Fraud in financial statements increasing

As recently reported by the National Fraud Authority, the current economic situation is revealing a significant increase in the volume and value of frauds and it is likely this will continue to rise.

False accounting or fraudulent financial reporting will be by far the largest corporate fraud risk as we go into the New Year. Management will try to justify this by anticipating growth in 2010 to absorb any over reporting and the desire to support the company’s share price so protecting the work force from redundancy.

As we approach 2010 many companies will be putting their year end accounts together revealing just how tough 2009 has been.  As monthly management accounts are aggregated and subsidiaries report to their parents, there will be a nasty surprise in store for some. Results may reveal performance far below what has been reported in monthly management packs and some tough questions will have to be asked. For a few there will be the temptation to plug any holes in the accounts with false accounting entries and fictitious supporting documentation.

This risk is compounded by the ability of senior management to override controls through collusion or just brow beating staff into manipulating the books and records. Both group directors and non-executive directors need to be aware of the fraud risks associated with financial statement fraud, including why might financial statement fraud be committed and what motivates the fraudsters to commit it.

High analyst or other pressure, aggressive accounting polices, declining industry or earnings, complex corporate structures, undue secrecy and remote locations are all examples of such risks. Put together they can produce a lethal cocktail of factors which significantly increase the risk of financial statement fraud.

However given the increased pressures brought about by the recession understanding the risks is no longer enough. The Federation of Small Businesses 2009 Survey revealed that a third of businesses have been affected by fraud. How you respond to a fraud can mean the difference between the company surviving or going under.

A response plan is a vital precaution in a company’s response to financial statement fraud and to satisfy the demands of a regulator. From receiving a report through evaluating the suspicion, investigation and recovery, all elements should be detailed and responsibilities assigned. The chances of recovery diminish with every day after a fraud has been detected. It is therefore imperative that those charged with financial statement fraud understand the protocol for investigating, who to involve in that investigation and as importantly who not to involve.

Case study:

The Northwest subsidiary of an office supplies firm over reported trading results throughout the year to trigger a buyout bonus for the local directors. This was concealed from head office by creating false sales invoices which were reversed after the year end. This fraud was only spotted in the second year when the fraudsters tried but failed to conceal the accumulating black hole as an inter-group debtor, producing false documentation from another subsidiary to support this claim. As it was, substantial bonus’s were paid to the subsidiary directors in the first year and significant investment decisions were based on fraudulent accounting information which resulted in further consequential losses to the business.

For further information contact:

David Alexander, Director of Forensic Services

020 7131 8290 or 0121 710 5260

Email David Alexander

PR enquiries to:

Jess Koslow/ Kate Harrison 020 7131 4264/ 4228

Disclaimer

By necessity, this briefing can only provide a short overview and it is essential to seek professional advice before applying the contents of this article. No responsibility can be taken for any loss arising from action taken or refrained from on the basis of this publication. Details correct at time of writing.

Note to editors

Smith & Williamson is an independent professional and financial services group employing around 1,500 people. The group is a leading provider of investment management, financial advisory and accountancy services to private clients, professional practices and mid-to-large corporates. The group operates from offices in London, Belfast, Birmingham, Bristol, Dublin, Glasgow, Guildford, Salisbury, Southampton and Worcester.

Smith & Williamson Limited

Regulated by the Institute of Chartered Accountants in England and Wales for a range of investment business activities. A member of Nexia International

Nexia Smith & Williamson Audit Limited

Registered to carry on audit work and regulated by the Institute of Chartered Accountants in England and Wales for a range of Investment business activities. A member of Nexia International