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Fraudulent Financial Reporting

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    Fraudulent Financial Reporting

    According to (Bartov, Givoly, & Hayn. (2002), financial accounting scandals have been on the increase due to lack of inaccurate auditing procedures that cannot guarantee 100 percent accuracy. As noted by (Brown, 2001) management is more likely to be involved in fraudulent reporting in an environment of less corporate governance, biased top management, and pressure to perform. Despite many efforts from the U.S government including the enactment of the Sarbane-Oxley Act, Macey, (2003) notes that fraudulent financial reporting has continued to thrive to date undeterred. Macey, (2003) further notes that, the fact that investors and other shareholders depend on the financial reporting in judging organizations’ financial position contributes to the problem. This is explained by the fact that in the corporate world, financial statements is what end users use to judge corporate profitability hence their decision on future action.

    Fraudulent financial reporting can be defined as the impropriety of intentional misstatements or omissions of amounts or disclosures in the process of financial statements preparations, with an intention of misleading end users (Bartov, et al. 2002). Also referred to as management fraud, fraudulent financial reporting mostly originates from the top management. It involves, overstatement of inventory, shifting expenses to the future, ignoring liabilities, improper financial statements, poor management and overstatement of revenues and assets. (Brown, 2001).

    Fraudulent financial reporting is an un ethical practice which affects organizations credibility often resulting in loss of capital, decline of public trust in corporate and audit firms, bankruptcy, de-listing incase of listed companies, penalties as well as legal suits.

    Causes of fraudulent financial reporting.

    With analysts’ prediction’s gaining much prominence in the financial markets, the pressure is high on the part of top management to meet the analysts, predictions. This makes managers to adapt the “ the end justifies the means” philosophy and therefore engaging in fraudulent financial reporting to protect their “image”. The act is geared at misguiding those who make decisions based on the financial statements reports such as the investors and creditors. There is a generall craving for many companies to join the 500 fortune club. In organzations with a culture of arrogance and greed, managers may want to interfere with financial statements so as to potray the organization as doing well while it could actually be struggling. Fraudelent financial reporting also comes as a result of auditors, under pressure from management, compromise, professonallism and  intergrity and deliberately falsefy financial statements.

    Corporate governance is almost always responsible for fraudulent reporting. In cases whereby the management is not professional, chances of malpractices are higher than in organizations that observe professionalism. Poor corporate governance is evident in cases where organizations lack proper control systems and employees are too loyal to the leadership to blow the whistle.

    Where by top management chooses not to adhere to established standards of accountancy, quality assurance is lacking and therefore high chances of improprieties. Interest in the business for top mangers, risk taking, availability of a favorable environment to cheat, pressure from within or outside to cut a certain image aimed at improving chances of the organization to woe investors also contribute to fraudulent financial reporting. All of the above provide a fertile ground for fraud.

    The fight against fraudulent financial reporting requires massive resources, good will from the government, improved corporate financial reporting process as well as involvement of external anti-fraud specialists in the auditing process. According to Brown, (2001) involvements of external independent public accountants as well as sound and correct quarterly reporting are good deterrents to fraudulent financial reporting.

    Top management influences the company environment and determines how other organs of the company are going to function. By maintaining internal controls, fraudulent financial reporting can be prevented and detected before it is too late. Management should ensure that internal audit department is effective and functional.

    Independent audit committees play a very big role in maintaining the integrity of companies; therefore, there is a need for all companies to have them as a rule. Until the end users of these reports are quite informed and educated on the under dealings which happen before the final financial reports are released, there is bound to be more and more cases of losses resulting from the effects of fraudulent financial reporting. The accepted auditing standards need to incorporate a provision for independent public accountants to play a bigger role in detection and prevention of fraudulent financial reporting. Strengthening of peer reviews and concurring (comparing notes) also highly contribute to deterrence of fraudulent financial reporting. Resisting pressures on the part of accounting firms is necessary to ensure audit quality. It is the responsibility of independent public accountants to make sure their end users are guaranteed of mistakes and errors. Brown, (2001) adds that, there is a need to make sure that; audits that serve as a guide to assuring financial statements are free from misstatements. The audit reports should also indicate how reliable they are so as to enable users to properly judge their dependability.

    Role of the Accounting Profession.

    The public accounting fraternity can better control and prevent fraudulent financial reporting by introducing mandatory memberships. This can put into check players are out to capitalize on fraudulent financial reporting. Under one umbrella body, members will be guided by a certain code of conduct as well as rules and regulations therefore making it harder for them to involve in fraudulent activities. By educating aspiring professionals on role and importance of professionalism and ethics future practitioners would be in better equipped to appreciate importance of honesty and professionalism and therefore desist from fraudulent activities. These values if incorporated in curricula activities and examinations for accountants will also contribute in proactive fraud prevention.

    Role of Government.

    Through the State control boards, the government has put in place programs geared at quality assurance of services being offered by independent public accountants. By availing resources such as funding programs and trainings, the government plays an important role in ensuring that fraudulent control bodies are up to their task and are not impeded in their performance by limited resources.

    A wave of financial misreporting which has hit the U.S corporate sector in the recent times. Fraudulent financial reporting cost the US investors over $100 billion in 2001 and 2002 (Bartov, et al 2002). Financial misstatements and occupational fraud such as asset misappropriations and corruption are the commonest types of fraudulent financial reporting according to (Bartov, et al 2002).

    Examples of famous fraudulent financial reporting in the US include the Enron[1] and Worldcom[2] (New York) scandals. The two cases plus others in the recent past served as an eye opener to the problem of fraudulent financial reporting. This led to interest from the Congress, which in turn culminated in the enactment of the Sarbane-Oxley Act in the year 200. Below, is a graph depicting losses in dollars resulting from occupational fraud in the U.S for the period 1996 to 2002.

                                                                          Source: Association of Certified Fraud

    Through the financial crimes section (FCS), Federal Bureau of Investigation’s (FBI) is mandated to investigate corporate fraud, as well if necessary, facilitate forfeiture of assets obtained through fraud.

    Sarbanes – Oxley Act

    Of all efforts so far by the government to solve the fraudulent financial reporting problem, it is the Sarbanes – Oxley Act of 2002 (Pub. L.No. 107-204, 116 Stat. 745 (Public Company Accounting Reform and Investor Protection Act of 2002) that is the most remarkable.

    Named after Senator Sarbanes Paul and Representative Michael G. Oxley, it was an effort aimed at restoring public trust, which was waning after a wave of mega scandals. It increased corporate board’s responsibilities as well as penalties for fraudulent financial reporting criminals. On top of that, it mandated the Securities and Exchange Commission (SEC) to implement rulings on requirements for compliance with the Act (Macey, 2003).

    Conclusion.

    The contention that internal controls are the solution to fraudulent financial reporting is questionable. Given the fact that these can not 100% deter fraud, there is a need to incorporate both information of technology and goodwill from government to solve the problem.

    REFERENCE:

    Antifraud and Corporate Responsibility Resource Center, http://antifraud.aicpa.org/.

    Accessed on 17/10/06.

    Bartov, E., D. Givoly, and C. Hayn. (2002). The Rewards to Meeting or Beating

    Analysts’ Forecasts. Journal of Accounting and Economics 33: 173-204.

    Brown, L.D. (2001). A Temporal Analysis of Earnings Surprises: Profits versus Losses.

    Journal of Accounting Research 39: 221-241.

    Macey, J. R. (2003)”A Pox on Both Your Houses: Enron, Sarbanes-Oxley and the

    DebateConcerning the Relative Efficacy of Mandatory Versus Enabling Rules,” Washington.

    [1] Andrew Fastow, former CFO of Enron Adelphia founder John J. Rigas and his two sons allegedly looted over $300 million from the company. Visit http://antifraud.aicpa.org/ for more information.
    [2] WorldCom, an international telecommunications company, has its corporate headquarters in Clinton, Mississippi. Visit http://antifraud.aicpa.org/ for more information.

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