Methods of committing fraud in financial statements
The main method of fraud in financial statements is overstating assets and income or understating liabilities and expenses. Of course, sometimes the opposite of the mentioned cases occurs; That is, by understating assets or income and overstating liabilities or expenses, fraud occurs in financial statements.
In general, there are five common ways to commit financial statement fraud.
Registration of fictitious income: This means that goods or services are not provided, but the accounts receivable books are debited and income is credited. Examples include fake customers and fake sales. This type of fraud will increase assets and ultimately exaggerate (show more than actually) profit, and it is the most common type of financial statement fraud.
Incorrect assessment of assets: examples of this method include exaggeration of current assets, such as manipulation of inventory accounts. By exaggerating the balance at the end of the period, the cost of goods sold is reduced and finally the profit is reported higher than the actual one. Another is misvaluing assets and capitalizing research and development expenses instead of expenseing them. Also, not recording the cost of depreciation of tangible and intangible assets, exaggerating assets at the time of acquisition and merger, showing assets in financial statements, while those assets are not actually owned by the unit, are among other things that be able to name
Major elimination of debts and expenses: This is done in order to better show the financial situation; Such as not recording accounts payable and other debts, recording unrealized income and profits, and not considering legal liabilities, Enron has used this method in its financial statement fraud.
Inadequate disclosure: not disclosing changes in accounting procedures and violations of accounting principles or any other significant information that, if disclosed, affects the results of financial statements and users’ decisions. Other examples include misrepresenting the nature of a company’s performance, misrepresenting management decisions, and not adequately disclosing them.
Incorrect use of time difference: In this method, incomes of the next period are recognized in the current period and, on the other hand, the expenses of the current period are transferred to the next period or periods. Because this phenomenon causes the loss of results, normal operations and performance of the mentioned companies. This type of financial scandal, which has caused doubt in the capital market, has in some cases led to a decrease in the trust of the capital market and its activists in the information of financial reports and has finally caused the emergence of markets with poor efficiency. On the other hand, with every fraud that takes place, the reliability, quality, transparency, and integrity of the financial reporting process are weakened, and the accounting and auditing professions are put under pressure; So that the integrity and impartiality of the auditing profession is damaged (especially auditors and auditing institutions) and public trust and confidence in the auditing and accounting profession is lost.