Detecting Accounting Fraud Before It's Too Late E-Book

Oriol Amat

• Herausgeber: John Wiley & Sons
• Kategorie: Fachliteratur
• Serie: Wiley Finance Series
• Sprache: Englisch

Seitenzahl: 283

Veröffentlichungsjahr: 2019

Beschreibung

Detect accounting fraud before it's too late Accounting fraud is the deliberate manipulation of accounting records in order to make a company's financial performance seem better or worse than it actually is. Accounting scandals often have catastrophic consequences for shareholders and employees. Thus, analysts and auditors must be equipped to detect accounting fraud. This book is a comprehensive guide to detecting accounting fraud for auditors investigating accounting fraud and analysts/managers seeking to prevent it. A wide variety of warning signs are described, as are several techniques for detecting and addressing fraud. * Understand the motivations and warning signs behind accounting fraud * Get to know how accounting fraud is done and how to detect it * Avoid the losses that often come from accounting fraud * Benefit from case studies throughout to that help illustrate the author's points It's unfortunate that managers, auditors, and analysts must be wary of accounting fraud--but this book equips you with the know-how to detect it before it's too late.

Leseprobe

Table of Contents

Cover

Prologue

Introduction

ACKNOWLEDGMENTS

CHAPTER 1: Fraud and Accounting Manipulations

1.1 FRAUD AND ITS EFFECTS

1.2 MODIFYING COMPANIES' FINANCIAL INFORMATION

1.3 CALLING THINGS BY THEIR NAME: FROM CREATIVE ACCOUNTING TO BIG BATHS

REFERENCES

CHAPTER 2: Accounting Fraud: An Ancient Practice

2.1 THE FIRST ACCOUNTING FRAUDS

2.2 ACCOUNTING FRAUDS CONTINUE WITH THE DOUBLE ENTRY

2.3 THE CRASH OF 1929 AND THE OBLIGATION TO AUDIT ACCOUNTS

2.4 REINFORCEMENT OF THE COMMERCIAL LAW AND AUDITING AFTER THE STRING OF SCANDALS OF 2000

2.5 WITH THE CRISIS OF 2008, HISTORY REPEATS ITSELF

REFERENCES

CHAPTER 3: Problems with Legislation and Those Involved in the Financial Information

3.1 HOW FINANCIAL INFORMATION IS GENERATED

3.2 AUDITING OF ACCOUNTS: ESSENTIAL, BUT NOT INFALLIBLE

3.3 ANALYSTS AND RATING AGENCIES

3.4 REGULATORS AND THE LIMITATIONS OF ACCOUNTING REGULATIONS

3.5 ROLE OF THE MEDIA

REFERENCES

CHAPTER 4: Why Are Accounts Manipulated?

4.1 MOTIVATION, OPPORTUNITY, AND RATIONALIZATION

4.2 THE DOOR TO FRAUD

REFERENCES

CHAPTER 5: Legal Accounting Manipulations

5.1 ALTERNATIVES, ESTIMATIONS, AND LEGAL GAPS

5.2 MAIN LEGAL MANIPULATIONS

5.3 IMPACT OF LEGAL MANIPULATIONS IN THE ACCOUNTS

REFERENCES

CHAPTER 6: Illegal Accounting Manipulations

6.1 ACCOUNTING CRIME

6.2 HOW ILLEGAL MANIPULATIONS ARE DONE

6.3 OPERATIONS THROUGH TAX HAVENS

6.4 MAIN ILLEGAL MANIPULATIONS

6.5 MAIN ITEMS AFFECTED BY ACCOUNTING FRAUDS

REFERENCES

CHAPTER 7: Ethical Considerations and Economic Consequences of Manipulations

7.1 THE ETHICAL DIMENSIONS OF ACCOUNTING FRAUD

7.2 ECONOMIC CONSEQUENCES OF ACCOUNTING FRAUD

7.3 CONSEQUENCES TO MANAGERS AND COMPANIES THAT MANIPULATE ACCOUNTS

7.4 WHAT TO DO WHEN A COMPANY DETERIORATES

REFERENCES

CHAPTER 8: Personal Warning Signs

8.1 MOMENTS THE WARNING SIGNS OCCUR

8.2 WARNING SIGNS BEFORE FRAUD OCCURS

8.3 WARNING SIGNS AFTER THE FRAUD OCCURS

8.4 LANGUAGE OF FRAUDSTERS

8.5 SUCCESSFUL BUSINESSMEN WHO END UP IN JAIL

REFERENCES

CHAPTER 9: Organizational Warning Signs and Nonfinancial Indicators

9.1 WARNING SIGNS BEFORE A FRAUD OCCURS

9.2 WARNING SIGNS AFTER A FRAUD OCCURS

9.3 WARNING SIGNS BASED ON NONFINANCIAL INDICATORS

REFERENCES

CHAPTER 10: Warning Signs in the Accounts

10.1 AUDITING OF ACCOUNTS

10.2 BALANCE SHEET

10.3 INCOME STATEMENT

10.4 CASH FLOW STATEMENT

10.5 STATEMENT OF CHANGES IN EQUITY

10.6 NOTES

10.7 RATIOS THAT ANTICIPATE FRAUDS

10.8 VARIATIONS IN ACCOUNTS THAT WARN OF FRAUDS ALREADY PRODUCED

10.9 RATIOS THAT WARN OF FRAUDS ALREADY PRODUCED

10.10 SYNTHETIC INDEX TO DETECT MANIPULATING COMPANIES

REFERENCES

CHAPTER 11: Some Suggestions to Improve the Current Situation

11.1 REINFORCE VALUES AND INSTITUTE ETHICAL CODES

11.2 IMPROVE CONTROL SYSTEMS IN ORGANIZATIONS

11.3 IMPROVE REGULATION

11.4 REINFORCE SUPERVISION

11.5 REINFORCE THE SANCTIONING REGIME

11.6 THE CHALLENGE OF PROVIDING RELEVANT INFORMATION FOR DECISION-MAKING

REFERENCES

NOTE

EPILOGUE

APPENDIX 1: Criminal Responsibility of Legal Entities and Regulatory Compliance

A1.1 INTRODUCTION

A1.2 TYPIFIED CONDUCTS

A1.3 CRIMES ATTRIBUTABLE TO LEGAL ENTITIES

A1.4 ORGANIZATION AND MANAGEMENT MODELS

A1.5 MODELS OF PREVENTION AND CONTROL

REFERENCES

NOTE

APPENDIX 2: Audit Program for the Identification of Fraud Risks

A2.1 OBJECTIVE

A2.2 CONCLUSION

List of Companies Mentioned in the Book and Section in which They Appear

Index

End User License Agreement

List of Illustrations

Chapter 1

FIGURE 1.2 A bank's result with and without income smoothing

Chapter 3

FIGURE 3.1 Agents that intervene in the formulation, approval, control, and d...

FIGURE 3.2 Evolution of Lehman Brothers quotation (dollars) and rating

Chapter 4

FIGURE 4.1 The Triangle of Fraud (Cressey, 1980)

FIGURE 4.2 The door to fraud

FIGURE 4.4 Evolution of Royal Ahold price, compared to that of Carrefour and ...

Chapter 6

FIGURE 6.6 Evolution of the earnings per share declared by Xerox, manipulatio...

Chapter 7

FIGURE 7.2 Example of impact of accounting manipulations in the earnings of f...

FIGURE 7.4 Evolution of the price of Tesco

FIGURE 7.5 Evolution of Olympus' price from 2000 to 2016

Chapter 10

FIGURE 10.3 Evolution of the earnings (measured by net profit plus depreciati...

FIGURE 10.4 Z-score evolution of a company that was in default in year 8

FIGURE 10.5 Evolution of the price of LH from December 1999 to November 2000...

FIGURE 10.8 Evolution of incentives received by managers of La Polar

FIGURE 10.9 Evolution of the retail (sales) income and the financial income o...

Chapter 11

FIGURE 11.1 The door to fraud and several measures to reduce frauds

FIGURE 11.2 The Price of Deutsche Bank AG between 1999 and October 6, 2016

Guide

Cover

Table of Contents

Begin Reading

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Detecting Accounting Fraud Before It's Too Late

ORIOL AMAT

Copyright © 2019 by Oriol Amat. All rights reserved.

Published by John Wiley & Sons, Inc., Hoboken, New Jersey.

Published simultaneously in Canada.

English version by Raffaele Manini, UPF.

No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, scanning, or otherwise, except as permitted under Section 107 or 108 of the 1976 United States Copyright Act, without either the prior written permission of the Publisher, or authorization through payment of the appropriate per-copy fee to the Copyright Clearance Center, Inc., 222 Rosewood Drive, Danvers, MA 01923, [phone], fax [phone], or on the Web at www.copyright.com. Requests to the Publisher for permission should be addressed to the Permissions Department, John Wiley & Sons, Inc., 111 River Street, Hoboken, NJ 07030, [phone], fax [phone], or online at www.wiley.com/go/permissions.

Limit of Liability/Disclaimer of Warranty: While the publisher and author have used their best efforts in preparing this book, they make no representations or warranties with respect to the accuracy or completeness of the contents of this book and specifically disclaim any implied warranties of merchantability or fitness for a particular purpose. No warranty may be created or extended by sales representatives or written sales materials. The advice and strategies contained herein may not be suitable for your situation. You should consult with a professional where appropriate. Neither the publisher nor author shall be liable for any loss of profit or any other commercial damages, including but not limited to special, incidental, consequential, or other damages.

For general information on our other products and services or for technical support, please contact our Customer Care Department within the United States at [phone], outside the United States at [phone], or fax [phone].

Wiley publishes in a variety of print and electronic formats and by print-on-demand. Some material included with standard print versions of this book may not be included in e-books or in print-on-demand. If this book refers to media such as a CD or DVD that is not included in the version you purchased, you may download this material at http://booksupport.wiley.com. For more information about Wiley products, visit www.wiley.com.

Library of Congress Cataloging-in-Publication Data

Names: Amat, Oriol, author.

Title: Detecting accounting fraud before it's too late / Oriol Amat.

Description: Hoboken, New Jersey : John Wiley & Sons, Inc., [2019] | Includes bibliographical references and index. |

Identifiers: LCCN 2019003711 (print) | LCCN 2019005387 (ebook) | ISBN 9781119566861 (Adobe PDF) | ISBN 9781119566878 (ePub) | ISBN 9781119566847 (hardback)

Subjects: LCSH: Accounting fraud.

Classification: LCC HF5636 (ebook) | LCC HF5636 .A43 2019 (print) | DDC 658.4/73—dc23

LC record available at https://lccn.loc.gov/2019003711

Cover Design: Wiley

Cover Image: © stevanovicigor/Getty Images

To Pilar, Mireia, Natàlia, Marc, Lluis, and Anna.

Prologue

I consider myself an expert on corporate manipulation and fraud. I researched the issue extensively and was an expert witness in numerous lawsuits of corporate misinformation and fraud. I am also a CPA and have taught accounting for decades. So, I really didn't expect to learn a lot from yet another book about corporate fraud. What a surprise! Detecting Accounting Fraud Before It's Too Late, by Professor Oriol Amat, a well-known and prolific accounting scholar, is full of new facts, insights, and useful prescriptions about corporate fraud and information manipulation. What a delight to learn so many new and practical things from this book. It's also great fun to read. Did you know, for example, that fraud already existed in Mesopotamia in 1700 B.C.?

Information manipulation by public companies is prevalent. In the United States, more than 70% of public companies regularly beat analysts' consensus earnings estimates. This cannot be done without certain a “management” (an elegant term for manipulation) of analysts' estimates, reported earnings, or, in many cases, both. Accounting and finance research documents extensively numerous cases of corporate misinformation and reporting fraud. There is no doubt that this phenomenon is, regrettably, quite prevalent. But the evidence is scattered, and often anecdotal. There is, therefore, a need for a comprehensive, in-depth, and practical discussion of corporate fraud. This is provided by Detecting Accounting Fraud Before It's Too Late.

The book appropriately starts with a definition of financial reporting manipulation: intervention in the process of preparation of financial information to affect investors' perceptions. It goes on to note that 11% of all corporate-fraud cases involve accounting manipulations, closely behind theft and bribery. So, the book deals with a serious, worldwide phenomenon.

The main contribution of this book is in its wide scope. It opens with a fascinating historical perspective of infamous fraud cases: from Mesopotamia, through the Dutch East India Company in 1600, and ending with the recent scandals of Enron and Lehman Brothers. It then continues with a thorough treatment of information fraud, starting with the major means of fraud: accounting manipulations—using accounting procedures, such as manipulating the multiple estimates underlying financial reports, to change reported information, and real manipulations—cutting, or delaying expenditures, such as R&D, advertising, or maintenance to inflate reported earnings. The discussion of the means, or techniques, of fraud is demonstrated by multiple real-life fraud cases.

The book then moves to the important topic of who wins and who loses from financial information fraud. It turns out that in many cases the losers are the innocent bystanders: employees and customers who are seriously harmed by the implosion of fraudulent companies, like Enron and WorldCom. So, this is an important societal issue.

Next is a discussion of fraud prevention and the role of corporate governance in mitigating fraud. Finally, and this is a unique and an important contribution of this book, the author offers an evidence-based list of fraud warning signs (red flags). For convenience, the individual warning signs are combined into a fraud index that yields a unique number. This is very useful: Investors can rank companies, using the fraud index, by susceptibility to financial information fraud.

Detecting Accounting Fraud Before It's Too Late is thus a very important contribution to the growing literature on financial manipulation and fraud. Investors, corporate managers, and public policymakers in economics and capital markets will find this book very useful. It can also serve as textbook for the many college corporate fraud and forensic accounting courses.

Baruch Lev

Philip Bardes Professor of Accounting and Finance at New York University Stern School of Business

Introduction

Companies' financial information is essential for making decisions. For example, to study stock acquisition, grant a loan, or evaluate the company's management team. But there are many decisions regarding marketing, human resources, technology, or any other dimension of the company in which knowledge of the company's financial situation is decisive.

Therefore, it is essential that the accounts be reliable, because otherwise erroneous decisions can be made and in addition trust in the company may be lost.

However, problems of accounting reliability often occur. As an example, we recall a 2014 PriceWaterhouseCoopers (PwC) report that shows that in the two previous years, accounting fraud occurred in 11.2% of companies worldwide. It is 8.6% at the European level.

Accounting manipulation is a problem that causes concern, especially when it is repeated frequently, a circumstance that occurs mainly in years of economic crisis, since, with the fall of economic activity, the numbers deteriorate and more managers fall into the temptation to hide that things aren't going well. This concern motivates our interest in detecting fraud before it is too late.

On this topic, in 1996 we wrote the book Creative Accounting in cooperation with the late professor John Blake. Twenty years later the problem continues to exist, albeit with different dimensions, as the world of business, as well as the accounting and mercantile legislation, has undergone significant changes. In some aspects it has improved, but in many others it has gone backward.

This book describes and analyzes the nature of accounting manipulations, its motivations and also proposes several techniques to detect these practices.

In order to present the different topics in a more practical way, several real cases are described. Since some of these cases are recent events that are still being settled in court, the affected companies' names were omitted.

At the end there are suggestions that can help reduce accounting manipulations or, in case they occur, to detect them in time. The following figure shows the outline of the book:

ACKNOWLEDGMENTS

Before beginning the presentation, some acknowledgments: First, to Raffaele Manini, who is responsible for the English version of the book; to Jordi Lapiedra Cros, Josep María López Serra, and Beatriz Calvo Vallejo, who have made contributions included in Appendices 1 and 2; to Andrei Boar and Clara Calabuig, who helped me in the analysis of the Olympus case. I also appreciate the suggestions received from Tomàs Casanovas; Daniel Faura, president of the Col.legi d'Auditors-Censors Jurats de Comptes de Catalunya; the Board Members at ACCID (Fernando Campa, Carlos Puig de Travi, Xavier Subirats, Gemma Soligó, Joaquim Rabaseda); as well as Nicola Eusebio, Manel Haro, and Marc Oliveras. Finally, I also appreciate the collaboration of Bianca Regina Held for her insights regarding the translation of the book.

CHAPTER 1Fraud and Accounting Manipulations

A gray area where the accounting is being perverted; where managers are cutting corners; and where earnings reports reflect the desires of management rather than the underlying financial performance of the company.

—Arthur Levitt, Chairman of the SEC (Securities and Exchange Commission, US stock market regulator and supervisor), 1998

1.1 FRAUD AND ITS EFFECTS

A fraud is the action of deceiving someone to obtain an unjust or illegal benefit. According to the Association of Certified Fraud Examiners (ACFE—the international reference organization in relation to fraud detection), the main types of business frauds are:

Theft of assets: cash, overpriced merchandise, inflated expenses, employees who are paid but aren't working.

Corruption: conflict of interests, bribery, illegal gifts, extortion.

Accounting manipulation: overvaluation (or undervaluation) of assets, liabilities, expenses, and income. (ACFE 2016)

In recent years, the relevance of cybercrime or computer crime, which is fraud done through information technology (IT) tools or with the aim to destroy and damage computers, electronic media, and internet networks, has been increasing. Thus, according to a PricewaterhouseCoopers (PwC) global survey regarding business fraud, cybercrimes are already the second most frequent type of crime behind assets theft (PwC 2016).

Continuing with the ACFE (2016), the different types of fraud cost companies around 5% of their sales figure. This is a very relevant loss if we compare it, for example, to the average profit of companies, which in good years is around 3% of sales (ACCID, 2016). This loss is caused by accounting manipulations (68%), asset theft (21%), and corruption (11%) of the total losses caused by business frauds.

In another study (KPMG, 2010) referring to Europe, 34.5% of executives surveyed indicated that their companies had been subject to some form of fraud in the past 12 months. Of all frauds, 11% were accounting manipulations, the third most important behind theft (28%) and bribery and corruption (13%). These data show that accounting manipulation is a very important issue due to its frequency and the losses it generates.

Accounting manipulation consists in intervening in the process of preparation of the financial information in order to ensure that the accounts present a different image than the one it would offer if the manipulation hadn't been done. It is a serious problem, because it affects the reliability of the accounts. Manipulations are done so the accounts reflect what executives and managers want them to. This way, the reality isn't reported and users of the accounts are deceived.

1.2 MODIFYING COMPANIES' FINANCIAL INFORMATION

Accounts can be modified through accounting notes or real transactions, which can be legal or illegal (see Figure 1.1):

Accounting Manipulations

Actual Transactions

Legal

These are manipulations (see

Chapter 5

) that take advantage of:

The alternatives provided in the legislation

The possibilities of performing more or less optimistic forecasts

The legal gaps in aspects not regulated by the regulations

Perform actual transactions that affect companies' accounts (for example, advance or delay a transaction; or sell to clients with low credit rating).

Illegal

Accounting manipulations that violate the legislation (see

Chapter 6

). For example, conceal or inflate assets, debts, sales, or expenses.

Actual operations that aren't authorized by current legislation (for example, illegal transactions with companies located in tax havens).

FIGURE 1.1 Classification of account manipulation practices

Legal accounting manipulations:

These are postings that, in principle, do not infringe the accounting regulations, since they take advantage of the alternatives established in the legislation, the possibilities of making more or less optimistic estimations and the legal gaps. Many authors call this type of manipulation

creative accounting

, although there isn't unanimity, as some people use this denomination to refer to illegal accounting manipulations. This topic is expanded on in

Chapter 5

.

Illegal accounting manipulations:

These are practices not allowed by current legislation (concealing sales or expenses, posting fictitious sales or expenses, concealing assets or debts, and so on). By violating the current legislation they can have legal consequences as they are accounting offenses. It is a topic that is expanded on in

Chapter 6

.

Legal real transactions:

These are real and legal operations designed to make the accounts show the image of interest. Examples of this are:

Selling properties to generate exceptional results in the desired moment.

Selling assets and then repurchasing them to materialize results.

Delaying the delivery of merchandise so it enters the next accounting year.

Advancing or delaying investments.

Increasing or reducing expenses easily modifiable by the company, such as training or advertising.

Invoicing between companies of a group to transfer results among themselves.

Increasing the sale of products to distributors (increasing excessively their warehouses) with the aim to improve results.

Illegal actual transactions:

These are actual operations that are not legal. Examples would be sales at prices different from market prices through third companies or subsidiaries in tax havens, which alter the company's profits, assets, or liabilities.

INFLATING THE BENEFITS OF COCA-COLA IN JAPAN WITH ACTUAL TRANSACTIONS

Between 1997 and 1999, Coca-Cola Japan modified the commercial conditions to its distributors so they would buy more, although it excessively increased their warehouse inventories. At the end of 1999, the distributors' warehouse levels had increased by 60% and were unsustainable. Coca-Cola told the SEC that it would modify its policy to reduce the distributors' warehouse, but the SEC described this whole operation as “misleading” and that it had been done to fictitiously inflate profits to meet the analysts' profit estimates.

1.3 CALLING THINGS BY THEIR NAME: FROM CREATIVE ACCOUNTING TO BIG BATHS

There are several names for accounting manipulations. Thus, in the United Kingdom, when referring to accounting manipulations the expression creative accounting is used. The term creative accounting is also used by many authors to refer to accounting manipulations done without violating current legislation. Aggressive accounting refers to manipulations done to increase profits.

The term earnings management is predominant in the United States and usually refers to legal accounting manipulations. On the other hand, when the manipulations are illegal, they are called earnings manipulations. Although these denominations seem to refer only to manipulations that affect earnings, in practice, they are used for all types of accounting manipulations.

In the United States, terms like accounting shenanigans and income smoothing are also used. Income smoothing aims to avoid the negative effects of the volatility of the results. It is a variant of earnings management that consists in transferring results from one year to another, reducing the earnings in good years and thus being able to increase them in following years. This transfer is done, for example, by recording significant deteriorations in one year, which are annulled in a future year. This way, the profit of the first year is reduced and, instead, it increases in the future.

Income smoothing can be done with three types of practices:

Year in which the transaction takes place. For example, a property can be sold at the end of December or, at the beginning of January and, therefore, in the following accounting year. By choosing the specific moment in which the transaction is done, we can determine the result of each year.

Allocation of expenses and income throughout different years. For example, depreciations and provisions are items that can be distributed over a greater or a lesser number of years.

Place where an item is classified. For example, an item of expenses or income can be included in ordinary or exceptional results (or results of continued or discontinued operations) according to the interest, thus varying the image offered by the accounts.

The two examples in Figure 1.2 show the difference in the earnings caused by the income smoothing practice.

FIGURE 1.2 A bank's result with and without income smoothing

Income Smoothing at Nortel

In 2007, Nortel Networks, an American company of telecommunications and IT, was accused by the Securities and Exchange Commission (SEC) of accounting fraud for fraudulently reducing (with an excess of provisions) the earnings of 2002 by 350 million dollars. This accounting fraud allowed transforming the losses of 2003 into profits by annulling the excess of provisions of the previous year.

Income Smoothing at a Bank

A real bank, in year 2, considerably raised the goodwill's impairment of several subsidiaries, with the aim of reducing that year's earnings that had been very high. This manipulation (see Figure 1.2), consisting of some extremely pessimistic estimates regarding the future of the subsidiaries, enabled increasing the profits of years 3 and 4. On the other hand, the declared earnings (see continuous line) increase every year, which presents a more favorable situation. Income smoothing gives those who do it an additional advantage that allows making use of privileged information. For example, if a company lowers its profits aiming to increase them in the future, it is information that allows anticipating that in the future, the price of the company's shares will increase (when the increase in profit is reported).

The expression window dressing is also used to refer to manipulations done to make the figures at end of year the best possible. Examples of this type of manipulations are, delay payments to providers at the end of the year to make the cash balance higher, offer high discounts to clients to increase December's sales, postpone posting the expenses until after the closing of the year, and so forth.

Another variant of manipulation is the big bath, which consists in increasing losses one year to reverse them in the future and thus improve future earnings. This situation occurs more frequently when there is a change in the leadership of the company and the incoming management formulates the accounts immediately after its incorporation. In many cases the big bath allows generating excessive provisions, called cookie jar, that can be reverted in future years and, as a result, increase the profits of the years in which they are reverted.

EXAMPLE OF PROJECTION OF LOSSES COINCIDING WITH THE CHANGE IN THE BOARD OF DIRECTORS

Figure 1.3 shows the example of the result of a real company where, in the years of renewal of the board of directors (2008 and 2014), significant negative results occurred in the first accounts formulated by the new board of directors.

2007

2008 Year with change of board of directors

2009

2009

2010

2011

2012

2013

2014 Year with change of board of directors

2015

2016

Result

+16

−72

+9

+35

+23

+15

+31

+167

–65

+14

+49

FIGURE 1.3 Results of a company in millions of euros. The accounts of 2008 and 2014 were drawn up by the incoming board of directors

Another term associated to manipulation is impression management, which consists in presenting the accounts with data and graphs that highlight the positive aspects and hide the negative. This way, they are able to favorably impress shareholders and the media.

Key Topics of the Chapter

A fraud is the action of deceiving someone to obtain an unfair or illegal benefit.

The main types of business frauds are corruption, asset theft, and accounting manipulation.

Frauds cost companies around 5% of their sales figure. This loss is caused mainly by accounting manipulations.

Accounting manipulations are done mainly to modify the profit and/or debt.

Accounts can be modified through accounting manipulations (legal or illegal) and actual transactions (legal or illegal).

Accounting manipulations have several denominations:

Creative accounting

is the most-used expression in the United Kingdom.

Earnings management

is predominant in the United States and usually refers to legal accounting manipulations that seek to increase or reduce earnings. However, when manipulations are illegal they are called

earnings manipulations

.

Accounting shenanigans

.

Income smoothing

is an earnings management variant that transfers earnings (or losses) from one year to another.

Big bath

is another variant of earnings management that consists in increasing losses (or reducing profits) significantly in a year to reverse them in the future and thus, improve future profits.

REFERENCES

ACCID. (2016).

Ratios sectoriales 2015: Balances de situación, cuentas de resultados y ratios de 166 sectores, Barcelona

.

ACFE. (2016).

The 2016 ACFE Report to the Nations on Occupational Fraud and Abuse

. Austin: Association of Certified Fraud Examiners.

Amat, O., and Blake, J. (1996).

Contabilidad Creativa

. Barcelona: Gestión 2000.

Black, E.L., Sellers, K.F., and Manly, T.S. (1998). Earnings management using asset sales: An international study of countries allowing noncurrent asset revaluation.

Journal of Business Finance & Accounting

(November–December): 1287–1317.

Elvira, O., and Amat, O. (2008). La manipulación contable: Tipología y técnicas.

Partida Doble

203 (October): 48–59.

Gay, J.M. (2013). Escándalos contables y financieros: de Banesto a Bankia,

Revista de Contabilidad y Dirección

(16): 63–108.

KPMG. (2010).

Informe sobre los delitos económicos y fraude empresarial

.

Laínez, J.A., and Callao, S. (1999).

Contabilidad Creativa

. Madrid: Ed. Civitas.

National Commission on Fraudulent Financial Reporting. (1987).

Report of the National Commission on Fraudulent Financial Reporting

.

https://www.coso.org/Documents/NCFFR.pdf

.

Paris, J. (2016):

Estudio de las prácticas de alisamiento de resultados. Perfil de la empresa alisadora

. Tesis Doctoral, Universitat Abat Oliba CEU, Barcelona.

PricewaterhouseCoopers. (2016).

Global Economic Crime Survey 2016

.

https://www.pwc.com/gx/en/economic-crime-survey/pdf/GlobalEconomicCrimeSurvey2016.pdf

.

Saurinas, J. (1999). Existe alisamiento del beneficio en las cajas de ahorros españolas.

Moneda y Crédito

(209): 161–193.

Stolowy, H., and Breton, G. (2000). A framework for the classification of accounts manipulations.

Les cahiers de recherche

. Chambre de Commerce et d'industrie de Paris (28 June).

CHAPTER 2Accounting Fraud: An Ancient Practice

A merchant wanted to know how much two plus two was.

The accountant, after ensuring no one could hear them, murmured in his ear:

“How much do you want it to be?”

—Anonymous Venetian

2.1 THE FIRST ACCOUNTING FRAUDS

Recent accounting scandals promote the belief that this is a problem of the nowadays' world, but actually it's an ancient problem and inherent to the human being. As José Saramago (2000) reminds us: “Man is capable of the best and the worst.” Accounting fraud exists since the existence of accounting. The first evidence of the existence of accounting is in ancient Mesopotamia, over 4,000 years ago, and it was related to the commerce and the tributes that financed the activity of the temples. From those times are the first accounting records on clay boards or papyruses that informed the profits obtained with the harvests and they were the basis for calculating taxes. From those remote years there is evidence of accounting frauds like the ones mentioned below.

Years later, to avoid these scams, clay tablets or papyruses started being guarded in clay envelopes that weren't opened until they were delivered at the temples.

Centuries later, around 400 BC, in Ancient Egypt, Babylonia, and India, there were control systems of the entrances and exits of stores that were oral, since movements were explained out loud to tribute inspectors. In fact, these controls were the first audits (from Latin audire, which means to hear). Also during those years there were several frauds. For example, in the fourth century BC, over 40 embezzlements of public funds from accounting fraud have been documented in India.

ACCOUNTING FRAUDS IN ANCIENT MESOPOTAMIA

Accounting frauds occurred when workers and scribes sent by the temple kept a part of the tribute, after modifying the profits of the harvests. When there were suspicions that the clay tablets or papyruses had been manipulated, it was investigated and if the suspicions were confirmed, the offenders were punished with fines that, according to the Hammurabi Code (from the year 1780 BC), could reach six times the embezzled amount. This code was engraved in a basalt block almost 2.5 meters high and was based in the law of retaliation. In the most serious cases of fraud, the sentences could consist of mutilations or even death. If the fraud was done harming the king, the author should compensate with 30 times the embezzled amount. If the author couldn't pay, he was executed.

2.2 ACCOUNTING FRAUDS CONTINUE WITH THE DOUBLE ENTRY

Years passed and concepts, accounting techniques, and the quality of information provided improved, but frauds continued. One of the most decisive advances occurred in 1494, when Luca Pacioli published his book Summa de Arithmetica, Geometria, Proportioni et Proportionalità, in which he explained the bases of double entry, the accounting system that is still used today. Accounting information has been improving in quality, especially as a reaction to scandals that have been occurring. We can recall, for example, the case of the Dutch East India Company.

Shareholders' complaints, like those that occurred in the Dutch East India Company in 1622, made the authorities force companies to provide information to its shareholders.

These scandals motivated some companies to voluntarily employ auditors to ensure that there were no frauds in the accounts. Thus, for example, from 1880, Scottish and English capitalists who invested in the American stock market sent their auditors to ensure that the balances provided by the companies were reliable.

THE DUTCH EAST INDIA COMPANY