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Financial statement fraud hard to detect, potentially devastating

By AdvocateDaily.com Staff

Financial statement fraud should scare businesses because of how difficult it is to detect and its potential to cause devastating losses, Toronto forensic accountant and investigator Dave Oswald tells AdvocateDaily.com.

According to the Association of Certified Fraud Examiners (ACFE), company financial statement fraud only accounts for about 10 per cent of occupational fraud worldwide, but results in the largest loss averaging US$800,000 per incident.

“It’s an area where large amounts of money can go missing really quickly,” says Oswald, founder and owner of Oakville-based white-collar crime investigation boutique Forensic Restitution.

The ACFE says financial statement fraud occurs when someone intentionally misstates or omits financial statement amounts or disclosures to deceive users of the financial statements.

“What’s frightening about it is that these companies are usually just trying to get themselves out of trouble with a little change to the accounts. It’s often done with best interests at heart, but once you’ve started on that track, it’s hard to come back and go clean.”

Oswald says the biggest problem with detecting this type of deception is that it’s frequently a team effort.

“More often than not, you have a number of people within management perpetrating it, rather than a single individual,” he says. “Much of the time, executive bonuses are based on how well the company has done, and if they believe there has been a temporary downturn, they might smooth out operations, so investors don’t get a shock.

“They’re basically playing with the figures to makes themselves look better,” Oswald adds.

Since the fraud typically starts small, with a few invoices shifted or falsified to improve accounts-receivable ratios, Oswald says it can be hard to spot, even on close inspection.

In fact, he says it’s likely that many more instances are never detected if an anticipated upturn actually materializes, allowing the perpetrator to cover up previous misdeeds. Problems usually only arise when small adjustments snowball over time.

“The balance as a whole might not look way out of line, so someone viewing it at a single point in time is unlikely to pick up what has happened,” Oswald says. “But it’s nasty because an investor can come in thinking that a business is doing relatively well. Then when you’re actually on the inside, you find a whole bunch of assets with no value behind them, or you owe a great deal more than you thought in accounts payable.

“That’s why it’s often worthwhile to do extensive due diligence before you invest in a company,” he adds.

According to Oswald, the temptation for key players in a company to manipulate their accounts is illustrated by the propensity for governments in many jurisdictions to fudge numbers in their own reports to taxpayers.

For example, he points to Ontario Auditor General Bonnie Lysk’s condemnation of the province’s “bogus” accounting relating to the effect of green energy initiatives on electrical power prices.

According to the Globe and Mail, Lysk objected to the characterization of consumers’ outstanding balances, and a new strategy that allowed the province to shift the shortfall resulting from a rate cut plans to future years.

“They managed to move $6 billion from expenses into assets, which was a future debt to be recovered between 2024 and 2042,” Oswald says. “When you look at the balance sheet now, you see $6 billion receivable, but in five years' time, it will start to be recovered, and push costs up at that point. The scary part for me is that three large accounting firms signed off on this.

“If the government is willing to do it at that level, you can see why someone who’s trying to sell a company for a few million dollars might be willing to do something similar to get an extra $100,000 out of the deal,” he adds.

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