Accounting Fraud

Case Study
Freddie Mac Scandal (2003)

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Bagas Septianto Prabowo (1406545453)

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Hidayatur Rahman Handoko (1406546494)

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A Paper for
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Introductory Acounting I
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Course
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Faculty of Economics
Universitas Indonesia
Depok
2014
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 STATEMENT OF AUTHORSHIP

“We, the undersigned, certify that the paper/assignment attached is purely our original work.
No work of others that we use without citing its sources.

Except where reference is made in the text, this document contains no material presented
elsewhere or extracted in whole or in part from a document presented by us for another
qualification at this or any other institution.

We understand that the paper which we collect may be reproduced or communicated for the
purpose of detecting plagiarism.”

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Name NPM Signature

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Bagas Septianto Prabowo 1406545453
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Hidayatur Rahman Handoko 1406546494

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Course : Introductory Accounting I

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Title of the Paper : Case Study

Freddie Mac Scandal (2003)
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Date : October 22th, 2014

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Lecturer : Rallyati Anas, M.Ak.

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 CONTENTS

Cover Page …………………………………………..…………………………………….. 1

Statement of Authorship ………………………………………………………………….. 2

Contents ……………………………………………………………………………………. 3

Chapter 1 : Introduction ………………………………………………………………….. 4

A. Background …………………………………………………………………….. 5

B. Problem Formulation ………………………………………………………….. 6

C. Objective of Analysis ………………………………………………………….. 7

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D. Methods of Analysis …………………………………………………………… 8

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E. Outline of the Paper …………………………………………………………… 9

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F. Theoritical Basis ……………………………………………………………….. 10
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Chapter 2 : Case Analysis ……………………………………………………………….. 11
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A. Case Summary ………………………………………………………………… 12

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B. Case Analysis ………….………………………………………………………. 13

Chapter 3 : Conclusion …………………………………………………………………… 14

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Bibliography ……………………….……………………………………………………….. 15
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 CHAPTER 1
INTRODUCTION

A. Background
Freddie Mac is a Government-Sponsored Enterprise (GSE) that has a mission to stabilise
the nation's mortgage markets and widen opportunities for home ownership and affordable
rental housing. But from 2000 to 2002, Freddie Mac understating their earning by around
$5 billion. Some insider trading case are revealed. Freddie Mac fined $50 million by the
U.S. Securities and Exchange Commission.

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B. Problem Formulation

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What is the solute of Freddie Mac scandal in 2003?

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C. Objectives of Analysis
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The objective is to find out what the solution of Freddie Mac scandal in 2003 is.
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D. Method of Analysis
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The method of analysis used is literature study from virtual sources.

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E. Outline of the Paper

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• Introduction; contains background, problem formulation, objectives of analysis, method

of analysis, outline of the paper, and theoretical basis.
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• Case analysis; contains causes and effects of misstating accounting report, especially in
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the Freddie Mac accounting fraud case in 2003.

• Conclusion; contains what the solution of Freddie Mac scandal in 2003 is.
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F. Theoretical Basis
Financial Accounting Standards Board (FASB) has been the designated organization in
the private sector for establishing standards of financial accounting that govern the
preparation of financial reports by nongovernmental entities. Those standards are officially
recognized as authoritative by the Securities and Exchange Commission (SEC) (Financial
Reporting Release No. 1, Section 101, and reaffirmed in its April 2003 Policy Statement)
and the American Institute of Certified Public Accountants (Rule 203, Rules of Professional

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 Conduct, as amended May 1973 and May 1979). Such standards are important to the
efficient functioning of the economy because decisions about the allocation of resources
rely heavily on credible, concise, and understandable financial information.

Accounting period is the regular span of time used for accounting purposes. A time
period reflected by a set of financial statements. In terms of taxation, it is the twelve month
period a taxpayer uses to determine their tax or related tax liability.

Accounting scandals are political and/or business scandals in form of financial misdeeds
by trusted executives of corporations or governments. Such misdeeds typically involve
complex methods for misstating funds, overstating revenues, understating expenses,
overstating the value of corporate assets or underreporting the existence of liabilities,

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sometimes with the cooperation of officials in other corporations or affiliates.

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On the other hand, from Webster’s Finance and investment dictionary, accounting fraud

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is known as falsifying accounting records, such as sales or cost records, in order to boost
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net income or sales figures. Accounting fraud is illegal and subjects the company and the
executives involved to civil lawsuits. Company officials may resort to accounting fraud to
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reverse a loss or to ensure that they meet Wall Street’s earnings expectations.
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Another definition of acounting fraud, is the intentional misrepresentation of accounting

records regarding sales, revenues, expenses, and other factors for a profit motive such as
inflating company stock values, obtaining more favorable financing or avoiding debt
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obligation. Employees who commit accounting fraud at request of their employers are
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subject to personal criminal prosecution.

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False Accounting Fraud, which happens when company assets are overstated or
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liabilities are understated in order to make a business appear financially stronger or

weaker than it really is. By misstating the financial statements, the company cannot reflect
their real value or their financial condition to those who needs it, which can leads to many
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problems.

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 CHAPTER 2
CASE ANALYSIS

A. Case Summary
- Freddie Mac is a Government-Sponsored Enterprise (GSE), that is, a business

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entity that has a distinct relationship with the government, was chartered by

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Congress in 1970 as a private company with a mission to stabilize the nation's

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mortgage markets and widen opportunities for home ownership and affordable

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rental housing.
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- Freddie Mac was created by Congress to make mortgages affordable and pump
cash into the market by buying blocks of home loans from lenders and bundling
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them into securities for sale to investors worldwide.

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- Freddie Mac misstated earnings by understating them, around $5 billion from 2000-
2002.
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- Understating earnings effect the economy by misallocation of resources.

- Insider trading is another consequence of understating earnings, which make the

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market thinks the company has a lower income and seems uninteresting for the
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market. The insider taking advantage of this false information illegally.

- Another consequence is the market may misestimate the risk of the company.
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- The SEC fined Freddie Mac for $50 million. The four executives who conceived and
executed this fraud were also punished. Their fines ranged from $65,000 to
$250,000. They paid out disgorgement amounts that ranged from $29,227 to
$150,000.

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 - In a lawsuit filed in federal court in Washington, the SEC said Freddie Mac
"engaged in a fraudulent scheme that deceived investors about its true
performance, profitability and growth trends.”

B. Case Analysis

Misstating accounting report, especially understating it, could be done by decreasing the
income, increasing the liabilities, decreasing the assets, increasing the expense, etc.
Those kind of thing would make investors think that the company is not performing well,
even tough it is doing well. Therefore, the price of the company in the stock market will be
decreasing as well.

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The top persons of the company could take advantage on this situation illegally. They who

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know the real condition of the company could buy the company’s stocks as much as

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possible since the price has been dropped to its lowest level. They do not have to be

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worried because they could put the right report any time they want and then the price of
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the company’s stock will rise again. This is usually called by insider trading and is a high
level crime.
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The misstated accounting report done by Freddie Mac - smartpros.com

Reported Net Restated Net
Year Difference
Income Income
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2000 $2.547 $3.666 $1.119

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2001 4.147 3.158 (0.989)

2002 5.764 10.090 4.326
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The table above is presenting the misstated earnings Freddie Mac made in 2000 to 2002.
As we have told earlier, this case are indicating that the board of Freddie Mac is doing
insider trading.

Furthermore, misstating accounting report could also put the money market into disorder.
It would make the investors misjudge the market. The economy would also affected since
the resources would be misallocated. Moreover, it would make the company looks steady
as well.
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 CHAPTER 3
CONCLUSION

To reduce this kind of crime, a firm penalty has to be done to each of the suspects that
have done this crime earlier as an example to other companies and their board that this
kind of crime is unacceptable in the economy and business.

The four executives who involved in the fraud, was given punishment by paying a certain
amount of money to the SEC. They are former president and chief operating officer David
Glenn, ex-chief financial officer Vaughn Clarke, and former senior vice presidents Robert

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Dean and Nazir Dossani. David Glenn, fined $ 250.000 in civil fine, and $ 150.000 in

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restitution. The ex-chief financial officer Vaughn Clarke, fined $ 29.227. The former senior

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vice presidents Robert Dean, fined $ 34.658 in restitution.

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 BIBLIOGRAPHY

Ketz, J Edward 2007, Freddie Mac’s Scandal and the SEC’s Judgment, SmartPros,
viewed 11 November 2014, <http://accounting.smartpros.com/x59491.xml>

2003, Freddie Mac Outlines Details of Earnings Manipulation, Accounting Web, viewed 11
November 2014, <http://www.accountingweb.com/topic/freddie-mac-outlines-details-
earnings-manipulation>.

2012, Freddie Mac Fraud, Slide Share, viewed 11 November 2014,

<http://www.slideshare.net/acw007/freddie-mac-fraud>

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2010, -, Your Distionary, viewed 11 November 2014,

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<http://www.yourdictionary.com/accounting-fraud>.
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‘Action Fraud’ -, False Accounting Fraud, U.K. Police, viewed 11 November 2014,
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<http://www.actionfraud.police.uk/fraud-protection/false-accounting-fraud>.
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‘Definitions’ -, -, U.S. Legal, viewed 11 November 2014, <http://definitions.uslegal.com/>.

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-, Facts About FASB, FASB Official Website, viewed 11 November 2014,

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<http://www.fasb.org/facts/>
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