Financial statement fraud has been around for a long time.

An employee who is stealing assets, cash or writing fraudulent checks will then manipulate financial statements to keep them in line with the books.

It has contributed to some of the most dramatic failures in the history of the financial services industry and continues to wreak havoc on businesses large and small.

From Cover-Up Tactic to Primary Fraud

But in the past few years, there’s been a shift from financial statement fraud as a secondary fraud to cover up a deception to financial statement fraud as the primary fraud, says Tiffany Couch, founder and principal of Acuity Forensics, a forensic accounting firm based in Vancouver, Washington.

She gives an example of someone applying for a loan who wants to stay within the loan covenant or want to make their company look healthier than it is.

“They’ll make revenues look better, assets look better, in order to get the loan,” she says.

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“We’re seeing people who were used to getting large bonuses, stock options and, as a result of the financial results of a company, start losing out because the companies aren’t as healthy.

So I’ve seen financial statement fraud just to make company look healthy so that I can get my bonus or my stock option or my raise,” says Couch.

Types of Financial Statement Fraud

There are a couple common forms of financial statement fraud.

The Recording of Fictitious Revenues

The most common form of financial statement fraud is the recording of fictitious revenues.

“I just record fake sales that make my income statement look better, my bottom line look better, and it creates accounts receivable,” says Couch. “And banks love accounts receivable on the balance sheet.”

Not Recording Expenditures and Liabilities on Time

The second most common scheme is not recording expenditures and liabilities on time, says Couch.

“I’ve incurred that expense but I’ll just wait until the next month or the next fiscal year to record it and make my company look healthier.”

Red Flags for Financial Statement Fraud

A common indicator is the presence of a closely held group of people at the top who restrict an investigator’s ability to talk to anyone outside the group, says Couch.

“They are really controlling your access as a monitor or investigator, [controlling] your ability to get information.”

The presence of financial pressure is another red flag, she says. “So you know that their industry is falling or in a downturn, maybe their margins are tighter, they’re having a hard time with cash flow. Those are just some incentives, it doesn’t necessarily mean that somethings going to happen but that’s a red flag and you just need to satisfy yourself that nothing bad is going on. So you just need to be closely looking at their books, interviewing and reviewing documents.”

Who Commits Financial Statement Fraud?

Not surprisingly, financial statement fraud is usually committed by those in senior positions, such as upper level management, CEOs, CFOs, COOs and owners. These are the people who stand to gain from a healthy bottom line.

Sometimes, but less commonly, an upper level sales person will manipulate results for a commission.

Importance of Oversight

Preventing fraud is a top-down initiative, and a strong board of directors is a powerful deterrent. “Any sort of oversight you can have by external auditors or internal auditors is really smart,” says Couch.

She also recommends examining trends and using financial statement analytics and ratio analysis to detect anomalies. “Do they look in line with the industry? Does it look in line with the company as a whole? And does anything seem out of whack?”

But as with any type of fraud, a strong tone at the top and a commitment from the board of directors with follow through from management all the way down to the individual employee is the best way to foster a culture in which fraud can’t flourish.