Financial Statement Fraud: Strategies for Detection and Investigation

CHAPTER FIFTEEN

Detecting Financial Statement Fraud

THE DETECTION AND INVESTIGATION of financial statement fraud involves the following 10 steps:

1. Understanding whether the behavioral conditions are ripe for fraud, primarily by determining whether there is a strong incentive present for individuals to engage in fraudulent financial reporting

2. Identifying the presence of fraud risk indicators (red flags); these are the symptoms that exist when certain financial reporting frauds are occurring

3. Considering whether there are weaknesses in internal controls that could make it easier for financial reporting fraud to be carried out without detection in the normal course of business

4. Performing analytical procedures geared toward the identification of financial statement fraud, such as ratio and trend analysis

5. Engaging in targeted analysis of journal entries, since most financial reporting fraud is either carried out or covered up through the use of nonstandard journal entries

6. Following up on and assessing the information gathered to determine whether there are clear signs of fraudulent financial reporting

7. Assessing whether the financial statements are materially misstated as a result of noncompliance with U.S. GAAP or IFRS (or another acceptable basis of accounting)

8. Digging deeper into additional evidence to determine whether there is evidence of intentional circumvention of internal controls and intentional misstatement of financial reports

9. Determining who is ...