Accountants: Detecting Financial Statement Fraud

Posted on: April 7, 2022 by Huntersure

Business owners place their trust in accountants to keep track of the financial health of their businesses, prepare taxes and help them make sound financial decisions. However, sometimes businesses engage in fraudulent accounting practices to make their financial picture appear different than it is. Accountants whose errors or negligence result in financial statement fraud that causes harm to a company or a company’s customers or shareholders may be liable for damages. Accountant professional liability insurance protects accounting firms from financial loss caused by this liability. 

What Financial Statement Fraud Is

According to the Association of Certified Fraud Examiners, accounting fraud is an act of misrepresentation or deception that a person or entity intentionally engages in that could benefit that person, entity or a third party. Most of the time, financial statement fraud involves changing financial statements in a way that makes a company seem more profitable than it is.

Kinds of Financial Statement Fraud

There are several kinds of financial statement fraud:

• Recording expected sales to overstate revenues
• Concealing liabilities on a company’s balance sheet
• Inappropriately applying depreciation to increase an asset’s net worth
• Disclosing structured finance deals and related-party transactions inappropriately

How To Detect Financial Statement Fraud

The key to detecting financial statement fraud is to know what to look for when reviewing financial statements. Several red flags may indicate fraud:

• Accounting anomalies
• An unusual increase in financial performance
• Inadequate internal corporate governance
• A company suddenly replaces an auditor
• Sales growth at a time when competitors are struggling
• Depreciation methods that vary from industry standards

Additionally, an unusual number of complicated third-party transactions or company incentives that encourage management fraud can also signal a problem.

How To Spot Red Flags

The two main methods of discovering red flags are horizontal and vertical analysis of financial statements. Horizontal analysis involves converting financial information into a percentage of the figures reported in a specific base year and looking for unusual changes. Vertical analysis is similar but focuses on comparing each item on an income statement as a percentage of revenue and comparing it to yearly trends.

Auditors may also use comparative ratio analysis to find inconsistencies in financial metrics that may indicate fraud. Auditors commonly use the Beneish Model to evaluate ratios, such as gross margin, asset quality, leverage and depreciation. They use the model to calculate a score that indicates whether there is a likelihood of manipulation that warrants further investigation.

The Role of Accountant Professional Liability Insurance

Accountants are often responsible for reviewing financial statements for fraudulent activity. An accountant who fails to detect fraud because of negligence or errors may be liable for damages that result. Accountant professional liability insurance provides financial protection for accountants and accounting firms in these scenarios.

About Huntersure

Huntersure LLC is a full-service Managing General Agency that has provided insurance program administration for professional liability products to our partners across the United States since 2007. We specialize in providing insurance solutions for businesses of all sizes. Our program features can cover small firms (grossing $2.5 million annually) to large corporations (grossing $25 million annually or more). We make doing business with us easy with our breadth and depth of knowledge of E&O insurance, our proprietary underwriting system that allows for responsive quoting, binding and policy issuance and tailored products to meet the needs of your insureds. Give us a call at (855) 585-6255 to learn more.

Posted in: Accounting