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FINANCIAL STATEMENT FRAUD IN AN ORGANIZATION: PROBLEMS AND SOLUTIONS

CHAPTER ONE

INTRODUCTION

1.1       Background of the Study

In recent years crimes in financial organization had been intensifying more than what has been speculated in the past years. Fraud has been the leading undetectable crime which captures a large segment in the economy. It is referred as an undetectable crime because needs a lot of investigation have to be conducted to detect the act and for many years people have been getting away with it. For instance in South Africa fraud is the leading economic crime whereby it cost the economy over approximately 2million USD yearly as stated by (Luway & Bowman, 2009). Fraud cases have highly been recorded in the auditing system were by as auditors are the basic feature in organizations they play a big role in reporting accounts in finances, if the data has been corrupted in any way this results to a major economic, social and political concerns. It has been a major issue across borders to verify the fact how fraud can bring major effect let’s look at the statistics United States of American is the leading area facing a lot of fraud cases as stated in (Civil Division, 2013) show that fraud cases have increased as from 2007 it was recorded to be approximated 2 billion to 2012 were its 5 billion fraud cases recorded. This vividly illustrate over an interval of 5 year fraud cases have increased 2 times from the base year of 2007. Among the major cases ever recorded in the history are Adelphia (USA), Bonds Corp and HIH insurance in Australia as stated by (Karen, Zhou, Tracy, & James, 2007). These companies tend to show significant damage done by practicing fraud.

Fraud as defined by (Wiley & sons, 2010) is an” intentional deception to cause a person to give up property or some lawful right something said or done to deceive; trick; artifice” in most cases fraud in financial aspect it always start with a person inside the company. Fraud can easily be expressed as a purposeful demonstration intended to make someone else to part with something of worth, or to surrender a legitimate right. It is a conscious deception or disguise of data with a specific end goal to scam or mislead. Apart from that (Vasiua, Warrenb, & Mackaya, 2003) they stated Actuating an approach by misleading or other untrustworthy behavior, including acts or exclusions or the laying forth of false expressions orally or in writings with the object of getting cash or other profit from or of dodging a liability to the Commonwealth . Fraud involves manipulating of financial statement so let’s define the term financial statement fraud as defined by (Gupta & Gill, Prevention and Detection of Financial Statement, 2012) is a mindful distorting or discarding of financial accounts by the organization in the records of an association with the purpose of deceiving bankers and financial experts. Financial statement fraud may involve the practice of different things such as; misrepresentation or manipulation of financial reports, subsidiary documents, intentional misstatements, omissions, or misrepresentations of events. It can also include deliberate wrongful implementation of accounting standards, policies, principles and approaches used to ration, reports of economic events and trade transaction. Sometimes is may get to an extent of using antagonistic accounting techniques so as to gain prohibited earnings.

The main difference between theft and fraud is that the top manager of the company, him or her becomes a part of the act, like stealing in a house you’re staying in, this is because he or she has a mentality of untruthful additional gain. Fraud can be classified into two categories as stated by (Gottschalk, 2010) that is internal and external fraud. Internal fraud involves management and employee, management fraud deals with the manipulating the financial statements were by the manager acts as a push factor for fraud to occur in manipulating income statement, balance sheet and cash flow which are very essential to external users. Meanwhile employee can be an agent of fraud by giving out trade secrets or emblazonment of funds. External fraud involves supplier fraud is when a supplier close full information about a product in a way like hiding the actual price when signing a contract just to get the tender or manipulating there invoice of the product and fraud in investment happens when stock or securities are sold to a consumer under disclosed information such as the value of the investment that an investor wants to make. Consumer fraud Clients deceive salespersons into giving something they ought not to have or charging them short of what they ought to.

There have been several cases by businesses of what appears to be financial statement fraud, which have been undetected by the auditors. According to Joseph T. Wells (2002), one of the most remarkable cases in the twentieth century occurred in the 1970s, when an enterprising insurance salesman, Stanley Goldblum, managed easily to add 65,000 phoney policy holders to his company’s – Equity Funding – rolls, along with $800 million of fake assets – right under the nose of its independent audit firm (cited in Rezaee, 2002).

The international auditing firm, Arthur Andersen, which audited Enron, appears to be an example of a firm entangled in a major audit failure. The case brought to light the weaknesses of the audit process. As a result, more people believe professional accountants have to learn how to detect financial statement fraud more effectively. One of the best ways is to profit from the mistakes of others. Enforcement actions against auditors have been rare (although we believe there will be more in the future), but the consequences of individual cases can be great and the cases offer the profession an opportunity to learn and grow (Beasley, Carcello and Hermanson, 2001).

1.2       Statement of the Problem

A series of big-name frauds in the past decade has been accompanied by lawsuits against auditors because of their suspected negligence in not detecting the financial statement fraud. As a result, auditors have risked the loss of money and what is even more influential, the loss of their reputations. This situation has pushed auditors and the related organizations and institutions to improve the audit processes in order to be more effective in identifying risk and collecting evidence for issuing audit opinions on financial statements.

According to a study published in 1999 by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), the use of fictitious revenues is the most popular method of committing financial statement fraud. As reported by the Securities and Exchange Commission (SEC) Commissioner, Isaac C. Hunt, Jr., in his speech “Current SEC Financial Fraud Developments,” “Over half of financial report cases are directly related to revenue recognitions” (Hunt, 2000). Accounts receivable are attractive fraud targets, primarily because of the way receivables are viewed by lenders. Unlike inventory or fixed assets, accounts receivable – in the eyes of financiers – are the next best thing to cash. Because the mechanics are simple, sales/receivables fraud schemes lead the fraudulent financial statement pack (Wells, March 2001).

In this study, the main problem is to investigate the problems and some recommended solutions to financial statement fraud in an organization.

1.3       Objectives of the Study

The study sought to assess the problems of financial statement fraud in an organization. Specifically, the study sought to:

1. examine the relationship between financial statement fraud and organization performance.

2.  examine the consequences of financial statement fraud in an organization.

3.  examine the reasons for fraud, types and implication of costs of fraud in an organization.

4.  suggest possible solutions for detecting and preventing financial statement fraud in an organization.

1.4       Research Questions

1.  What is the relationship between financial statement fraud and organization performance?

2.   What are the consequences of financial statement fraud in an organization?

3.   What are the reasons for fraud, types and implication of costs of fraud in an organization?

4.   What are the possible solutions for detecting and preventing financial statement fraud in an organization?

1.5       Research Hypotheses

Ho1: There is no relationship between financial statement fraud and organization performance.

Ho2: There are no consequences of financial statement fraud in an organization.

1.6       Significance of the Study

This study will be of immense benefit to other researchers who intend to know more on this study and can also be used by non-researchers to build more on their research work. This study contributes to knowledge and could serve as a guide for other study.

1.7       Scope/Limitations of the Study

This study is on problems of financial statement fraud in an organization with a view of finding possible solution to it.

Limitations of study

Financial constraint: Insufficient fund tends to impede the efficiency of the researcher in sourcing for the relevant materials, literature or information and in the process of data collection (internet, questionnaire and interview).

Time constraint: The researcher will simultaneously engage in this study with other academic work. This consequently will cut down on the time devoted for the research work.

1.8       Definition of Terms

Financial Statement: It is the combination of the three major reports on a business. It will contain the cash flow statement, the income statement and the balance sheet of the business.

Fraud: Wrongful or criminal deception intended to result in financial or personal gain. A person or thing intended to deceive others, typically by unjustifiably claiming or being credited with accomplishments or qualities.

Organization: an organized group of people with a particular purpose, such as a business or government department.

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