U23000 - Financial Statement Frauds: Impact, Prevention & Solutions

This report examines the impact of financial statement fraud on organizations, focusing on its effects on business performance and exploring methods for prevention and detection. The research employs a deductive approach, drawing on various articles and past examples of fraud in financial reporting. It identifies the causes and consequences of such fraud, highlighting the importance of internal controls and ethical management. The report also addresses the role of accountants and auditors in ensuring the accuracy and reliability of financial information, emphasizing the need for vigilance in detecting and preventing fraudulent activities to maintain investor confidence and protect the financial health of businesses. The study further aims to provide solutions and counter measures which can be taken by the management of company in retaliation of such frauds in the financial statement of a business.

Running head: INDEPENDENT STUDY FOR ACCOUNTANTS
Independent Study for Accountants
Name of the Student:
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Author’s Note

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Executive Summary
The main purpose of this assessment is to analyze the impact of Frauds in financial statement and
how the same has impacted businesses performance. The assessment considers various articles
on the basis of which vital information are collected and the research follows a deductive
approach for the purpose of bringing out results for the same. The analysis further cites certain
past examples for frauds in financial reporting in business. The assessment also puts emphasis on
the prevention and detection of frauds in the business and how the same can prevent any negative
impacts on any business.

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Table of Contents
Introduction......................................................................................................................................3
Rationale..........................................................................................................................................3
Research Objectives.........................................................................................................................4
Research Questions..........................................................................................................................5
Literature Review............................................................................................................................5
Effects of Financial Frauds on the Companies............................................................................7
Prevention of Financial Frauds....................................................................................................9
Research Methods..........................................................................................................................12
Conclusion and Scope of Future Research....................................................................................15
Reference.......................................................................................................................................17

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Introduction
The main purpose of this research proposal is to assess the impact of frauds on financial
statement and analyze how management can prevent such frauds from taking place. The research
proposal would be considering the situation due to which frauds arise in first place in a reporting
process. The research would be collecting information from various journal articles relating to
impact on frauds on business organization (Cohen et al., 2013). The research would be analyzing
the basic causes for frauds in the first places, overall consequence of financial reporting frauds
on the business and preventive measures which can be applied by businesses for the purpose of
early detection and prevention of frauds in the first place. The methodology which be consisting
of secondary data collection and analysis which can be collected from various journal articles
and the same is to be considered for this research.
Rationale
In this era of globalization, the financial information is the basis on which the
performance of a business is highly depended. Therefore, any fraud in financial reporting would
affect the reliance on the financial information included in the annual report of the business. The
role of accountants, auditors and other finance experts has increased significantly in a business
organization as they need to ensure that the information which are included are showing true and
fair view of the situation displayed (Warren, Reeve & Duchac, 2013). The cases of Enron,
World.com also has alerted the society and therefore, the role of the auditor has increased and the
auditor needs to ensure that the financial statement are free from an misstatement and does not
involve any incidence of frauds.

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In recent years the frauds in financial statements have increased in many business and
examples can be given of Enron, Worldcom. Most of the businesses try to manipulate the
financial information in order to show a favorable financial statement of the business. The
impact of such frauds affects the reputation of the business and the creditability of the business.
The practice of manipulating the financial statements results in showing favorable results to the
clients with the help of which the business can attract more investors. The case of Enron and
World.com are relevant examples of how cooking of profits in the books of account affect the
creditability of the business (Young & Peng, 2013). The impact on the frauds in financial
statement has serious consequence on the profitability of the business. The changes in the
business environment and economic recession in the market has forced the top-level
management to effectively focus on paying more attention to the genuineness of financial
statement of the business and ensure that the financial statement is showing correct information.
The research paper aims to establish the impact which frauds in financial statement has on the
business.
Research Objectives
The main purpose of this research is to conduct an analysis on the impacts which frauds
in financial statements has on the entire business. The fraud can be identified as manipulation in
the books of accounts so that the financial statement is showing true and fair view. The
implication of the fraud is that the business needs to incurs costs of such frauds and the
reputation of the business is also affected by such frauds. The research paper also aims to
identify the solutions which is available to the business. The research considers measures which
can be taken by a business for the purpose of improving the misrepresentation in financial
statement of the business. The research also aims to conduct secondary analysis for the purpose

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of bringing out the exact results of the research. The research also aims to identify what are the
counter measures which can be taken by the management of company in retaliation of such
frauds in the financial statement of a business.
Research Questions
This research would be focusing on the following research question which are related to
frauds in financial statements of a business:
1. How does frauds in the financial statement of a business impact the organization as a
whole?
2. What are the steps which the management can initiated for the purpose of preventing
frauds in the financial statement of a business?
3. Who can significantly reduce the frauds in financial statement of an organization?
Literature Review
Financial statement frauds can be identified as deliberate misrepresentation in the books
of account of a business with a view point of making the financial statement look more
favorable. Any omission of material information in the financial statement of a business which
is of deliberate nature can be treated as act of frauds. Such frauds are undertaken by the
management with a view of manipulating the financial information which will result in favorable
financial statement. The main causes due to which frauds in financial statement occur are
situational pressure on the managers of the business and the opportunity to commit frauds
(Sharma & Panigrahi 2013). The sudden decrease in the revenue of the business and also the
pressure of the shareholders and industry causes situational pressure on the business. In addition
to this, weakened internal controls system or lack of appropriate supervision in the business is

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another cause, which can create an opportunity for committing frauds. As the technological level
in the world increases, the reliance on financial information has increased significantly and
simultaneously the risk of financial frauds in a business environment has increased (Peecher,
Solomon & Trotman, 2013). Various acts can bee taken as an act of fraud but in general terms
intentional misleading of any person or deception of any individual which can result in some
kind of losses to that individual comes under the purview of fraud. In the case of financial
reporting fraud, the users of the financial statements take their decisions on the basis of the
information which are contained in the annual reports of the business. If the financial
information are misrepresented than the same would result wrong investments on the part
investors which might result in financial losses of a business.
The global economy is undergoing rapid changes as new technologies and innovations
are taking place and due to this a series of economic and financial crises is common. This can
create an environment of distrust among the employees and also create some doubts in the mind
of potential buyers (Siregar & Tenoyo, 2015). This gives rise to manipulation in the books of
accounts in order to ensure that the financial statements are shown favorable and the business
can retain the investors. The cooking of profits is mostly done by the management that in the
next year, the performance of the business would be better and therefore necessary adjustments
can be made. However, the losses just keeps on piling and sooner or later the same affects the
business adversely which is precisely the case which happen with Enron.
It can be seen from the research objectives and the research questions that the main aim
of this research is the analysis and evaluation of different aspects of the effects of financial
frauds on the performance as well as other aspects of the business organizations. Over the years,
the presence of many instances can be seen where the managements of the business

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organizations were caught in the process of falsify their financial statements with the aim to gain
some personal benefits. Thus, frauds in the financial statements of the companies indicate
towards the situation when the managements of the companies intentionally provides the false
and manipulated financial information to the users of the financial statements like investors and
other stakeholders (Kanapickienė & Grundienė, 2015). The occurrence of the financial
statements frauds can be seen with the aim that that the auditors of the companies ensure that
there is not any material misstatements in the financial statements as a result of frauds and errors.
The aim of the present study is the exploration of three major aspects of financial fraud in the
companies; that they are the exploration of the areas that are affected by the frauds in the
financial statements; the processes that help the companies in the prevention of these frauds in
the financial statements; and the persons as well as procedures that the companies use for the
reduction of the frauds in the financial statements (Amara, Amar & Jarboui, 2013). As the topic
of the research is a common one, there have been many researchers conducted on this particular
research area.
Effects of Financial Frauds on the Companies
The overall impacts of frauds on a business is immense and adverse in nature and the
same can directly impact the financial statement of a business. The corporate frauds of a business
which can be identified are financial reporting frauds, misappropriation of assets of a business
and corruption. These are the most common frauds which can be identified in a business
organization. In this research the focus is mainly fixed on financial reporting profits which
includes manipulation of entries and cooking of profits in the books of account of a business. As
per Association of Certified Fraud Examiners (ACFE), financial reporting frauds are most costly
for a business as per the global fraud study which was conducted in 2016. In addition to this, the

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scandal which has taken place in the cases of Enron, WorldCom, Xerox, Lehman Brothers has
increased the concerns for impact on fraudulent activities of the business. The financial reporting
frauds not only results in financial losses for a business but also impacts the morale of the
investors of the business and in most cases results in loss of confidence. Moreover, there is a
general decline in the reputation of the business in the market which would result in the fall in
the market share value of the business. In case of a big fraud, the government also might impose
certain regulations on the business or even charged penalty on the business for frauds. The
incidence of fraud leaves a business on the brink of financial crisis and can even affect the going
concern principle of a business.
There is not any scope to deny the fact that fraud in financial statements is a negative
aspect and it has many negative impacts on the overall business organizations. The companies
have to suffer from downfalls in the presence of financial frauds like major financial losses, loss
in the confidence of the external stakeholders, decrease in the company morale, increase in audit
costs and others. There are examples of many companies that were impacted from different
aspects due to fraud in the financial statements and the case of Satyam Computer is one of them.
According to Bhasin (2015), financial frauds can have major impact on the companies along
with their shareholders and public confidence in the capital market. As opined by Bhasin (2015),
financial frauds can lead to loss in reputation, loss in goodwill along with the customer relations.
Bhasin (2015) has also mentioned the fact that the presence of financial frauds has the ability to
question the transoerecny as well as integrity of the company’s financial reporting. As mentioned
by Okoye & Gbegi (2013), the presence of frauds in the financial statements of the companies
has broader effects in the economic system as it can negatively affect the foreign investors as
they become doubtful in doing business with the countries. In addition, frauds in the financial

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statements of the companies can affect the gross domestic product (GDP) of the economy of the
countries (Okoye & Gbegi, 2013).
Some of the fraud cases which have recently turned up and increase the significance on
financial reporting fraud controls are the cases of Enron, World.com, Lehman brother. In the
case of Enron, the management of the company has deliberately manipulated the profits of the
business and effectively understated the profits of the business. On the basis of favorable
financial statement of the business, the management then took a lumpsum loan. When the
manipulation in the financial statement was revealed the business collapsed. Similarly, in the
case of World.com as well a material amount of expenses roughly around $ 3.8 million was
hidden from the general investors and not disclosed appropriately in the financial statements of
the business. This resulted in overstatement of net profit in the financial statement for 2001.
When the company collapsed, it left great depression in the economy and the country had to face
a situation of financial crisis. In addition to the losses to businesses and economy, there are other
consequences as well such as it undermines the reputation of accounting profession by not
considering the financial reporting framework. The frauds in financial statement has a impact on
the overall growth of the nation and thereby should be dealt with a priority.
Prevention of Financial Frauds
Prevention of frauds in the financial statements is a major initiative for the companies and
the managements can use different tools and techniques to prevent the frauds in the financial
statements. The presence of different kinds of tools can be seen that the companies can use for
the deletion and prevention of financial frauds in the financial statements. According to Gray &
Debreceny (2014), there has been major increase in the use of data mining as a major tool for the
detection frauds in the company financial statements. One crucial aspect is also mentioned by

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Gray & Debreceny (2014) that auditors of the modern business environments are using the tools
of data mining with the aim to detect the frauds in the financial statements. Under the process of
data mining, the auditors can use both the internal data sources and external data sources in the
process of data mining. On the other hand, according to Petraşcu & Tieanu (2014), the processes
and procedures of internal audit play a crucial role in the process of the prevention as well as
detection of frauds in the financial statements. As opined by Petraşcu & Tieanu (2014), under the
mechanism of internal auditing, the responsibility for the detection and prevention of financial
statements is divided between the external audit committee, internal audit committee and
executive board. For this reason, there is not any scope to avoid the fact that all the business
organizations must have effective internal control mechanism to increase the efficiency of the
financial statements of the companies (Petraşcu & Tieanu, 2014).
The prevention of frauds in the financial statement is the responsibility of the
management of the business for which the business must have a strong internal control system.
Some of the popular techniques which can be applied by businesses in preventing frauds in the
first place is by incorporating proper supervision of different activities of the business which
would ensure that the financial reporting for the business is done appropriately. The first step in
prevention of frauds in financial statements is by detecting the frauds in the first place. The
frauds in the annual reports of the business can be appropriately detected by analyzing the
changes which have occurred in the books of accounts from past year changes (Omar & Rizuan,
2014). The management can use tools such as Horizontal and Vertical analysis and also ratio
analysis for the purpose of detecting changes in the annual reports of the business in comparison
to previous year analysis. The management of companies need to identify the areas of reporting
which are most likely to be misstated and therefore exercise more scrutiny in the area so that

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there is no scope of fraud in the area. The management of the business can also place senior
accounting professionals who will be reviewing the work of accountants and ensure that all
necessary disclosures and notes to accounts are included in the financial statements of a business.
This research recognizes the counter measures which are taken by Public Company Accounting
Oversight Board (PCAOB) for the purpose of ensuring that the financial statement of a business
shows true and fair view of the financial position of the business. In addition to this, various
accounting standards are introduced so that no scope of material misstatement in the financial
statement should be present. The passage of the Sarbanes-Oxley Act (2002) and the American
Institute of Certified Proceedings of the International Conference on Accounting Studies, Public
Accountants Statement on Auditing Standards (SAS) No. 99 have further enhanced the role of
auditors and they cannot ignore any fraud in the financial statement.
Reduction of Financial Frauds in the Organizations
In every business organizations, the presence of some specific persons as well as
mechanism can be seen that help the managements of the companies in the reduction of the
financial frauds in the financial statement. According to Halbouni (2015), the companies need to
consider the auditors for the reduction in the financial statements frauds as the auditors perceive
frauds fraud as a major concern for the business organizations. In addition, the auditors also
consider the fact that the auditors perceive that the presence of financial statement fraud can
create negative impact on the users of the financial information. According to Halbouni (2015),
one important aspect is that there can be opportunities of the occurrence of frauds when an
employee reaches a level of trust in the company or when there is the presence of weak internal
control in the companies (Halbouni, 2015). According to Shi, Connelly & Hoskisson (2017), the
agency theory suggests towards the fact that the external governance mechanism can discourage