Chapter 15

Journal Entry Fraud

After reading the title of this chapter, you're probably thinking that journal entries aren't a core business system. Sure, they are part of the accounting process, but a system unto itself? Let us explain. As with any daunting task, we have to break things down into sizes we can work with, and sometimes that is the rawest of the raw data. Financial reporting and statements can be thought of as the first and top-most level of journal entry fraud because financial reporting misstatement implicates the organization as a whole. With this starting point in mind, the answers to our usual question of “who,” “when,” and “how” such fraud is committed are pretty obvious.

Typically, it is executive management that benefits from financial statement manipulation. For example, a company has a sizable loan with certain financial covenants that must be met or there would be a default. One such covenant could concern something as simple as a working capital ratio that has to be maintained at 2:1 per the loan agreement. If management realizes that the covenant will not be met during a specified financial reporting period, then account balances could be inflated or deflated through fraudulent journal entries to meet the covenant. This type of fraud doesn't always occur at the CEO level—for example, a sales department may inflate the number of sales completed in a reporting period in order to meet quotas or, in the case of an individual salesperson, perhaps to receive ...

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