The most expensive frauds in the business world don’t involve the theft of cash or other assets, but rather the falsification of financial statements.  Repeated fraud investigations have found that these financial statement frauds usually are perpetrated by or at the direction of senior management.

“This is fraud at the very highest levels of a company,” said David Anderson, principal of David Anderson & Associates, a Philadelphia forensic accounting firm that provides a full range of fraud investigation and fraud deterrence programs in the Delaware  Valley.  “These cases generally involve big money and can have a significant impact on the value of a company’s stock, the purchase price of a company, the amount of investment funds a company can attract, the amount of taxes a company pays and on and on.  And financial statement fraud can affect anyone from a shareholder to an investor to a divorcing spouse.”

Anderson, a forensic accountant in Philadelphia who also is a Certified Fraud Examiner in Philadelphia, said there are two methods by which management perpetrates financial statement fraud:

• Falsifying financial statements to make the company appear more profitable and/or with more net balance sheet value;
• Falsifying financial statements to make the company appear less profitable than it actually is.

The first method is used primarily when management wants to maintain or increase the price of its publicly traded shares so as to appease shareholders, or when management wants to make the company appear more attractive to potential investors, purchasers or lenders, explained Anderson, a forensic accounting expert in Philadelphia who has conducted numerous fraud investigations.

The second method, he said, is used for two potential purposes — to reduce the company’s income tax liabilities or to reduce the value of the company so that the spouse who owns an equity interest will have less to pay in a divorce.

For management to make a company appear more profitable, it must either increase revenues or decrease expenses, according to Anderson, a Certified Fraud Examiner in Philadelphia whose firm provides a full range of forensic accounting services in Philadelphia and the Delaware Valley.

Creating fictitious revenues can be accomplished in a variety of ways, Anderson said, including entering fake transactions on the company’s books; creating fictitious sales to related entities; or shipping unwanted product to customers and booking the shipments as sales (and when the product is returned, crediting the customers in a subsequent financial reporting period).

Fictitious decreased expenses can be achieved by booking certain expenditures as assets instead of expenses (also known as improperly capitalizing expenses) and by using book entries to transfer expenses to related entities, said Anderson, a forensic accountant in Philadelphia.  The telecommunications giant Worldcom used both of these methods (booking fictitious revenues and improperly capitalizing expenses) to maintain high share prices in perpetrating what was once the largest financial statement fraud in American history.

For management to increase the net balance sheet value, it must either increase the value of assets on its books or decrease the liabilities and debts on its books, explained Anderson, a Certified Fraud Examiner in Philadelphia.

The energy company Enron created special purpose entities that were not reported as part of its financial statements, and then transferred certain of its debts and losses to the special purpose entities, Anderson said.  Mirant (also an energy company) used fictitious accounting transactions to inflate the value of its inventory and accounts receivable, thereby increasing its net balance sheet value, he added.

Anderson said that fraudulent transactions designed to make a company appear more profitable or have a stronger balance sheet are more likely to occur in large- to medium-sized companies, but financial statement frauds designed to make a company appear less profitable are more likely to occur in medium- to small-sized companies.

For a company to appear less profitable, revenues must be reduced and/or expenses must be increased, explained Anderson, a forensic accountant in Philadelphia who recommends that every company enact a comprehensive fraud deterrence program developed by an experienced firm that provides forensic accounting services in Philadelphia and the Delaware Valley.   Management usually reduces revenues by not recording cash sales, he said.  Another method is to not record a sale, but instead have the customer make the payment to an affiliated company or directly to the owner.

To fraudulently increase expenses, management usually runs personal (non-business) expenses through the business or has the business pay the expenses of an affiliate, Anderson noted.  One other often-used method of increasing expenses is to have the business make payments to a third party for non-existent services, and to then have the third party pass the funds back to the owner.

“The consequences of these frauds can be enormous,” said Anderson, a forensic accounting expert in Philadelphia.  “Not only can financial statement fraud cost millions and even billions of dollars, but it also can result in myriad devastating outcomes, such as SEC investigations, jail sentences, bankruptcy filings, widespread job loss and massive losses for investors, to mention just a few.”

If you require the services of a Certified Fraud Examiner in Philadelphia or any other forensic accounting services in Philadelphia and the Delaware Valley, please contact the Philadelphia forensic accounting firm of David Anderson & Associates by calling David Anderson at 267-207-3597 or emailing him at  david@davidandersonassociates.com.

About David Anderson & Associates

David Anderson & Associates is a Philadelphia forensic accounting firm that provides a full range of forensic accounting services in Philadelphia and the Delaware Valley.  The experienced professionals at David Anderson & Associates provide forensic accounting, business valuation, fraud investigation, fraud deterrence, litigation support, economic damage analysis, business consulting and outsourced CFO services.  Company principal David Anderson is a forensic accounting expert in Philadelphia who has more than 30 years of experience in financial and operational leadership positions and is a Certified Public Accountant, a Certified Valuation Analyst and a Certified Fraud Examiner in Philadelphia.