Fraud Examination, 4E
Chapter 13: Liability, Asset, and
Inadequate Disclosure Frauds
Albrecht, Albrecht, Albrecht, Zimbelman
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distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Learning Objectives
Identify fraudulent schemes that understate
liabilities.
Discuss the understatement of liabilities fraud.
Describe fraudulent schemes that overstate
assets.
Understand the overstatement of assets fraud.
Albrecht, Albrecht, Albrecht, Zimbelman
© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license
Learning Objectives
List fraudulent schemes that inadequately
disclose financial statement information.
Explain the inadequate disclosure fraud.
Albrecht, Albrecht, Albrecht, Zimbelman
© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license
Types of Financial
Statement Fraud
Understating liabilities
Overstating assets
Inadequate disclosure
A few year’s ago Waste Management, Inc., the leading provider of comprehensive waste
and environmental services in North America improperly inflated its operating income and
other measures of performance by deferring current-period operating expenses into the
future by netting one-time gains against current and prior period misstatements and current
period operating expenses.
Albrecht, Albrecht, Albrecht, Zimbelman
© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license
Understatement of
Liabilities Fraud
Schemes that understate liabilities
Understating Accounts Payable
Understating Accrued Liabilities
Recognizing Unearned Revenue as Earned Revenue
Underrecording Future Obligations
Not Recording or Underrecording Various Types or Debt
(Notes, Mortgages, etc.)
Omission of Contingent Liabilities
Albrecht, Albrecht, Albrecht, Zimbelman
© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license
Understatement of
Liabilities Fraud
Understating Accounts Payable
Accounts Payable can be understated by a
combination of:
Not recording purchases or recording the purchases
after the end of the year.
Overstating purchase returns or purchase discounts.
Making it appear as if liabilities have been paid off or
forgiven when they have not.
Albrecht, Albrecht, Albrecht, Zimbelman
© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license
Understatement of
Liabilities Fraud
Understating Accrued
Liabilities
Common accrued
liabilities accounts:
Salaries payable
Payroll taxes payable
Rent payable
Utilities payable
Interest payable
Albrecht, Albrecht, Albrecht, Zimbelman
© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license
Understatement of
Liabilities Fraud
Recognizing Unearned Revenue as Earned Revenue
Recognizing revenues instead of recording a liability has a positive
effect on a company’s financial statements because it understates
the company’s liabilities and overstates its revenues and net
income.
By manipulating the timing of revenue recognition, a company can
very easily either understate or overstate deferred revenue
liabilities.
To understand the motivation of these types of frauds, remember
that stock prices are affected by both risk and return.
Albrecht, Albrecht, Albrecht, Zimbelman
© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license
Understatement of
Liabilities Fraud
Underrecording Future Obligations
Future obligations examples include:
Warranty
Service Obligations
This type of fraud is easy to perpetrate and results
in overstated net income and understated liabilities.
Albrecht, Albrecht, Albrecht, Zimbelman
© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license
Understatement of
Liabilities Fraud
Not Recording or Underrecording Various Types or Debt
(Notes, Mortgages, etc.)
Either not reporting or underrecording debt to related parties
Borrowing but not disclosing debt incurred on existing lines of
credit
Not recording loans incurred
Claiming that existing debt has been forgiven by creditors
Claiming that debt on the company’s books is personal debt of the
owners or principals, rather than debt of the business
Albrecht, Albrecht, Albrecht, Zimbelman
© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license
Understatement of
Liabilities Fraud
Omission of Contingent Liabilities
If likelihood of loss is reasonably possible, the contingent
liability should be disclosed in the footnotes to the financial
statements.
Contingent liabilities can be used to fraudulently misstate
financial statements by underestimating the probability of
occurrence and not recording or disclosing contingent
liabilities in the financial statements.
Albrecht, Albrecht, Albrecht, Zimbelman
© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license
Understatement of
Liabilities Fraud
Ways to detect
understatement of liabilities
Analytical symptoms
Accounting or Documentary
symptoms
Albrecht, Albrecht, Albrecht, Zimbelman
© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license
Understatement of
Liabilities Fraud
Analytical Symptoms
Accounts Payable:
Balances appear too low
Cost of goods sold numbers are low
Unearned Revenue:
Payables or other accrued liabilities are low
Income that is “too smooth”
Albrecht, Albrecht, Albrecht, Zimbelman
© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license
Understatement of
Liabilities Fraud
Analytical Symptoms
Recognition of Unearned Revenues:
Unearned liability balances appear too low and revenue
accounts appear too high
Under- or nonrecording of services/warranty:
Balances in warranty, repurchases, or deposits
accounts appear too low
Unrecorded contingent liabilities:
Analytical symptoms are not particularly helpful to
detect unrecorded contingent liabilities
Albrecht, Albrecht, Albrecht, Zimbelman
© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license
Understatement of
Liabilities Fraud
Analytical Symptoms
Unrecorded Notes/Mortgages:
Unreasonable relationship between interest expense
and recorded liabilities
Significant purchases of assets with no recorded debt
Recorded amounts of notes payable, mortgages
payable, lease liabilities, pension liabilities and other
debts are too low
Albrecht, Albrecht, Albrecht, Zimbelman
© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license
Understatement of
Liabilities Fraud
Accounting or Documentary Symptoms
Photocopied records where originals should exist
Unusual discrepancies between the entity’s records
and confirmation replies
Transactions not recorded in a complete or timely
manner or improperly recorded amounts
Balances or transactions that lack supporting
documents
Missing documents
Unexplained items on reconciliations
Denied access to records, facilities or others whom
audit evidence might be sought Albrecht, Albrecht, Albrecht, Zimbelman
© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license
Overstatement of Asset
Fraud
Albrecht, Albrecht, Albrecht, Zimbelman
© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license
Overstatement of Asset
Fraud
Overstatement of Fixed Assets by:
Leaving worthless or expired assets on the books
Underreporting depreciation expense
Overstate asset costs with related parties
Colluding with outside parties to overstate assets (e.g., allocating
inventory costs to fixed assets)
Fabricating fixed assets to record on the financial statements
Albrecht, Albrecht, Albrecht, Zimbelman
© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license
Overstatement of Asset
Fraud
Overstatement of
Receivables and
Inventory
Cover thefts of cash or other
assets by overstating
receivables or inventory
Albrecht, Albrecht, Albrecht, Zimbelman
© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license
Overstatement of Asset
Fraud
Overstatement of Cash, Short-Term
Investments, and Marketable Securities
Schemes
Reporting restricted cash as unrestricted on the
balance sheet
Having vendors or employees steal significant amounts
of cash over time so that financial statements are
misstated
Cash is quite hard to overstate because of verification
from financial institutions
Albrecht, Albrecht, Albrecht, Zimbelman
© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license
Overstatement of Asset
Fraud
Use market values rather than book values to record
assets.
Have the wrong entity be the “purchaser.”
Allocate costs among assets in inappropriate ways.
Record fictitious assets or inflate the value of assets in
intercompany accounts or transactions
Albrecht, Albrecht, Albrecht, Zimbelman
© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license
Overstatement of Asset
Fraud
Overstatement of
Intangible or
Deferred Assets
Startup companies can
fraudulently capitalize
intangible assets like start-
up costs, advertising
costs, salaries by writing
them off as deferred
charges.
Albrecht, Albrecht, Albrecht, Zimbelman
© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license
Overstatement of Asset
Fraud
Ways to detect overstatement of assets
Compare changes and trends in financial statement account
balances
Compare changes and trends in financial statement relationships
Compare financial statement balances with nonfinancial
information or things, such as the assets they represent
Compare financial statement balances and policies with those
used by other similar companies
Albrecht, Albrecht, Albrecht, Zimbelman
© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license
Inadequate Disclosure Fraud
Disclosure Fraud Schemes
Misrepresentation about the nature of the company or its products
Misrepresentations or omissions in the MD&A
Misrepresentations or omissions in the footnotes to the financial statements
Albrecht, Albrecht, Albrecht, Zimbelman
© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license
Inadequate Disclosure Fraud
Ways to identify Disclosure Fraud
Look for inconsistencies between disclosures and
information in the financial statements
Inquire of management concerning related-party
transactions, contingent liabilities, and contractual
obligations
Review a company’s files and records with the SEC and
other regulatory agencies
Albrecht, Albrecht, Albrecht, Zimbelman
© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license
