Keeping Everyone Honest: Financial Statement Fraud Schemes and IFRS

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Misty Carter, CFE
ACFE Research Specialist

The International Financial Reporting Standards (IFRS) are becoming familiar to many in the accounting and auditing world, especially those who perform work internationally. For those who are not familiar with the term, IFRS are a set of accounting standards developed to drive consistency in how publicly traded companies prepare financial statements. In other words, its purpose is to ensure that companies that transact business internationally are on the same page when reporting financials. I like to refer to it as a way of “keeping everyone honest.” Personally, I think that the idea of having one global standard for how companies prepare and report their financial statements is a good one. In fact, approximately 120 nations either permit or require IFRS. The European Union (EU) has fully conformed to IFRS and requires companies whose securities are listed on the EU-regulated stock exchange to prepare their financial statements in accordance with IFRS.

If someone were to ask my opinion on the biggest impacts the IFRS have on financial statements, I would have to say it would be related to how a company recognizes its revenue and values its assets. Why? Because these are the two areas in which fraudsters most commonly manipulate or falsify financials. When it comes to committing financial statement fraud schemes, falsifying revenue and overstating or even understating assets is a common theme — a theme that is not limited to any one specific accounting standard used in any particular country. I believe that it is vital for all companies, regardless of where they operate, to be aware of financial statement fraud schemes so they can be proactive in detecting red flags and identifying ways to prevent these schemes.

For those of you interested in learning more about IFRS and common financial statement fraud schemes, I encourage you to check out the new online self-study course, International Financial Reporting Standards for Financial Statement Fraud. This course provides an overview of IFRS with an emphasis on revenue recognition and the fair value of assets. It also covers the basics of financial statement fraud schemes, including red flags and methods to detect these schemes.

With so many companies operating globally, it is vital that everyone be aware of new and emerging changes in the financial world. One way to stay abreast of these changes is by becoming familiar with IFRS and its impact on financial statements. It is also essential that all companies take the necessary steps to prevent and detect financial statement fraud schemes.

Fraud Doesn’t Have to Be a Cost of Doing Business

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Zach Capers, CFE
ACFE Research Specialist

As a fraud examiner, I often see occasions when it seems that others do not recognize the seriousness of the threat posed by fraud. While Certified Fraud Examiners (CFEs) are trained to be familiar with many of the underlying causes of fraud and associated prevention strategies, fraud is too often dismissed by others as an acceptable loss or casually labeled as a cost of doing business. Moreover, management at many organizations would simply prefer to ignore these problems and absorb losses from fraud rather than open the company up to scrutiny and risk reputational harm. This frustrating attitude not only breeds an environment of indifference, but can often exacerbate the very factors that lead to fraud in the first place.

Few other industries are reputed to treat the problem of fraud with more apathy than that of construction. According to the ACFE’s 2014 Report to the Nations, 3.1 percent of all reported fraud cases occurred within the construction industry, resulting in a median loss of $245,000. Additionally, a recent Grant Thornton report found that approximately 10 percent of the global construction industry’s profits are lost to fraud — a staggering amount totaling an estimated $860 billion.

While the ACFE’s new online self-study course, Construction Fraud, might seem suited only for those people either directly or indirectly involved in the construction industry, it has been designed to be of use to CFEs of all backgrounds. One of the most interesting aspects of fraud in the construction industry specifically is the fact that, from the inception of a project to its completion, virtually every type of scheme imaginable can take place, including corruption, bid rigging and fraudulent disbursements. Furthermore, the intricacy of most construction projects requires the inclusion of numerous parties, including government officials, corporate executives, contractors, suppliers and procurement specialists to name only a few. These factors combine to form a veritable microcosm of fraud from which everyone can learn.

Perhaps it is this overwhelming complexity that causes people to view fraud as an inevitable consequence of business in not only the construction industry, but countless others as well. However, all CFEs know that the only people benefiting from fraud in any industry are the fraudsters themselves.

Fraud affects the bottom line of all companies, which in turn affects every employee, whether in the form of a decrease in benefits, a salary increase put on hold, or any number of other negative consequences. For this reason, we should never accept fraud merely as a cost of doing business and should instead endeavor to change the permissive attitudes that enable fraud at the expense of everyone else.

How to Tame ‘Data in the Wild’

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Misty Carter, CFE
ACFE Research Specialist

Emails, social media posts, blogs, instant messages — what do they all have in common? For one, they are tools used by millions of people each day to communicate with the rest of the world. What else do they have in common? They help detect fraud. You might be wondering, “Why and how is a Facebook update relevant to fraud detection?” Consider how much new data is created every second. Think about how many posts, emails or text messages you personally send each day. Now think about how much of this data is never touched. 

To put it into perspective, a study conducted by International Data Corporation (IDC), a U.S. market research firm, estimated that text, also known as unstructured data, will account for 90 percent of all data created in the next decade. Unstructured data, sometimes referred to as “data in the wild,” is basically free-form data that has not been put into a structured format. Since unstructured data is a relatively unexploited resource for fraud examiners, it makes sense to use it in a way that can provide more insight into areas prone to fraud that might have been previously untouched.

Before coming to the ACFE, I spent 10 years working in the audit field. I found mining through text data during fraud investigations to be one of the most useful tools in my auditing toolkit. Today, many fraud examiners are using a similar data analysis method to help explain, understand, or interpret a situation or a person’s actions or thoughts. This type of non-traditional analysis is referred to as textual analytics. In fact, the FBI and Ernst and Young’s Fraud Investigation and Dispute Services Practice have used textual analysis on email communications from past corporate investigations to determine the most common words used by employees engaged in rogue trading and fraud. As a result of their analysis, they identified the top 15 keywords and phrases used by fraud perpetrators. This list of keywords can be used proactively to prevent fraud from occurring or spot it early in the process.

The use of keywords, however, is only one facet of analyzing textual data. The ACFE’s new online course, Textual Analytics, identifies various techniques that can help fraud examiners, including examples of how data from free-text fields, email, social media sites and other sources can be used to uncover fraud. This course provides an overview of different types of data and how it should be managed prior to being analyzed. It also explains how textual data can be used to assess fraud risk in areas that might not be on management’s radar. 

If you are looking for new and innovative ways to add value to your organization, this course will provide you with the tools necessary to effectively reduce fraud risk exposure while enhancing your fraud detection skills.

Read more about the new course.  

Preventing and Detecting Financial Institution Fraud

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Jacob Parks, J.D., CFE
ACFE Research Specialist

One of the most flagrant money laundering violations in recent memory occurred at an HSBC branch in Mexico, where drug traffickers were depositing huge sums of cash in violation of anti-money laundering regulations and best practices. The task was so routine for the criminals that they started transporting the cash in boxes that were specifically designed to fit through the dimensions of the teller’s window. Then, someone started thinking outside the box and came up with the idea of making the opening in the teller’s window bigger to more easily facilitate the cash deposit process. That kind of breakdown in ethical culture only occurs when there is either corruption in management or (at best) poor oversight.

Frauds against financial institutions from outside parties are often crimes of opportunity, especially when it comes to cybercrime. Customer information, proprietary data and other confidential information stored by financial institutions are top targets for cybercriminals, and breaches can result in both financial losses and a damaged reputation.

Fraudsters find it easy to rationalize their crimes against what they perceive to be large, monolithic profit machines. When the bank is the victim, the criminal might think: “The banks deserve this.” “The money is insured, anyway.” “It’s a victimless crime.” Never mind the fact that the costs of fraud inevitably get passed on to consumers, because most fraudsters are not interested in taking rationalizations all the way to their moral conclusions. Likewise, frauds committed by financial institutions and their employees often involve large groups of victims, such as a class of customers, the government, investors or other financial institutions.

While the rationalizations for fraud involving financial institutions might be inevitable, these organizations can take measures to reduce their exposure and to prevent people within their organization from committing fraud. The ACFE’s new Preventing and Detecting Financial Institution Fraud course reviews these and similar schemes, and the ways to detect and prevent them.

These schemes and countless other threats make being a fraud examiner in the financial institution sector a challenging task. However, there are effective controls and techniques available to reduce fraud losses, comply with regulatory demands, and satisfy customers.

How to Start the Ethics Conversation

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Catherine Lofland, CPA
ACFE Research Specialist

Someone once told me about a girl who was a cashier at a large grocery store chain. On her 15-minute break, she helped herself to a snack from the bulk bins. Although each item from the bulk bins is priced differently and therefore charged individually, she assembled a quick mix of almonds, cashews, dried cranberries and goji berries in one bag. When she paid for the bag, she checked herself out and used the code for almonds, the cheapest item in the mix. As she left the store after her shift, she was arrested and charged with theft.

The cashier probably thought mischarging a few goji berries (which can cost over $14/lb) was no big deal. Her employer clearly disagreed.

While some might argue involving the police was an unnecessarily harsh reaction to such a petty crime, it is critical for a company’s employees to exhibit an unwavering commitment to high ethical standards. After all, if this employee had gotten away with mischarging these items, what might she steal in the future? Could you really describe this employee as “ethical?”

For many people, ethics is an esoteric concept. Philosopher Philip Wheelwright defines ethics as “that branch of philosophy which is the systematic study of reflective choice, of the standards of right and wrong by which it is to be guided, and of the goods toward which it may ultimately be directed.” While most people have a general idea of what ethics is, the concept does not receive enough discussion, analysis and attention. Many leaders avoid the topic because it is not cut-and-dry. It is difficult to teach and understand. However, I think everyone recognizes the importance of an ethical workplace culture.

If you’ve been looking for a way to start the conversation about ethics at your organization and implement a formal ethics program, or tweak an existing one, I encourage you to check out one of our newest online self-study courses, How to Build an Effective Ethics Program. This course teaches you how to perform an ethics audit, it identifies the essential components of an ethics policy and it provides guidance on how to conduct engaging ethics training. Most importantly, however, it teaches you how to integrate an ethics policy into the operations and culture of your organization.

According to the 2012 Kroll Advisory Solutions’ Global Fraud Report, more than 66 percent of corporate frauds are committed by insiders. Although conducting background checks and speaking with references are good practices for vetting job seekers, not all unethical people have an incriminating past. The ACFE reports in its 2012 Report to the Nations on Occupational Fraud and Abuse that 87 percent of fraudsters had no criminal background prior to the offense and had never been punished or terminated by an employer.

For an ethics program to be successful, an organization must support an ethical culture. Individual character traits might predispose a person to ethical or unethical behavior, but the cultural context in the organization also has a powerful influence on the employees’ actions. Being immersed in an ethical culture might make someone think twice about stealing a few goji berries… or embezzling a few thousand dollars.