the collector performs the following:
Informs the management that the client has paid JD8000, and considers that the client’s receivable account is settled to zero, and because the client is not aware of such things, the collector goes, collects the cash, and issues a false receipt voucher to the client using one of the following methods:-
• A printed receipt voucher.
• A master receipt voucher from the company, originated by the accountant, the first copy, with a value of JD10000, and the second copy, with a value of JD8000.
• A cash receipt voucher on a letterhead from the company.
• The difference will be entered as an allowable deduction.
(2) Recognition of the embezzled amount in the form of bad debt.
This means that the amount paid by the customer will not be recorded in the cash journal, and will not be added to the company’s fund, as it will be embezzled, and the balance of the customer's debit account will be settled as a bad debit. The following is another accounting treatment (manipulation), for example:
The accounting records of a food distribution company showed that the customer, Abd Rabbo al-Mahmoudi, owed JD1,500 to the company. Since the administration demanded to focus on collecting the customer’s debts, the collection officer conducted the collection process and informed the administration that the customer had moved from his place and that he cannot be found. By creating a fake story to the management, and claiming that this amount was considered bad debts, the necessary accounting entry was made to consider that the payable amount is a bad debt, while the collected amount is in the hands of the embezzler collector. (It is worth noting that the Income Tax Law does not consider bad debts an expense to produce income except in clear conditions stipulated in the law).
(3) Recognition of the embezzled amount in the form of fictitious returns of sold goods.
This means that the amount paid by the customer will not be recorded in the cash journal, and will not be added to the company’s fund, as it will be embezzled, and the balance of the customer's debit account will be settled as if the customer has returned the goods to the company.
Sometimes the accountant is (manipulative even with words), as he/she records an amount as returns of sold goods, and/or on the debit side of sales so that no number appears under the sales returns item. However, this account may attract the attention of the auditor or tax estimator, if it was relatively significant to sales, and in this case, the account will be meticulously investigated.
(4) Using split payments to settle embezzled customer collections.
In this case, the embezzler settles the due balance of a client, whose payments were embezzled, by using the amounts collected from other clients. The embezzler frequently repeats this activity, for example, he/she receives from a client an amount of JD1000 and embezzles this amount, and on another day, he/she embezzles another JD2000 from another client, the accountant prepares a receipt voucher for the client from which he collected JD1000, and prepares a voucher for an amount of JD1000 for the client whom he previously stole, and so on.
(5) Recognition of fictitious purchase invoices.
When collusion occurs between the employees of an entity and one of the suppliers, the embezzlement of cash, in this case, is committed by proving fictitious purchase invoices or amounts more than the value of the goods received from the suppliers, or through double recording of purchase invoices. Those transactions result in showing the supplier’s account with an amount higher than the actual one, and when settling the account of the supplier, the difference is embezzled as follows:
This case is very common in practical life, where in general the procurement representative in the private sector or the representative of the ministries in the public sector, purchases for the benefit of the ministry or to the company in which he/she works (companies that have a special procurement representative). The representative makes an agreement to buy materials, for example, the purchase price of a ton of a substance is JD (500), but the representative persuades the supplier (weak and complicit) to write that the selling price of one ton is JD (700). The representative stipulates that the payment be in cash or check, and even if the payment is done by check, it should be written to the first beneficiary only. Then, the representative completes the process and pays the supplier JD500, to be accounted for with the supplier in the event that the payment was made by check, the representative takes the difference of JD200 to his/her benefit and the benefit of those who helped in this illegal action.
In a case that involves payment of a commission, where the focus is on one supplier, and the representative agrees with the supplier on a commission on each invoice, here the representative claims to the company that this supplier is the right supplier who supplies the goods according to the rules.
Another case is where the inventory officer agrees with the supplier that the quantity purchased on the invoice will be different from the quantity delivered to the company; the difference is handled with the process of destruction, etc.
(6) Payroll manipulation:
Payroll manipulation is conducted by adding fake names of employees in the payrolls using higher wage categories and embezzling the corresponding amounts.
This action was possible to be done before the application of social security to all operating companies and institutions, everyone who worked in a regulated institution for consecutive 16 days should be subject to social security.
The manipulation includes the following:
Adding fictitious overtime hours, which are calculated, but the amounts of which are not delivered to employees, and the employee signs to receive all his/her dues for working for a certain month on a salary slip separate from the payroll.... etc.
Not calculating employee deductions, absence days, and so on.
Not deducting advance amounts and deductions from the employee, in the payroll, and deducting them upon delivery of the monthly salary, to embezzle them for long periods, and pay them at intervals.
Adding the names of workers in the payroll, especially in construction companies, under the heading of daily workers, for short and different periods, not exceeding sixteen consecutive days.
(7) Falsification of cash exchange documents or petty cash.
The investigator can discover the embezzlement related to this item by comparing the exchange documents vs what is registered in the petty cash journal, after examining the documents themselves and making sure that they are correct in form and substance.
However, regarding some small petty cash expenditures for which there are no supporting documents, the investigator must obtain an approval from the competent authority for such amounts. In the first place, the investigator should count the remaining balance of the advance amount and reconcile the balance with the exchange documents and the origin of the advance payment, and make a report of the count outcome.
Such manipulation can be done in one of the following ways:
Disbursement of previously paid bills.
Manipulating the value of the invoices after they get approved by the authorized person for exchange.