An accountant with his dark side showing because he committed accounting fraud

Accounting Fraud: Prevention and Detection

We’ve come across more accounting hack jobs than we’d like. Thankfully, nothing comes close to full-scale accounting fraud. This is how to spot and prevent fraudulent accounting activity with examples of the worst accountants in the industry. 

In this article:

  • Top 5 worst accountants list 
  • What is accounting fraud?
  • Creative accounting vs accounting fraud
  • Accounting fraud examples
  • Accounting fraud prevention and detection

Top 5 Worst Accountants List

Let’s start things off with some of the worst accountants in the business. Unfortunately, there is an exhaustive list of horrible people posing as financial advocates. These guys make the cut on our list because they are examples of preventable accounting fraud discussed further in the article.

1. Andrew Fastow, Chief Financial Officer At Enron

He spearheaded a plan to hide liabilities in subsidiary holdings. The subsidiary holdings concealed losses attributed to shady mark-to-market (MTM) accounting tactics. MTM accounting goes like this—Enron would purchase new subsidiaries (factory, business entity, etc) and report its projected revenue as actual revenue, and any real losses were reported off-the-books under the subsidiary. When all was said and done, shareholders lost a total of $74 billion in investment.

2. Arthur Andersen Of Arthur Andersen LLP

Arthur Andersen, a high-profile accountant, gets credit twice on this list. As the head of a top auditing firm in the country, he helped Enron avoid scrutiny from governing bodies. He would sign off on phony corporate statements, certifying their accounting as accurate. 

He also was embroiled in the Waste Management Scandal. The company reported inflated earnings of $1.7 billion, audited and verified by Mr. Andersen. The SEC eventually closed his firm, resulting in the elimination of countless jobs, and investments in the companies he “audited.”

the worst accountants stealing money out of a safe

3. Edward Cooper Of Jonesboro Accounting

He forged payments to himself from his client Roach Manufacturing. Edward accumulated $9 million in checks from 1996-2018, never reporting more than $70,000 in annual taxes. He and his wife enjoyed the money, splurging on the finer things: travel, jewelry, furs, and a $2 million cabin.

4. Andrew Munton Personal Accountant To The Stars

This accountant defrauded his celebrity clientele, including Rita Ora, out of 3.5 million euros. He falsified bank documents under client names to obtain credit. Then invested the money in lucrative football and star wars memorabilia. As well as funded his healthy gambling habit. 

5. Stuart Wiles aka “Mickey” The Ice Cream Accountant

He embezzled more than $300,000 from his employer Ben & Jerry’s while he was acting CFO from 2000-2004. Wiles issued company checks for charitable contributions, unspecified legal expenses, and fake expenses. All to pay for personal expenses like vacations, car repairs, clothing, electronics, gifts, entertainment, and an addition to his home.

What Is Accounting Fraud?

Accounting fraud is the deliberate manipulation of accounting procedures and financial documents. It is an effort by an accountant, or employee at an organization, to fabricate a story of prosperous financial health. Such misinformation twists tax and business laws to influence investments from public and private sectors.

Creative Accounting vs Accounting Fraud

Creative accounting, aka aggressive accounting, is a lesser form of accounting fraud. In the financial industry it is the exploitation of generally accepted accounting standards; a reinterpretation of accounting policies that push the boundaries of true reporting. Sometimes it is done in the ruse of transparency, by presenting information in a way that certain accounting principles don’t consider. However, the purpose is the same as accounting fraud and is meant to present the company in a better light. 

For Example: Pro forma non-GAAP reporting does not include one-off transactions. So these reports may show “more accurate” accounting data than GAAP reporting, by excluding a random event. This form of aggressive accounting is usually done to show a better cash position and is NOT considered illegal because it is reported next to GAAP figures

It is important to distinguish between accounting fraud and creative accounting. Creative accounting practices are seen as stretching the truth, so it is disregarded in the corporate world. On the other hand, accounting fraud is a deliberate attempt to deceive the public with falsified financial records or loopholes that break the laws.  

worst accountants cooking the books erasing numbers and taking money

Cooking the Books: Accounting Fraud Examples

To represent their business in the best possible way, an enterprise will use accounting techniques to manufacture financial information. The worst accountants on our list cock-tailed these forms of accounting fraud to work in their favor:

1. Revenue Recognition

Fraudulent revenue recognition manipulates sales revenue on the books to avoid taxes or inflate figures to inspire more investment. 

Examples of fraudulent revenue recognition:

  • Keeping the books open past the end of the reporting period to log more sales
  • Recognizing revenue before a good or service is delivered
  • Recognizing recurring revenue as one lump sum upfront
  • Delivering product before it is purchased
  • Sending products to another warehouse and reporting it as a sale
  • Not finalizing invoices in their proper reporting period

2. Inventory Valuation

Companies will overstate or understate inventory to reduce or increase revenue. Some companies will use one of the 3 inventory valuation methods to their advantage. While this lacks transparency, it is viewed as creative accounting. However, if inventory is valued inconsistently from year to year, and circumnavigates the law, it is considered accounting fraud. 

Examples of fraudulent inventory valuation:

  • To reduce revenue and minimize taxes 
  • Adjusting cost of products sold to inflate earnings
  • Conceal cash as an inventory asset

3. Undervaluing Liabilities

This occurs when a company understates what it owes. This form of fraud shows a business having limited liabilities which overvalues the business’s short-term cash liquidity and increases its book value

Examples of fraudulent liability valuation:

  • Not recording expenses
  • Manipulating depreciation figures
  • Not reporting contingent liabilities (a non-cash expense that is highly likely to occur in the future i.e. a legal settlement)

4. Boosting The Balance Sheet

Boosting the balance sheet is an effort to inflate the value of a company. Fraudsters will use the balance sheet as a way to impress investors and exhibit strategic operational management, to get more funding or financing.

Examples of boosting the balance sheet:

  • Overvaluing fixed assets net worth
  • Overstating sales via accounts receivable without reporting doubtful debt
  • Using the equity method to report large investments or subsidiaries as assets
An accountant at trial for accounting fraud

Accounting Fraud Prevention

When accounting fraud takes place, the first suspect is the accountant. Who better to cook the books than the person who is nose deep in the ledger all day. Therefore, prevention methods should focus on the people and processes of the accounting department. These accounting fraud prevention tactics are helpful:

Background Checks

Know your accounting team. Hiring employees who will have access to sensitive information should include a background check. These individuals must have a track record of trustworthiness, so obvious red flags would be criminal activity like embezzlement, forgery, or larceny. You want to be confident that the financial services you receive will be done professionally and ethically.

Internal Audits 

To maintain the integrity of accounting records a periodic review needs to happen. This is a time where the department goes through the general ledger in search of any errors, makes adjustments, and detailed notes of the adjustments. Whenever you perform an internal audit of your revenue, it should be accompanied by a verified report of the results—regardless of the outcome, honesty is the ticket

Segregation of tasks in daily accounting operations is a crucial component of internal auditing. One person is assigned to and documents one task, to help with disclosure of any future discrepancies. This internal control safeguards a company’s internal audit procedure, by providing a reference point of error. For Example: The company owner receives sealed or encrypted bank statements; the accountant reviews every check for the authorized signature and approves electronic payments;  Payment processing is done by the bookkeeper. 

Peer Review

We leverage peer reviews for complex accounting procedures. Peer reviews are a check-off by a superior person on the team, preferably the CEO or upper management. It adds another step but it makes certain that financials are accurate. Plus, inserting a peer review into your workflow, reduces time on internal audits since you catch mistakes sooner.

Accounting Fraud Detection On Financial Statements

If an employee is committing accounting fraud, then they may need to forge financial statements. To ensure public trust governing bodies, like the SEC and the IRS, analyze income statements, balance sheets, and cash flow statements, to mitigate corporate malfeasance. With your own investigation, and with meticulous attention you too can spot fraudulent activity like the pros.

1. Income Statement

Vertical and horizontal analysis is a straightforward way to sniff out accounting fraud on the income statement. A vertical analysis takes each line mentioned on the income statement as a percentage of gross sales or revenue. You want to see consistency when comparing line items over a span of time. Any outliers are a powerful cause of concern and the balances should be re-evaluated down to the ledger. 

Horizontal analysis looks at the year-over-year growth rate of line items on an income statement. This financial data is represented as a percentage of change from one year to the next for revenue, gross sales, and on down the P&L. It helps you visualize any growth that seems too good to be true.

2. Balance Sheet

The Beneish Model is a mathematical approach to verifying the balance sheet. The idea is to find out if a company is experiencing continuously increasing revenue alongside continuously decreasing expenses because it is likely fraudulent reporting activity. The adage more money more problems rings true because as a company grows, revenue and expenses will naturally increase together. 

So the Beneish model measures business performance over time. It evaluates eight ratios to determine a company’s M-score, which represents a numerical possibility of earnings manipulation. After combining the variables into the model, if the value derived is more positive than -2.22 (ex: -1.78, -1.52, etc)  it indicates further investigation; negative numbers beyond -2.22 (ex: -4, -5, etc) suggest confidence and reliability.

Note: the M-score result doesn’t mean there is accounting fraud, but the likelihood of illicit activity. So the company should be thoroughly audited.

3. Cash Flow Statement

Follow the cash when analyzing a company. Performing a cash flow analysis of inflows and outflows will help determine cash flow statement manipulation. Improper categorization will be the best indicator that something has been falsified. Look for inconsistencies like cash decreasing and sales increasing or false sales paid for with fraudulent bank loans.

Accountant in jail because of accounting fraud prevention and detection techniques

Accounting Fraud: You’ll Pay to Play

Dear accounting fraudsters, advancements in cloud computing, and reporting techniques are going to get you. So before you cut yourself an illegal check, know that one day you will be caught and it will happen when you are least prepared. For business owners suspecting accounting fraud is taking place under their nose, get in touch with the Securities And Exchange Commission and a trustworthy auditor.  

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