Forensic Accounting
Content
CONCEPT OF FORENSIC ACCOUNTING: INTRO TO FORENSIC ACCOUNTING: The
integration of accounting, auditing and investigative si!!s "ie!ds the s#ecia!t" no$n as Forensic Accounting% &Forensic& 'eans &suita(!e for use in a court of !a$&% Foren orensi sic c ac acco coun unti ting ng is the s#ec s#ecia ia!t !t" " #r #rac acti tice ce area area of accountanc" that descri(es engage'ents that resu!t fro' actua! or antici#ated dis#utes or !itigation% Foren orensic sic ac acco count unting ing is the the a# a##!i #!ica cati tion on of a s#eci s# ecia!i a!i)e )ed d n no$ o$!ed !edge ge an and d s# s#eci eci*c *c si! si!!s !s to act act u#on u#on th the e evidence of fraudu!ent econo'ic transactions% Foren orensi sic c Acc ccou ount ntin ing g uti! uti!i) i)es es acco accoun unti ting ng,, audi auditi ting ng,, and and inve in vest stig igat ativ ive e s si! i!!s !s to co cond nduc uctt an e+a' +a'in inat atio ion n into into a co'#an #an"s *nanc nciia! state'e e'ents% Thus it #r #ro ovide des s an accounting ana!"sis that is suita(!e for court%
OT-ER TER.INO/OG0: FORENSIC IN1ESTIGA IN1ESTIGATION: TION: The uti!i)ation uti!i )ation of s#ecia!i)ed investigative si! si!!s !s in carr"ing out an in2uir" conducted in such a 'anner that the outco'e $i!! have a##!ication to a court of !a$% A Forensic Investigation 'a" (e ground gr ounded ed in acc account ounting, ing, 'ed 'edicin icine, e, engineer engineering ing or so' so'e e oth other er disci#!ine% FORENSIC AU3IT An e+a'ination of evidence regarding an assertion to deter'ine its corres#ondence to esta(!ish criteria carried out in a 'anner suita(!e to the court% An e+a'#!e $ou!d (e a Forensic Audit of sa!es records to deter'ine the 2uantu' of rent o$ing under a !ease agree'ent, $hich is the su(4ect of !itigation%
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A For orens ensic ic Acco Account untan antt is of ofte ten n ret etain ained ed to an ana!" a!"se se,, inte inter# r#rret et,, su''ari)e and #resent co'#!e+ *nancia! and (usiness re!ated issues in a 'anner $hich is (oth understanda(!e and #ro#er!" su##orted% Foren orensi sic c Accou ccount ntan ants ts can can (e en enga gage ged d in #u(! #u(!ic ic #r #rac acti tice ce or e'#!o #!o"ed (" insur ura ance co'#anie ies s, (an (ans, #o!ice ice forces ces, govern'ent agencies and other organi)ations% Investigative Accounting : 5I6 Investigating and ana!"sing *nancia! evide ev idence nce%% 5II6 5II6 Rev evie$ ie$ of the the fa fact ctua ua!! situa situatio tion n and #rov #rovis isio ion n of suggestions regarding #ossi(!e courses of action% 5III6 Assistance $ith the #rotection and recover" of assets% 5I16Co7ordination of other e+#erts, inc!uding: Private investigators, Forensic docu'ent e+a'iners, Consu!ting engineers% 516 Assistance $ith the recover" of assets (" $a" of civi! action or cri'ina! #rosecution% /i /ittigat igatio ion n Su## Su##o ort : Ass ssis ista tanc nce e in o(tai (taini ning ng docu docu' 'en enta tati tion on necessar" to su##ort or refute a c!ai'% Revie$ of the re!e !ev vant docu cu' 'entation to for' an initia! ia! assess'ent of the case and identif" areas of !oss% Assis isttance $it ith h E+a'ina ination for for 3isc iscover" er" inc! nc!udi din ng the for' fo r'u!a u!ati tion on of 2ue 2uest stio ions ns to (e as as ed regard egardin ing g the the *n *nan ancia cia!! evidence% Atten ttenda danc nce e at the the E+ E+a' a'in inat atio ion n fo forr 3isc 3iscov over er,, to rev evie ie$ $ th the e testi'on", assist $ith understanding the *nancia! issues and to for'u!ate additiona! 2uestions to (e ased% Revie$ of the o##osing e+#erts da'ages re#ort and re#orting on (oth the strengths and $eanesses of the #ositions taen% Assistance $ith sett!e'ent discussions and negotiations% Attendance at tria! to hear the testi'on" of the o##osing e+#ert and to #rovide assistance $ith cross7e+a'ination%
Basic Accounting Principles and Guidelines Si n ceGAAPi sf o un de do nt h eb as i cac c ou nt i n gp r i n ci p l e sa ndgu i d el i n es ,wec anb et t e ru nd er s t a nd GAAP i fwe u nd er s t a nd t h os ea c c ou nt i n gp r i n c i p l e s .Th ef o l l o wi n gi sa l i s to ft h et e n ma i n ac c ount i ngpr i nc i pl esandgui del i nest oge t herwi t hah i gh l yc onden sede xpl anat i onofeac h. 1.Economi cEnt i t yAssumpt i on
2.Monet ar yUni tAssumpt i on
3.Ti mePer i odAssumpt i on
4.CostPr i nci pl e
5.Ful lDi scl osur ePr i nci pl e
6 .Goi ngConc e r nPr i nc i pl e
7 .Ma t c hi ngPr i nc i pl e
8 .Re v enueRe cogni t i onPr i nc i pl e
9.Mat er i al i t y
1 0.Cons er v at i s m
8hat is fraud : Fraud 'eans di9er ere ent things to di9 i9e erent #eo#!e under di9 i9e erent circu'stances% circu'st ances% For instance, fraud can (e #erceived as dece#tion% One 'ight sa" sa " that that fr frau aud d in th the e fo for' r' of inte intent ntio iona na!! de dece ce#t #tio ion n 5i 5inc nc!u !udi ding ng !" !"in ing g an and d cheating6% Fraud can a!so (e associated $ith in4ur"% One #erson can in4ure another either (" force or through fraud% The use of force to cause (odi!" in4ur" is fro$ned on (" 'ost organi)ed societies using fraud to cause *nancia! in4ur" to another does not a!$a"s carr" the sa'e degree of stig'a or #unish'ent% Fraud is a $ord that has 'an" de*nitions% So'e of the 'ore nota(!e ones are: Fraud as a cri'e% Fraud is a generic ter', and e'(races a!! the 'u!tifarious 'ean 'e ans s that that hu hu'a 'an n inge ingenu nuit it" " ca can n de devi vise se,, $h $hic ich h ar are e res esor orte ted d to (" on one e indi indivi vidu dua! a!,, to ge gett an ad adva vant ntag age e (" fa fa!s !se e 'e 'ean ans s or re# e#rres esen enta tati tion ons% s% No de*nite and invaria(!e ru!e can (e !aid do$n as a genera! #ro#osition in de*ning fraud, as it inc!udes sur#rise, tric, cunning, and unfair $a"s (" $hich another is cheated% Cor#orate fraud : Cor#orate fraud is an" fraud #er#etrated (", for, or against a (usiness cor#oration% .anage'ent fraud% .anage'ent fraud is the intentiona! 'isre#resentation of cor#orate or unit #erfor'ance !eve!s #er#etrated (" e'#!o"ees serving in 'an 'a nag age' e'en entt ro!es o!es $h $ho o se see e to (e (ene ne*t *t fr fro' o' su such ch fr frau auds ds in te terr's of #ro'otions, #ro'o tions, (onuses or other econo'ic incentives, and status s"'(o!s% /a"#erson;s de*nition of fraud% Fraud : as it is co''on!" understood toda", 'ean 'e ans s di dish shon ones est" t" in th the e for for' of an in inte tent ntio iona na!! de dece ce#t #tio ion n or a $i $i!f !fu! u! 'isre#resentation of a 'ateria! fact% /"ing, the $i!!fu! te!!ing of an untruth, and cheating, the gaining of an unfair or un4ust advantage over another, cou!d cou !d (e use used d to fur furthe therr de* de*ne ne the $ord fra fraud ud (ec (ecaus ause e the these se t$o $or $ords ds denote intention or $i!!ingness to deceive% ACFE;s ACFE; s de* de*nit nition ion of fra fraud ud : The As Assoc sociat iation ion of Cer Certi* ti*ed ed Frau raud d E+ E+a'i a'iner ners s 5ACFE6 de*nes <<occu#ationa! fraud and a(use;; 5e'#!o"ee frauds6 as: <<the use of one;s occu#ation for #ersona! gain through the de!i(erate 'isuse or theft of the e'#!o"ing organi)ation;s resou resources rces or assets%;; The ACFE de*nes *nanc *n ancia! ia! st state ate'en 'entt fra fraud ud as: <<the <<the de! de!i(er i(erate ate 'is 'isre re#r #rese esenta ntatio tion n of the *nancia! *nan cia! condi condition tion of an ente enter#ris r#rise e acco acco'#!is '#!ished hed thr through ough the inten intentiona tiona!!
'issta 'iss tate te'e 'ent nt or o' o'is issi sion on of a' a'ou ount nts s or di disc sc!o !osu surres in th the e *n *nan anci cia! a! state'ents in order to deceive *nancia! state'ent users%;
FRAU3 TRIANG/E
In orde orderr to #r #ro# o#er er!" !" #r #rev even ent, t, de dete tect ct,, an and d res es#o #ond nd to fr frau aud, d, an anti tifr frau aud d staeho!ders need to understand $h" fraudsters co''it a fraud% No 'ode! or fra'e$or has (een 'ore usefu! than Cresse";s Triang!e Triang!e in #roviding that understanding% <<Fraud Triang!e;; : In the =>?@s, 3ona!d Cresse" $as encouraged (" Ed$in Suther!and, $ho $as serving on his dissertation co''ittee, to use a thesis of $h" a #erson in a #osition of trust $ou!d (eco'e a vio!ator of that trust% Suther!and and Cresse" decided to intervie$ fraudsters $ho $ere convicted of e'(e))!e'ent% Cresse" intervie$ed a(out @@ e'(e))!ers in #rison% One of the 'a4or conc!usions of his e9orts $as that ever" fraud had three things in co''on: 5=6 #ressur #ressure e 5so'eti'es referred to as 'otivation, and usua!!" a <<non7 <<n on7sha share rea(! a(!e e nee need;; d;;6 6 56 rat ration iona!i a!i)at )ation ion 5of #er #erson sona! a! eth ethics ics6 6 and 5B6 no$!edge and o##ortunit" to co''it the cri'e% These three #oints are the corners of the fraud triang!e% OPPORTUNIT0
PRESSURE
RATIONA/ISATION
motivation) refers to so'ething Pr Pres essu surre : Pressure (or incentive, or motivation) that has ha##ened in the fraudster;s #ersona! !ife that creates a stressfu! need that 'otivates hi' to stea!% motivation centers Usua!!" that motivation centers on so'e *nancia! strain, (ut it cou!d (e the drug ug ha habi bitt or s"'# s" '#to to' ' of othe otherr t" t"#e #es s of #r #res essu surres es%% For e+ e+a' a'#! #!e, e, a dr gambling habit habit cou!d create great *nancia! need in order to sustain the ha(it and thus create the #ressure associated $ith this as#ect of the fraud incentive% triang!e% So'eti'es a fraudster *nds 'otivation in so'e other incentive% For instance, a!'ost a!! *nancia! state'ent frauds $ere 'otivated (" so'e
incentive incent ive,, usu usua!! a!!" " re!at re!ated ed to stock prices or performance bonuses or both%% So'eti'es an insatia(!e greed causes re!ative!" $ea!th" #eo#!e to both co''it frauds% competiti titive ve and econo economic mic surviv survival al,, $hat other e"ond e"o nd th the e rea ea!' !' of compe polit litica ical, l, su surv rviv ival al pr prov ovide ide 'otives #reci#itate fraudD Socia! and po incentives,, too, in the for' of egoce incentives egocentric ntric and ideolo ideological gical motiv motives es,, es#ecia!!" in *nancia! state'ent frauds% So'eti'es #eo#!e co''it fraud to aggrandi)e their egos, #ut on airs, or assu'e fa!se status% So'eti'es the" survive vive pol politi itical cally ly,, or hav have e a bur burnin ning g des desire ire for pow power er.. dece de ceiv ive e to sur The" !ie a(out their #ersona! vie$s or # #retend retend to (e!ieve $hen the" do not% Or the" the" si si'# '#!" !" ch chea eatt or !ie !ie to th thei eirr #o #o!i !iti tica ca!! o# o##o #one nent nts s or in inte tent ntio iona na!! !!" " 'isstate their o##onents; #ositions on issues% .otives .otive s to co' co''it 'it fraud in (us (usine iness ss usu usua!!" a!!" are rat ration iona!i a!i)ed )ed (" the o!d business , $hich is a'ora!, sa"ing that all is fair in love and war—and in business, an"$a"% There is one further categor" of 'otivation, ho$ever% It 'ight (e ca!! ca !!ed ed #s #s"c "cho hoti tic, c, (e (eca caus use e it ca cann nnot ot (e e+ e+#! #!ai aine ned d in ter ter's of rati ration ona! a! (ehavior%
Rationa!i)ation : .ost fraudsters do not have a cri'ina! record% In the ACFE Re#ort to the Nation 5RTTN6 @@,=@ >B #ercent of the re#orted fraudsters had no #rior cri'ina! convictions% In fact, $hite7co!!ar cri'ina!s usua!!" have a #ersona! code of ethics% It is not unco''on for a fraudster to (e re!igious% So ho$ do fraudsters 4ustif" actions that are o(4ective!" cri'ina!D The" si'#!" 4ustif" 4ustif" their cri'e under their cir circu'stances% cu'stances% F For or instance, 'an" $i!! stea! fro' e'#!o"ers (ut 'enta!!" convince the'se!ves that they will repay it 5i%e%, <<I a' 4ust (orro$ing the 'one";;6% Others (e!ieve it hurts no one so that 'aes the theft (enign% Sti!! others (e!ieve the" are entit!ed to the (ene*ts of the fraud and are si'#!" taing 'atters into their o$n hands to ad'inister fair treat'ent 5e%g%, the" deserve a raise or (etter treat'ent6% .an" .a n" ot othe herr e+ e+cu cuse ses s co cou! u!d d se serv rve e as a rati ration ona!i a!i)a )ati tion on,, in inc!u c!udi ding ng so so'e 'e (enevo!ent ones $here the fraudster does not actually keep the stolen funds or ass funds assets ets but use uses s the them m for soci social al pur purpos poses es 5e%g%, to fund an ani'a! c!inic for stra" ani'a!s6% O##ortuni O##ort unit" t" : Ac Accor cordin ding g to Cr Cress esse"; e";s s resea researc rch h 5i% 5i%e%, e%, the Frau raud d Tria riang! ng!e6, e6, opportunity to co''it the fraudsters a!$a"s have the the knowledge and opportunity fraud% The for'er is reected in no$n frauds, and in research studies such as the ACFE;s RTTNs that sho$ e'#!o"ees and 'anagers tend to have a !ong !ong te tenu nurre $i $ith th a co co'# '#an an" " $h $hen en th the" e" co co'' ''it it th the e fr frau aud% d% A si si'# '#!e !e e+#!anation is that e'#!o"ees and 'anagers $ho have (een around for "ears no$ 2uite $e!! $here the weaknesses are in the internal controls and an d ha have ve gaine ained d su su cien cientt no no$! $!ed edge ge of ho$ to co co' ''it th the e cr cri' i'e e successfu!!"%
A #rere2uisite to opportunity is that the perpetrator be in a position of trust% trust% Re'e'(er Cresse";s thesis $as a(out trust vio!ators% And it is dicu!t to co''it a fraud $ithout (eing in a trusted #osition over assets% ut the 'ain factor in o##ortunit" is interna! contro!s% A $eaness in or a(senc a(s ence e of int inter erna! na! con contr tro!s o!s #r #rovi ovides des the o## o##or ortun tunit" it" for fra frauds udster ters s to co''it their cri'es% It is note$orth" that the Tread$a" Co''ission 5!ater no$n as the Co''ittee of S#onsoring Organi)ations, or COSO6 $as for'ed to res#ond to the savings and !oan frauds and scanda!s of the ear!" =>@s% The co''ittee;s conc!usion $as that the best prevention was strong internal controls, controls, and the resu!t $as the COSO 'ode! of interna! contro!s, $hich $as incor#orated into *nancia! auditing technica! !iterature as SAS H, Consideration of Interna! Contro! in a Financia! State'ent Audit% Then the Sar(anes7O+!e" Act 5SO6 focused on an annua! eva!uation of the interna! contro!s (" 'anage'ent $ith an inde#endent o#inion of that eva!uation (" the *nancia! auditorsJSection K@K of the act% Again, if the #ur#ose of SO $as to 'ini'i)e fraud, interna! contro! is the e9ective $a" to acco'#!ish that goa!% In fact, it cou!d (e argued that this as#ect of the triang!e is the on!" one that auditors can easi!" o(serve or contro!% The o##ortunities to co''it fraud are ra'#ant in the #resence of loose or lax man manage agemen mentt and 5co 5conco nco'i 'itan tant6 t6 ina inade2 de2uat uate e att attent ention ion to int inter erna! na! contro!s% 8hen 'otivation is cou#!ed $ith such o##ortunities, the #otentia! for fraud is increased%
Fraud L Triang!e Lfraud e+a'ination 'ethodo!og" Intro to *nancia! state'ents *nancia! state'ents frauds frauds in FIs res#onsi(i!it" of 'anage'ent M auditors intro to M #reva!ence of fraud #er#etrators M fraud triang!e theor" of fraud #er#etrators
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Financia! state'ents frauds : Timing i!erences ("mproper T Treatment reatment of #ales) : There are a variet" of $a"s to #er#etrate a ti'ing di9erences sche'e to e+aggerate revenues excess ess inv invent entory ory to for for the the cu curr rren entt *s *sca ca!! #e #eri riod od%% On One e $a $a" " is to #ush exc salespeople sales people or consi consignment gnment $hereu#on the inventor" is treated as a sa!e, no$ing fu!! $e!! that 'uch of it $i!! (e returnedJ(ut in a su(se2uent channel el stu$ stu$ng ng%% Sa #eri #e riod od%% Th This is 'et etho hod d is n no$ o$n n as chann Sa!e !es s a!so a!so ca can n (e (oo (oo ed in oth other er vio vio!at !ation ions s of gen gener era!!" a!!" acc acce#t e#ted ed acc accoun ountin ting g #ri #rinci nci#!e #!es s 5GAA 5G AAP6 P6 5e 5e%g %g%, %, ea ear! r!" " rev even enue ue rec ecog ogni niti tion on6% 6% For in inst stan ance ce,, a three%year contract to #r contract #rov ovid ide e se serv rvic ices es ac acrros oss s th the e #e #eri riod od ca can n a!! a!! (e (o (oo oed ed as revenue in the current year to year to inate #ro*ts for the ne+t set of *nancia!s, at the e+#ense of future *nancia!s, and o(vious!" not in co'#!iance $ith GAAP and the 'atching #rinci#!e% (#P&s) to Enron Enro n us used ed a si'i si'i!a !arr 'e 'eth thod od in its its special purpose entities (#P&s) account for a!! of the revenue fro' !ong7ter' agree'ents in the current "ear% In another fraud, the CFO for a (anru#t co'#an" 5as a resu!t of a *nancia! state'ent fraud6 ad'itted in his de#osition that 'an" sa!es $ere (ooed (efore the" $ere actua!!" consu''ated% -is reason: <<If "ou ne$ in "our heart it $as a sa!e, then $e (ooed it%;; 'ictitious evenues : Fictitious revenues are created si'#!" (" recor recording ding sa!es that never occurred% The" can invo!ve rea! or fae custo'ers% The end resu!t is an increase in re reven venues ues and #r #ro* o*ts, ts, and us usua! ua!!" !" ass assets ets 5th 5the e oth other er sid side e of the *ct *ctitio itious us accounting entr"6% For e+a'#!e, the infa'ous E2uit" Funding scanda! used a *ctitious revenues sche'e to inate (oth revenues and accounts receiva(!e% E2uit" Funding $as an insurance co'#an", to (e s#eci*c, a reinsurer% To create *ctitious re reven venues ues,, the CE CEO O si' si'#!" #!" cr creat eated ed #ho #hon" n" ins insur uranc ance e #o! #o!ici icies% es% After fter sev seven en "ear "e ars, s, th the e fr frau aud d $a $as s *n *na! a!!" !" e+# +#os osed ed in => =>HB HB (" a rec ecen ent! t!" " *r *red ed an and d disgrunt!ed $as #hon"% e'#!o"ee% At that ti'e, (i!!ion of the B (i!!ion in receiva(!es oncealed *iabilities ("mproper ecording of *iabilities) : *iabilities) : One $a" to #er#etrate this fraud sche'e is to si'#!" #ost#one the recording of !ia(i!ities in the t$e!fth 'onth of the *sca! "ear so that the current "ear $i!! have !ess e+#enses, and record that !ia(i!it" in the *rst 'onth of the ne+t *sca! "ear "ear%% It is #r #rec ecis ise! e!" " (e (eca caus use e of th this is #o #oss ssi(i i(i!i !it" t" that that *n *nan anci cia! a! au audi dito tors rs #e #erf rfor or' ' su(se2uent7#eriod su(stantive testsJ!ooing for invoices that are dated the "ear under audit (ut #osted in the *rst 'onth of the su(se2uent "ear% Another $a" to co''it this fraud is to 'ove those !ia(i!ities so'e$here e!se% If the co'#an" is !arge and has su(sidiaries, this o(4ective can (e acco ac co'# '#!i !ish shed ed (" 'o 'ovi ving ng th the e !ia( !ia(i!i i!it" t" to a su su(s (sidi idiar ar", ", es es#e #eci cia! a!!" !" if that that co'# co '#an an" " is eith either er no nott au audi dite ted d or au audi dite ted d (" a di di9e 9erren entt au audi ditt *r *r' ' 5a 5an n intentiona! decision to hide the fraud6% This sche'e #ro(a(!" is used often ("
co'#anies% Our assu'#tion is (ased on the fact that the shifting of !ia(i!ities is dicu!t to detect in audits% -o$ever, if it is occurring, there shou!d (e changes in certain ratios: earnings #er share 5EPS6, de(te2uit", and so on% The fraudsters at Par'a!at Par'a!at used th this is 'ethod to hide !ia(i!ities and #er# #er#etrate etrate a *nancia! state'ent fraud of 'ore than =%B (i!!ion, 'oving !ia(i!ities to su(sidiaries in the Cari((ean, far fro' cor#orate head2uarters in Ita!", and to co'#anies audited (" a di9erent *nancia! audit *r'% The e+ecutives at Par'a!at a!so invented assets and forged docu'ents to (ac u# entries for the', $hich i!!ustrates the co'#!e+it" of 'an" frauds: The fraudster (egins #erha# #er ha#s s $it $ith h a sin sing!e g!e fra fraud ud sch sche' e'e e (ut so' so'eti eti'e 'es s e+ e+#an #ands ds to 'u 'u!ti !ti#!e #!e sche sc he'e 'es% s% Ade de!# !#hi hia a us used ed th the e sa sa'e 'e fr frau aud d 'e 'eth thod od,, 'o 'ovi ving ng !i !ia( a(i!i i!iti ties es to o9(a!ance7 sheet a!iates% Fina!!", a si'#!e fai!ure to record !ia(i!ities acco'#!ishes the sa'e #ur#ose% 8ithout the !ia(i!it", there is no additiona! e+#ense, no reduction in assets, or no decrease in e2uit" that nor'a!!" occurs% I'#ro#er 3isc!osures : One #rinci#!e of fraud is that it is a!$a"s c!andestine% The fraudster $i!! atte'#t to cover u# for frauds in the (oos% 5This is not necessar" for o97the7(oo sche'es%6 This cover7u# e+tends to disc!osures% 8hi!e 8hi! e En Enrron $a $as s te tech chni nica ca!! !!" " GAA GAAP P co co'# '#!ia !iant nt in di disc sc!o !osi sing ng SP SPEs Es in the the *nancia! state'ents and annua! re#ort, it $as fraudu!ent in hand!ing the associated revenues, and it $as c!andestine in its disc!osures% Enron did 'a 'a e di disc sc!o !osu surres reg egar ardi ding ng th the e SP SPEs Es,, as re2 e2ui uirred ed,, (u (utt th the" e" $e $erre so o(fuscated that even *nancia! e+#erts cou!d not read the' and understand e+act!" the *nancia! ra'i*cations of those SPEs, $hich is $hat $as intended% A!so, Andre$ Fasto$, CFO, re#orted!" hid his association $ith the SPEs fro' the (oa (oard rd to fur furthe therr o(f o(fusc uscate ate the their ir dis disc!o c!osur sure% e% Oth Other er 'e 'etho thods ds inc inc!ud !ude e o'iss o' ission ion in dis disc!o c!osur sures es of !ia !ia(i! (i!it" it",, sig signi* ni*can cantt eve events nts,, an and d 'an 'anage age'en 'entt fraud% An inade2uate disc!osure can (e a $a" to hide evidence of a fraud% I'#ro#er Asset 1a!uation : " inating the a'ounts of assets 5co''on!" receiva(!es, inventor", and !ong !ong7! 7!iv ived ed as asse sets ts6, 6, ca ca#i #ita ta!i !i)i )ing ng e+ e+#e #ens nses es,, or de dea ati ting ng co cont ntra ra ac acco coun unts ts 5a!!o$ 5a! !o$anc ance e for dou dou(tf (tfu! u! acc accoun ounts, ts, de# de#re recat cation ion,, a' a'ort orti)a i)atio tion, n, etc etc%6, %6, the *nancia!s $i!! sho$ a higher than truthfu! e2uit" and #ro*t% -ea!thSouth e+aggerated assets (a!ances to cover insucient #ro*ts over a #eriod of "ears% A transaction that de(its an asset and credits an e2uit" or revenue account <<'agica!!";;creates #ro*ts% In the case of the 8or!dCo' *nancia! state'ent fraud, !eases of te!e#hone !ines $ere c!ear!" an e+#ense% 0et 8or!dCo';s CEO convinced accountants interna!!" and *nancia! auditors e+terna!!" to treat the' as assets% Thus (" 'oving 'i!!ions of do!!ars of e+#enses to the (a!ance sheet, the inco'e state'ent sudden!" !ooed 'uch (etter%
asic Accounting Princi#!es and Guide!ines Since GAAP is founded on the (asic accounting #rinci#!es and guide! gui de!in ines, es, $e ca can n (et (ette terr un under derst stan and d GAA GAAP P if $e und under erst stan and d those accounting accounting #rinci#!es% The fo!!o$ing is a !ist of the ten 'ain acco ac coun unti ting ng #r #rin inci ci#! #!es es an and d gu guid ide! e!in ines es to toge geth ther er $i $ith th a hi high gh!" !" condensed e+#!anation of each%
+. &conomic &ntity ssumption The accountant ee#s a!! of the business business transactions transactions of a so!e #ro#rietorshi# se#arate fro' the (usiness o$ners personal o$ners personal tra rans nsac acttio ions ns%% For legal legal #ur#oses, a so!e #ro#rietorshi# and its o$ner are considered to (e one entit", (ut for accounting #ur#oses the" are considered to (e t$o se#arate entities%
-. onetary /nit ssumption Econo'ic activit" is 'easured in U%S% do!!ars, and on!" transactions that can (e e+#ressed in U%S% do!!ars are recorded% ecause of this (asic accounting #rinci#!e, it is assu'ed that the do!!ars #urchasing #o$er has not changed over ti'e% As a resu!t accountants ignore the e9ect of ination on recorded a'ounts% For e+a'#!e, do!!ars fro' a =>@ transaction are co'(ined 5or sho$n6 $ith do!!ars fro' a @=K transaction%
0. Time Period ssumption This accounting #rinci#!e assu'es that it is #ossi(!e to re#ort the co'#!e+ and ongoing activities of a (usiness in re!ative!" short, distinct ti'e interva!s such as the *ve 'onths ended .a" B=, @=K, or the ? $ees ended .a" =, @=K% The shorter the ti'e interva!, the 'ore !ie!" the need for the accountant to esti'ate a'ounts re!evant to that #eriod% For e+a'#!e, the #ro#ert" ta+ (i!! is received on 3ece'(er =? of each e ach "ear% "ear% On the inco'e state'ent for the "ear ended 3ece'(er B=, @=B, the a'ount is no$n (ut for the inco'e state'ent for the three 'onths ended .arch B=, @=K, the a'ount $as not no$n and an esti'ate had to (e used%
It is imperative imperative that that the ti'e interva! 5or #eriod of ti'e6 (e sho$n in the heading of each inco'e state'ent, state'ent of stocho!ders e2uit", and state'ent of cash o$s% /a(e!ing one of these *nancia! state'ents $ith state'ents $ith &3ece'(er B=& is not good enoughLthe reader needs to no$ if the state'ent covers the one week ended ended 3ece'(er B=, @=K the month month ended ended 3ece'(er @=K the threeB=, months months ended or the year B=, ended ended 3ece'(er 3ece'(er @=K% ended 3ece'(er B=, @=K 1. ost Principle Fro' an accountants #oint of vie$, vi e$, the ter' &cost& refers to the a'ount s#ent 5cash or the cash e2uiva!ent6 $hen an ite' $as originally o(tained, o(tained, $hether that #urchase ha##ened !ast "ear or thirt" "ears ago% For this reason, the a'ounts sho$n on *nancia! state'ents are referred to as historical historical cost cost a'ounts% ecause of this accounting #rinci#!e asset a'ounts are not ad4usted ad4usted u#$ard for ination% In fact, as a genera! ru!e, asset a'ounts are not ad4usted to reect any t"#e t"#e of increase in va!ue% -ence, an asset a'ount does not reect the a'ount of 'one" a co'#an" $ou!d receive if it $ere to se!! the asset at toda"s 'aret va!ue% 5An e+ce#tion is certain invest'ents in stocs and (onds that are active!" traded on a stoc e+change%6 If "ou $ant to no$ the current va!ue of a co'#an"s !ong7ter' !ong7 ter' assets, "ou $i!! not get this infor'ation fro' a co'#an"s *nancia! state'entsL"ou need to !oo e!se$here, #erha#s to a third7#art" a##raiser% 2. 'ull isclosure Principle If certain infor'ation is i'#ortant to an investor or !ender using the *nancia! state'ents, that infor'ation shou!d (e disc!osed $ithin the state'ent or in the notes to the state'ent% It is (ecause of this (asic accounting #rinci#!e that nu'erous #ages of &footnotes& are often attached to *nancia! state'ents% As an e+a'#!e, !ets sa" a co'#an" is na'ed in a !a$suit that de'ands a signi*cant signi*can t a'ount of 'one"% 'one"% 8hen the *nancia! *n ancia! state'ents are #re#ared it is not c!ear $hether the co'#an" $i!! (e a(!e to defend itse!f or $hether it 'ight !ose the !a$suit% As a resu!t of these conditions and (ecause of the fu!! disc!osure #rinci#!e the !a$suit $i!! (e descri(ed in the notes to the *nancia! state'ents%
A co'#an" usua!!" !ists its signi*cant accounting #o!icies as the *rst note to its *nancia! state'ents%
3. 4oing oncern Principle This accounting #rinci#!e assu'es that a co'#an" $i!! continue to e+ist !ong enough to carr" out its o(4ectives and co''it'ents and $i!! not !i2uidate in the foreseea(!e future% If the co'#an"s *nancia! situation is such that the accountant (e!ieves the co'#an" $i!! not (e (e a(!e to continue on, the accountant is re2uired to disc!ose this assess'ent% The going concern #rinci#!e a!!o$s the co'#an" to defer so'e of its #re#aid e+#enses unti! future accounting #eriods%
5. atching Principle This accounting #rinci#!e re2uires co'#anies to use the accrua! (asis of accounting% accounting% The 'atching #rinci#!e re2uires that e+#enses (e 'atched $ith revenues% For e+a'#!e, ein +a'#!e, sa!es co''issions e+#ense shou!d (e re#orted the #eriod $hen the sa!es $ere 'ade 5and not re#orted in the #eriod $hen the co''issions $ere #aid6% 8ages to e'#!o"ees are re#orted as an e+#ense in the $ee $hen the e'#!o"ees $ored and not in the $ee $hen the e'#!o"ees are #aid% If a co'#an" agrees to give its e'#!o"ees =Q of its @=K revenues as a (onus on anuar" =?, @=?, the co'#an" shou!d re#ort the (onus as an e+#ense in @=K and the a'ount un#aid at 3ece'(er B=, @=K as a !ia(i!it" ! ia(i!it"%% 5The e+#ense is occurring as the sa!es are occurring%6 ecause $e cannot 'easure the future econo'ic (ene*t of things such as advertise'ents 5and there(" $e cannot 'atch the ad e+#ense $ith re!ated future revenues6, the accountant charges the ad a'ount to e+#ense in the #eriod that the ad is run% 5To !earn 'ore a(out ad4usting entries go to &xplanation of d6usting &ntries and 7ui8 for d6usting &ntries.6 9. evenue ecognition Principle Under the accrua! (asis of accounting 5as o##osed to the cash (asis of accounting6, accounting6, revenues revenues are are recogni)ed as soon as a #roduct has (een so!d or a service has (een #erfor'ed, regard!ess of $hen the 'one" is actua!!" received% Under this (asic accounting #rinci#!e, a co'#an" cou!d earn and re#ort
@,@@@ of revenue in its *rst 'onth of o#eration (ut receive @ in actua! cash in that 'onth% For e+a'#!e, if AC Consu!ting co'#!etes its service se rvice at an agreed #rice of =,@@@, AC shou!d recogni)e =,@@@ of revenue as a s soon as its $or is doneJit does not 'atter $hether the c!ient #a"s the =,@@@ i''ediate!" or in B@ da"s% 3o not confuse revenue $ith revenue $ith a cash recei#t% recei#t% :. ateriality ecause of this (asic accounting #rinci#!e or guide!ine, an accountant 'ight (e a!!o$ed to vio!ate another accounting #rinci#!e if an a'ount is insigni*cant% Professiona! 4udge'ent is needed to decide $hether an a'ount is insigni*cant or i''ateria!% An e+a'#!e of an o(vious!" i''ateria! ite' is the #urchase of a =?@ #rinter (" a high!" #ro*ta(!e 'u!ti7'i!!ion do!!ar do! !ar co'#an"% co'#an"% ecause the #rinter $i!! (e used for *ve "ears, the matching matching #rinci#!e #rinci#!e directs the accountant to e+#ense the cost over the *ve7"ear #eriod% The materiality guide!ine a!!o$s this co'#an" to vio!ate the 'atching #rinci#!e and to e+#ense the entire cost of =?@ in the "ear it is #urchased% The 4usti*cation is that no one $ou!d consider it 'is!eading if =?@ is e+#ensed in the *rst "ear instead of B@ (eing e+#ensed in each of the *ve "ears that it is used% ecause of 'ateria!it", *nancia! state'ents usua!!" sho$ a'ounts rounded to the nearest do!!ar, to the nearest thousand, or to the nearest 'i!!ion do!!ars de#ending on the si)e of the co'#an"%
+;. onservatism If a situation arises $here there are t$o acce#ta(!e a!ternatives for re#orting an ite', conservatis' directs the accountant to choose the a!ternative that $i!! resu!t in !ess net inco'e andor !ess asset a'ount% Conservatis' he!#s the accountant to &(rea a tie%& It does not direct accountants to (e conservative% Accountants are e+#ected to (e un(iased and o(4ective% The (asic accounting #rinci#!e of conservatis' !eads accountants to antici#ate or disc!ose !osses, (ut it does not a!!o$ a si'i!ar action for gains% For*nancia! e+a'#!e, e+a'#!e, potential potential !osses !osses fro' !a$suits $i!! (e re#orted on the state'ents or in the notes,
(ut potential potential gains gains $i!! not (e re#orted% A!so, an accountant 'a" (ut $rite inventor" down downto to an a'ount that is !o$er than the origina! cost, (ut $i!! not $rite inventor" up up to to an a'ount higher than the origina! cost%
.otives for Financia! State'ent Fraud a% To 'ae a co'#an"s earnings !oo (etter on #a#er% ( To covers u# the e'(e))!e'ent of co'#an" funds% To To encourage invest'ent through through the sa!e of stoc stoc To To de'onstrate increase increase earnings #er share share thus a!!o$ing increased increased dividenddistri(ution #a"outs To To cover ina(i!it" to generate cash cash o$ To dis#e! negative 'aret 'aret #erce#tions To To o(tain *nancing, or to o(tain o(tain 'ore favoura(!e ter's ter's on e+isting *nancing *nancing h% To receive higher #urchase #rices for ac2uisitions To To de'onstrate co'#!iance co'#!iance $ith *nancing covenants To To 'eet co'#an" goa!s and and o(4ectives To To receive #erfor'ance7re!ated #erfor'ance7re!ated (onus (onus
