1. Fraud Examination, 3E Chapter 11: Financial Statement Fraud COPYRIGHT © 2009 South-Western, a part of Cengage Learning

2. Learning Objectives Discuss the role that financial statements play in capital markets. Understand the nature of financial statement fraud. Become familiar with financial statement fraud statistics. See how financial statement frauds occur and are concealed. Outline the framework for detecting financial statement fraud. 2

3. Learning Objectives Identify financial statement fraud exposures. Explain how information regarding a company’s management and directors, nature of organization, operating characteristics, relationship with others, and financial results can help assess the likelihood of financial statement fraud. 3

4. Financial Statement Fraud Misstatement of financial statements can result from manipulating, falsifying, or altering accounting records. 4

5. Elements of the Perfect Fraud Storm 1.A Booming Economy 2.Decay of Moral Values 3.Misplaced Incentives 4.High Analysts’ Expectations 5.High Debt Levels 6.Focus on Accounting Rules Rather Than Principles 7.Lack of Auditor Independence 8.Greed 9.Educator Failures 5

6. Nature of Financial Statement Fraud Involves intentional deceit Involves attempted concealment Rarely seen Many false red flags Conviction is very difficult 6

7. Detecting Financial Statement Fraud Strategic Reasoning Questions to ask: – What types of fraud schemes is management likely to use to commit financial statement fraud? – What typical tests are used to detect these schemes? – How could management conceal the scheme of interest from the typical test? – How could the typical test be modified so as to detect the concealed scheme? 7

8. Detecting Financial Statement Fraud Financial Statement Analysis Focus on the changes in reported assets, liabilities, revenues, and expenses from period to period or by comparing company performance to industry norms. *Not just general financial statement analysis 8

9. Detecting Financial Statement Fraud Nonfinancial Performance Measures Look for a discrepancy between the company’s financial and nonfinancial performance Example: Former HealthSouth CEO Richard Scrushy’s – The company’s revenues and assets were increasing while the number of HealthSouth facilities decreased 9

10. Detecting Financial Statement Fraud Fraud Exposure Rectangle 10