Identifying Financial Statement Fraud | Huntersure

Identifying Financial Statement Fraud

Posted on: July 30, 2020 by Huntersure LLC.

In the late-1990s and early-2000s, major corporations found themselves setting up the foundation for the United States’ economic recession in 2008. How? Through such actions as financial statement fraud, a deceptive method where financial information of a company is misrepresented, resulting in unauthorized benefits to the company or individuals within it.

Most notably, corporations such as Enron and WorldCom, once titans in the business world, had to disband and undergo criminal investigations due partly to financial statement fraud, becoming the most prominent corporate fraud cases in American history.

With this in mind, it’s important for financial professionals, such as accountants, to learn how to identify financial statement fraud and report it.

What Does Financial Statement Fraud Look Like?

Financial statement fraud comes in many different forms, including:

  • Overstating revenues by recording future potential sales
  • Inflating an asset’s net worth by knowingly failing to apply an appropriate depreciation schedule
  • Hiding obligations/liabilities from a company’s financial balance sheet
  • Incorrectly disclosing related-party transactions and structured finance deals

Another kind of financial statement fraud includes certain accounting practices, where firms understate revenues in one accounting period and maintain them as a reserve for the future with worse performance. This is done to temper the facade of volatility.

What Are Some Financial Statement Fraud Red Flags?

Financial statement red flags can point to potentially fraudulent practices. The most common red flags include:

  • Accounting anomalies, including growing revenues without a corresponding growth in cash flows.
  • Consistent sales growth while competitors in the same industry are struggling.
  • Weak internal corporate governance, which can turn into the likelihood of financial statement fraud going unnoticed or unchecked.
  • The sudden replacement of an auditor resulting in missing documents.
  • Depreciation methods and estimates of assets’ useful life that don’t relate to those of the overall industry.

Protecting Against Financial Statement Fraud Claims

The majority of corporate fraud cases include accounting schemes designed to deceive investors, analysts, and auditors about the true financial condition of a corporation or business. But while those in a company who are responsible for this kind of fraud are trying to keep their crimes away from external sources, they can also be putting those on the inside in harm’s way, legally speaking.

This includes accountants whose job it is to keep balance sheets transparent. If statement fraud claims are leveled against a company, accountants who are not responsible should be sure to protect their livelihoods by not only proving they were not involved but also obtaining Accountant liability coverage. Accountant liability insurance can help protect accountants who find themselves in legal situations related to financial fraud or negligence. Having this coverage can help to pay for damages or legal fees related to proving their innocence in a financial statement fraud case.

How to Detect Financial Statement Fraud

Red flags can help accountants spot financial statement fraud. But there are other methods that can target it more directly. Vertical analysis, for example, involves taking every item in an income statement as a percentage of revenue and comparing the trends of year-over-year statistics that could be a potential cause for concern.

A similar approach can also be used and applied to the balance sheet, using a company’s total assets as a benchmark to help monitor any major deviations from regular business activity. This is similar to horizontal analysis, which involves having an account serve as the point of reference and financial information is represented as a fraction of the years’ figures.

For comparative ratio analysis, analysts, auditors, and accountants alike can spot accounting irregularities. By analyzing certain ratios, information of day’s sales and other important metrics can be determined and looked over for any inconsistencies.

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