Financial Statement Fraud Detection

All multinationals and large organizations are at risk to fraud which can also lead to complete
collapse of the organization. A fraud is an act of deceiving others and causing a loss to the victim
and the executor achieves benefits and gain in return. The perpetrator can be from any ethnic
backgrounds, any religion, race or color but is convinced to commit the fraud (Richards, 2009).
These frauds can cause loss of investment, legal issues and capital loss. The fraudulent attitude of
few executives has also led to the downfall of the organization and has had very negative impact
on the brand name and reputation of the company (Richards, 2009). Organizations have
increased the responsibility of the management to create a risk free environment. In the recent
years the scandals in corporate sector has led to a non tolerant behavior from the higher
management and stakeholders. The management must ensure a set of values and good behavior
in the organization.
Over last decade the economic boost in the research and academic industry has increased the
amount of financial accounting fraud and it has become a subject of vast importance. The
internal audit systems in most of the organizations have failed due to which special procedures
have been created to detect the accounting frauds. The financial accounting fraud detection
(FAFD) is also known as forensic accounting (Anuj Sharma, 2012). Different procedures have
been designed to detect the frauds in the accounting. One of such technique is data mining. The
American Accounting Association (AAA) has a dedicated audit section that develops the
standards for auditing for the clients to view the academic literature and research. This
association carries out research on the financial reports of the fraudulent. (Hogan, 2008). The
consequences of the fraud and the trend that it follows are studies in the researches to find out the
possible reasons of the accounting frauds. These researches also analyze how to detect these
frauds and then how to prevent the organizations from such defaulters.
When a fraud occurs there are generally three reasons behind it according to the Statement on
auditing Standards (SAS). The first condition is that there is some pressure due to which the
fraud occurred. The second reason can be an opportunity from a weak management control
system or any other factor due to which the fraud perpetrate. And the third reason is that there is

a general behavior and attitude to commend a fraud. This is also called a fraud triangle (Hogan,
2008). This is the research finding of the SAS No. 99. For example the Bell and Carcello (2000)
supported this fraud triangle and found out that there are a number of factors such as fast growth
in business, weak management control, senior management over occupied in meetings, lack of
communication and lies between auditors and clients. (Hogan, 2008)
The pressure to misquote the earnings is raised when the analysts need the external financing. It
is also seen in few researches that misstatements are mostly reported in companies that are in
debt or companies raising new capital or where the chairman of the company is also the CEO.
Many companies have also been reported to backdate their stocks which is an act considered
under fraud. (Anuj Sharma, 2012)
The firms that do fraud have more difference between changes in financial measures and in
nonfinancial measures. The non financial measures are more closely examined while assessing
the fraud. Another approach to identify a fraud by Benfords Law is digital analysis (Pornelli,
2010). According to this law the actual number of digit in a data is compared to the anticipated
frequency and the divergence to it is noticed. At the initial stage when the beginning of the fraud
is being detected the Benfords Law can be applied.
The organization needs to put in careful efforts to protect it from any fraud. There are certain
measures that any management needs to take to manage this risk. Company may create a special
fraud risk management cell where a special policy is designed to manage the risks regarding the
fraud. The board of directors or senior management may design a written policy for fraud risk
management. This policy should be assessed occasionally to identify any potential factors that
might lead to fraud (Richards, 2009). Various techniques can be developed by the organization to
avoid the risk factors that may lead to a fraud. When prevention fails proper fraud detection
methods should be established by the management.
The preventive measure is the first step to minimize the risk of fraud. As the prevention step fails
the techniques to detect the fraud can be established. A detection plan which is successful can
lead to a strongest restraint to the fraudulent attitude. The fraud detection techniques depend
upon the type of risks in the organization. For example companies operating in countries having
a high corruption rate may implement detection techniques of FCPA and reports on the annual

expenses can be reviewed. For some companies internal audit can also serve as a detection
method. (Richards, 2009)
A morally cultured environment at the top leadership of the organization leads to create an
ethical culture and reduces the risk of fraud. The expectations of doing the right thing from the
top management provide less opportunity of fraud and if it is committed at any level it is easy to
identify it. When an organization has a culture of honesty and truthfulness it limits the fraudulent
activities (Pornelli, 2010). The top management needs to develop risk management and fraud
detection programs. Audit committees can be formed to monitor the risk and fraud. It is believed
that if the senior management lives by the rules of ethics and demonstrates it to its employees it
will play a vital role in decreasing the fraud.
When the accountants failed to recognize the financial statement fraud it was criticized
professionally throughout the USA, Canada and other states as well. This led to the requirement
that the auditors need to notice the fraud and detect it at the right time while conducting the
audit. Internal auditors and account officers are also asked to recognize the fraud taking place
and identify it while auditing procedure. (Subramanian, 2012)
There are several reasons for financial statement fraud identified by the experts. The root cause
of this increasing problem may be that the economy is increasing at a good rate and the
executives are more interested in the stock market benefits. It can also occur due to a moral
downfall of the individuals of the society (Subramanian, 2012). Another reason could be the
greed by the commercial and investment banks that focus on short term benefits. The common
factors of financial statement fraud can be the chance to commit a fraud because the rules of
accounting in USA are such that deceitful acts can be performed easily. (Gupta, 2012)
An auditors job is to detect the fraud and also prevent it. With the increase in the financial
statement fraud that occurred over the past few years the companies are looking for auditors who
can look into some warning symbols and detect and fraudulent activity. A number of warnings
are present in the case which can be detected by auditors. (Colby, 2015)One of the sign could be
weak internal environment of the organization and the decisions are under control of an
individual or a group of senior managers. Sometime it is because managers have a very harsh

and aggressive behavior. Managers also have some disputes with auditors which lead to the fraud
by the staff. (Colby, 2015)
It is the ultimate responsibility of the management of the organization to look after the financial
statement and to prevent any kind of fraudulent act and detect it at the right time. Various
practices can be implemented to reduce the risk of fraud by using techniques to prevent and
detect te fault. Along with the managements responsibility it is also the duty of the auditor to
keep a check and balance on the financial statements. (Gupta, 2012) It can be done by creating
an internal audit team and a special external audit committee for a double check. It is important
to beware of the warnings mentioned above. If any such sign is noticed by the auditor it means
there is a problem and then subsequent steps should be taken to prevent it. (Colby, 2015)
Timely Prevention and detection of financial statement fraud will contribute a lot to any
organization. New methods have been deduced such as data mining techniques for the prevention
and detection. (Subramanian, 2012) The data mining methods used are viewed on the basis of
three different criteria which measure the sensitivity and the selectivity. These techniques are
such that they will detect the fraud in case when the prevention technique is failed. Hence this
framework will detect the fraudulent behavior. (Gupta, 2012)

References

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https://arxiv.org/ftp/arxiv/papers/1309/1309.3944.pdf (Accessed: 12 April 2016).
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Richards, D. (2009) Institute of Internal Auditors. Available at:
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