Chapter 11 a:Financial statement fraud

Financial Statement FraudChapter 11aBy Ritika Sareen

Presentation OutlineTwo well known Frauds:

◦ENRON◦WorldCom

Using financial Statements for fraudBrief introduction to Financial

statement fraud.Overview of fraud related practicesFraud motivators and the elementsNature and Statistical findings.

Enron (US) - TimelineYear 2000

◦Revenue- $101 Billion◦Employees- 21000◦Countries of operation- 40

December, 2001◦Financial statement fraud detected◦Enron filed bankruptcy

Investigation findingsComplex accounting schemes-

Revenues Overstated

Income Overstated

Assets Overstated

Profits Overstated

Basic rules of accounting and ethics was violated

Why will they fraudulently misrepresent Enron’s financial condition ?

Share prices ( Oct- Dec 2001)

SEC Charges

Former CEO- Skilling

Current CEO- Ken Lay

CFO- Andy Fastow

Auditors- Arthur

Anderson

Another Massive FRAUD: WorldComStar performer- Telecom IndustryFraud more massive than EnronFinancial statement FraudFiled bankruptcyCEO, CFO – convicted to fraudAuditor - Arthur Anderson

Direct RelationshipFinancial

Statement

s

Capital

Markets

•Stock Markets & Bond Markets•Efficiency: based on investors and regulators•Significant role of financial statements• Fair representation• Based on GAAP

Unfortunately, sometimes misstates

IntroductionFinancial statement frauds

◦Intentionally misstating position.◦Manipulating accounting records.

Resulting to:◦Huge losses to Investors.◦Lack of trust in markets.◦Lack of trust in accounting system.◦Embarrassments for people

associated with fraud.

Capital Markets- Crisis

$15 Trillion

Decline

America

Experienced

Severe Crisis.

Years 2000-

2002

Overview- Fraud Related practicesMisstated financial statements

Qwest, Enron, World Com, Xerox etc.

Executive loan and corporate looting

Bernie Ebbers (WorldCom)

Insider trading scandals ImClone stock- Martha and Sam

IPO favoritism WorldCom & Enron

Excessive CEO retirement perks

Ford, PepsiCo, IBM, and GE

Bankruptcies and excessive debt

7 largest bankruptcies in US till(2001-02)

Massive frauds by employees

$2-$3 billion

Loans for trading fees Enron & WorldCom

Excessive compensation for executives

Bernie Ebbers (WorldCom)

Bankruptcy StormCompany Date Assets(i

n billions)

Lehman Brothers 2008 $639

Washington Mutual

2008 $327

WorldCom 2002 $103

General Motors 2009 $91

CIT 2009 $71

Enron 2001 $65

Conseco 2003 $61

Chrysler 2009 $39

Thornburg 2009 $36

Pacific Gas and Electric

2001 $36

Yet another practice-

BACKDATING

Receiving stock grants at the lowest price of the year

Selling the stock at the higher price

Difference in price will be management profit.

BACKDATING - Continued

270 companies admitted

to backdating their options

agreement.

Increased compensation

at the cost of shareholders

Clear violation of Income

tax rules.

Fraud Motivators

Perceived Pressure

Perceived Opportunity

Rationalization

The Fraud Triangle

Elements of Perfect StormBooming Economic Conditions

Moral Decay

Executive Incentives

Unachievable expectations- Wall Street

Enormous Debt

Nature of US accounting rule

Lack of auditor’s Independence

Greed

Educator Failures

Nature - Financial statement fraud

Concealed using the falsified

documents

Suppressed by

agreement between management and

employees

Rarely detected

and difficult to

prove

Symptoms of fraud does not always indicate

existence of fraud

Thus investigators must exercise extreme

care

Review

Financial statements are the backbone of _____. These frauds usually involves ____ management which is motivated to keep the company stock price_____. Financial statement fraud is usually crafted to conceal it internally from _____. _____ is very common practice for executive compensation.

Review- Answers

Financial statements are the backbone of Capitalism. These frauds usually involves Top management which is motivated to keep the company stock price High. Financial statement fraud is usually crafted to conceal it internally from Auditors. Backdating is very common practice for executive compensation.

Statistics

SOURCESEC’s Accounting and auditing

enforcement releases. (AAERs)National Commission on

Fraudulent Financial reportingThe Tradeway Commission ReportCommittee of sponsoring

organizations (COSO)

Sample Revealed Facts (1987-1997)

Average fraud last for 2 years

Overstating assets and understating expenses is most common practice of fraud

CEO was the fraud perpetrator in 72% cases

Severe consequences: Bankrupt or taken over by state

No independent directors or audit committee

Directors dominated by insiders and grey directors

Experiencing net losses or close to break-even point prior to fraud

Findings Reported (1998-2007)

18% more frauds were investigated

by SEC

Median assets of the companies increased from $16million to $100 million

CEO and CFO were named in

over 89% of cases.

60% of the cases accounted for

improper revenue recognition.

26% of the firms changed auditors around the time of

fraud.

Press coverage and government investigation led to decrease in

stock price.

ReferencesEllison, C. (2008, 05 08). [Web log message].

Retrieved from http://enron-online.com/2008/08/05/enron-goes-down-not-the-fun-way/

Eric S. (2010, 10 20). 10 largest bankruptcies in history. Retrieved from http://wildammo.com/2010/10/20/10-largest-bankruptcies-in-history

Albrecht, W. S., Albrecht, C. O., Albrecht, C. C., & Zimbelman, M. F. (2012). Fraud examination. (4 ed., Vol. e, pp. 357-366). United states of america: South western Cengage learning.