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What is Accounting Fraud and How to Prevent Financial Statement Fraud


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Key Takeaway: An understanding of what is accounting fraud and how to prevent financial statement fraud is an important lesson for managements across the world, in any kind of business. In the simplest terms, accounting fraud is the practice of manipulating accounting records so that the actual financial condition is hid from the investors, the public or the other stakeholders and a false picture, which shows the company to be in a falsely healthy condition, is presented in the books.

accounting-fraud-to-prevent-financial-statement-fraudFinancial management can go haywire if the proper steps for preventing accounting fraud are not taken. Companies need to have a solid understanding of how to prevent financial statement fraud, or else their hard work and effort go down the drain, and making up for lost financial gains becomes a herculean task.

Accounting fraud is perhaps as old as accounting itself. However, with the American corporate sector having committed financial misdoings of an unprecedented scale starting from about the late 1990’s, the need for an actual congressional legislation was deemed necessary to prevent the onslaught of these financial scandals, most of which were the result of accounting frauds carried out on the financial statements of the companies that carried out these scandals.

A long list of corporate frauds 
accounting-fraud-to-prevent-financial-statement-fraudManipulating the balance sheet has been at the core of most accounting frauds that shook the American corporate sector and culminated in the enactment of the Sarbanes Oxley Act:

  • The Waste Management scandal
  • Enron
  • WorldCom
  • Tyco
  • HealthSouth
  • Freddie Mac
  • AIG
  • Lehman Brothers
  • Bernie Madoff
  • Halliburton

Accountants can manipulate their financial statements and carry out a number of fraudulent activities that can be termed as accounting fraud. These are some of the practices that are common among accounting professionals who got caught by these famous scandals:

accounting-fraud-to-prevent-financial-statement-fraud

Internal controlsInternal controls in the form of deep and thorough scrutiny of the accounts records is the surest means for ensuring that the financial statement fraud does not take place. Staying compliant with the provisions of the SOX Act is another step in the right direction. Many companies supplement these by putting sound investigational techniques in place.

accounting-fraud-to-prevent-financial-statement-fraudCompanies can keep many checks and controls in place in the form of internal controls. They can ensure that the financial statements are vetted at various levels, starting with the accounts clerk and going all the way to the CFO. Not all types of accounts may need intervention from the CFO, but those that don’t can be handled by those in Finance who report to the CFO.

Making accounts pass through more than one sourceCrosschecking or double-checking accounts is another means of preventing financial statement fraud. The company can make a rule by which financial statements such as purchase records get checked by more than one person, with the aim of putting curbs on passing bills. When bills have to go through more than one person or level, there is a good chance of immediately detecting a fraud or a potential one. These employees can collude and cause a fraud anyway, but this is comparatively difficult, as in theory and practice, everyone through whom the bills get passed has to be involved to commit the fraud.

AuditsAudits, both internal and external, are another means of preventing financial statement fraud. When audits are carried out internally and checked by an independent, outside agency; a check is put in place, making financial statement fraud that much more difficult to commit.

Whistleblowing 
accounting-fraud-to-prevent-financial-statement-fraudWhen organizations put a good whistleblower culture in place, it can be a very strong deterrent at preventing financial statement fraud. This is not the easiest of practices to implement, but is strong one when it is implemented well. Ensuring security and protections for the whistleblowers, plus fixing rewards for their act is a means for motivating employees to take part in whistleblowing. To prevent misuse, the management can also put a system in place where wrongly called out whistleblowing results in penalties.

 

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