Normally it is said that this type of fraud is very rare, but the manipulation and distortion of financial statements is one of the types of corporate fraud that ultimately tends to have a greater impact on society.

Examples of cases such as Enron, show that the impact caused by this type of fraud is not limited to economic losses for shareholders, but includes employee layoffs, collateral effects on suppliers and other creditors and results in a general loss of confidence in the system.

In this article of Abogados Cabo we explain in broad strokes the figure of fraud in financial information:

Financial Statement Fraud Scheme

Financial statement fraud is considered to be a deliberate misrepresentation of a company’s financial condition achieved through the intentional misrepresentation or omission of amounts or disclosures in financial statements designed to deceive users of financial statements. It should be noted that, in most cases, financial statement frauds are intentional acts, and these are materialized by overstating assets, revenues and profits, or understating liabilities, expenses and losses.

Most common frauds in financial statements

This type of fraud often has a devastating effect on companies, since it affects both the reputation of the organization and its financial position, as well as the people involved in it, to the extent that in the case of a public company, it will have a direct effect on investments and share prices.

Although each case has its own nature, some of the reasons why these types of frauds are carried out, we find:

  • To make earnings look better on the bottom line.
  • To favor the figures to encourage investment through the sale of shares.
  • To demonstrate the increase in profits, allowing an increase in the distribution of dividends.
  • To cover the inability to generate cash flow.
  • To dispel negative perceptions of the entity in the market.
  • To obtain financing, or to obtain more favorable terms on existing financing.
  • To obtain high purchase prices for acquisitions.
  • To achieve company goals and objectives.
  • To obtain bonuses related to specific actions

The International Association of Fraud Examiners has categorized financial statement fraud into 5 types, as follows:

Most Common Types of Financial Statement Fraud

1. Fictitious revenues

Fictitious or fabricated revenues are caused by recording sales of goods or services that did not occur, where often the fictitious sales are adjusted at the end of the accounting period, reversing the sales generated by cancelling the sale or adjusting, trying to hide the fraud. However, the falsification of revenue in one period should reflect the drop in revenue in the next period’s accumulated revenue, creating the need for more fictitious sales, affecting the accounts receivable, speculating that it may be diluted by an allowance for doubtful accounts.

Most common frauds in financial statements

2. Adjustment for differences

Fraud in the Financial Statements should also involve timing or adjusting differences – that is, recording income or expenses in incorrect periods in order to shift income or expenses between one period and the next, increasing or decreasing profits as desired.

3. Improper Valuations

Typically, a fraudster increases asset accounts to strengthen the Statement of Financial Position and although the valuation of assets generally does not increase the current (market) value, it can be affected by the estimates that are used to determine the residual values and useful life of a depreciable asset, providing an opportunity to defraud by manipulating an inappropriate valuation of inventories, accounts receivable and fixed assets.

4. Censoring of Liabilities and Expenses

One of the most common methods is to hide liabilities or expenses and simply not record them, thus increasing the result. Likewise, debit notes may be created for refunds to suppliers, supposedly to claim allowable bonuses or subsidies, but sometimes they are only used to create additional income. If these items are correctly recorded in a settlement period it does not change the fraudulent nature of the current financial statements.

5. Inadequate Disclosures

Accounting principles require that financial statements include all necessary information to avoid incorrect reasoning by the user of the financial statement information by inducing error. The notes should include the necessary supporting explanations, and other information required to avoid misleading investors, creditors or other users of the financial statements.

Most common frauds in financial statements

Therefore, it is very important to keep in mind the premise that management will always have the obligation to disclose all appropriate information in the financial statements for discussion and analysis, considering that the information disclosed should not be misleading. Let us not forget that an inadequate disclosure of financial statements results in fraud that is reflected in the omission of liabilities, subsequent events and fraud in the management of resources, transactions and accounting accounts.

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