Financial Analysis

Common Forms of Financial Statement Fraud


In the summer edition of To Your Credit, we published an article on the work of Professor Messod D. Beneish from the Kelley School of Business, Indiana University on the subject of earnings manipulation.  In the sample of 74 companies that Pr. Beneish looked into for his research, he concluded that the typical manipulators “overstated earnings by recording fictitious, unearned, or uncertain revenues, recording fictitious inventory, or improperly capitalizing costs.” 

A review of SEC enforcement releases throughout the period of 2000-2006 that the Deloite Forensic Center conducted in June 2007 further reinforced this finding.  In their report Ten things about financial statement fraud, they came up with a list of the top six fraud schemes that were the most common amongst earnings manipulators and these were:

  • Manipulation of Assets
  • Manipulation of Expenses
  • Manipulation of Liabilities
  • Manipulation of Reserves
  • Revenue Recognition
  • Improper Disclosures

Fraudulent acts can be disguised in any one of the following forms:  

  • falsified purchase orders
  • false invoices
  • failure to write off assets
  • extending the lives of depreciable assets
  • inadequate reserve for known losses on obsolete inventory
  • recording ghost inventory
  • Recognizing revenue for future sales in current fiscal year

Opportunities for fraudulent financial reporting: Fraudulent financial reporting is likely to occur when the following conditions are present:

  • Poor internal accounting controls
  • Transactions are convoluted, complex and out of the ordinary
  • Accounting estimates requiring significant subjective judgment by company management
  • Absence of an audit committee
  • Understaffed internal audit department
  • Sudden decreases in revenue or market share
  • Unrealistic budget pressures

It may be difficult for credit professionals to develop the level of analytical skills necessary to expertly detect frauds.  However, when conditions such as the ones listed above become apparent with credit customers, it would be wise to exercise caution.        


Association of Certified Fraud Examiners,

Deloitte Forensic Center,

Journal of Accountancy,

Report of the National Commission on Fraudulent Financial Reporting


Published under: Financial Analysis
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