MIUFaculty of Business Administration and International Trade Department of Accounting

Techniques of Detecting and Preventing Fraud in Financial StatementsGraduation Project

Prepared by Nour Ali Al Mohanad Emad Youstina Kout Nourhan El-AgizyMirna Ismael

Supervised By: Professor Zakaria FaridProfessor of AccountingAin Shams University

Spring 2015Dedication and Acknowledgment

This research is dedicated to our two accounting professors who have defined a remarkable work in the field of accounting in Misr International University from our point of view; Professor Zakaa Khalifa and Professor Zakaria Farid.

Professor Zakaa Khalifa who is serving as the head of the accounting department in Misr International University provided us throughout our academic studies in the university with a prolific knowledge in different fields of Accounting as well as providing a constructive tips that helped us in our academic life.

Professor Zakaria Farid who is serving as the professor of Accounting in Ain Shams University provided us with boundless assistance in our project as well as fruitful and brand new ideas in finalizing our project observing his academic contribution in the field of Accounting and Financial Accounting in Egypt and Abroad.Not to forget all the staff of Accounting and Teaching assistants who has provided us with assistance through our academic studies in the university and to everyone who might find our project useful.

We designed this page to give our thanks for those who shaped significant differences in our knowledge, personality and attitude and we wish all readers to have the benefit from this humble work of us.

Table of ContentPages1. Dedication and Acknowledgment 22. Table of Content33. Chapter 1 (Introduction to Fraud in Financial Statements)4 - 124. Chapter 2 (Literature Review)13 - 235. Chapter 3 (Reasons and Effects of Fraud in Financial Statements)24 - 426. Chapter 4 (Indicators and ways to prevent Fraud in Financial Statements)43 - 657. Chapter 5 (Case Study and Application in Preventing Fraud in Financial Statements)66 - 848. Chapter 6 (Conclusion)85 - 869. References87 - 92

Chapter 1Introduction to Fraud in Financial StatementsI. Introduction:Nowadays, Fraud in financial statements becomes mutual as it causes a serious problem for everyone who is interested users of financial data from any company, whether to invest in, a competitor, or financial institutionsetc. Fraud has a direct impact on business as companies who commit fraud shows a manipulation in their financial statement in order to differentiate themselves from others. Fraud can be caused by many factors to meet expectations of the owners or creditors, or to obtain more favorable credit terms, to meet performance criteria set by related companies, or to maintain an impression of constant economic growth of the company. Not all these are justifications to commit fraud in financial statements, as fraud is extremely disastrous to any company, yet it can be easily identified and prevented through auditing procedures or analyzing the financial statements, which is very essential to stop this insalubrious act to any company, to its stakeholders, and to the whole community.

II. Background:1. Financial Statements:A companys financial statements give a lot of financial information that business owners and creditors use to estimate a companys financial performance. Financial statements are very essential to a companys top management because of spreading financial statements; management can communicate with outside parties about its role to run the company. Different financial statements focus on various fields of financial performances. Financial statements are important for many reasons, but here are three significant reasons (Eric Owen, 2013):a. Financial statements tell you the performance and the value (sort of) of your company.b. Financial statements are what others are using to measure your company. c. Financial statements and other tools help you manage your company when you can no longer be hands on with all the details.

2. Types of Financial Statements:There are three primary financial statements: Balance Sheet, Income Statement and Cash Flow Statement.a. Balance sheet: it is one of the most essential statements used by accountants to provide the top management and creditors with the information needed. The balance sheet presents a company's financial situation at the end of a specified date. Balance sheet consists of three main elements; they are assets, liabilities and Equity. Assets are the resources of the organization that have been gained through transactions, and have economic value that can be measured and expressed in dollars, such as cash, investments, inventories, land and equipments etc. Liabilities (obligations of the company) are amounts owed to creditors for a previous transaction such as accounts payable, notes payable, salaries payable etc. Owner's equity is actually means the book value of the company is equal to the reported asset amounts minus the reported liability amounts.The Following is an example of the balance sheet.

b. Income statement: it is one of the main financial statements referred to as the profit and loss statement (P&L), statement of operations, or statement of income. The income statement shows the net results of a company and its operations during the period specified in its heading.The Following is an example of the income statement.c. Cash flow statement: it shows the cash generated and used during a specific period of time. It consists from three main categories. Operating activities converts the items reported on the income statement from accrual basis of accounting to cash Basis, investing activities (reports the purchases and sale of long-term investments and property, plant and equipment) and financial activities (reports the issuance and repurchases of the company's own stock and bonds and the payment of the dividends) and the supplemental information (reports the exchange of significant items that did not involve cash and reports the amount of income taxes paid and interest paid).The Following is an example of Cash Flow Statement.

3. Users of the Financial Statements:There are internal and external users of financial statements:

a. Internal Users: such as Management to analyze the organizations performance and position and taking appropriate measures to improve the company results, Employees to assess companys profitability and its consequences on their future compensation and job security and Owners for analyzing the viability and profitability of their investment and determining any future course of action.

b. External Users: such as Creditors for defining the credit worthiness of the organization. Terms of credit are set by creditors according to the assessment of their customers' financial condition. Creditors include suppliers as well as lenders of finance such as banks, Tax Authorities for determining the reliability of the tax returns filed on behalf of the company, Investors for analyzing the feasibility of investing in the company, Investors want to make sure they can earn a reasonable return on their investment before they commit any financial resources to the company, Customers for assessing the financial position of its suppliers which is necessary for them to maintain a stable source of supply in the long term and Regulatory authorities for ensuring that the company's disclosure of accounting information is in accordance with the rules and regulations set in order to protect the interests of the stakeholders who rely on such information in forming their decisions.

4. Accounting Fraud:Accounting Fraud is one of the major obstacles, which the companies face. It is a type of manipulation in the financial statements in order to make the company looks better in performance or in order to hide a theft process of the assets, in other words accounting fraud can be described a situation when an employee of a business entity steals, misappropriate or misuse money or other resources. Anybody in the position of stealing ranging from unit managers to accounting clerks or chief financial officer can commit this kind of fraud. Factors like elevating oneself, covering for errors, and covering for loved one can be the motive behind the commission of accounting fraud. The interesting stuff about accounting fraud is that small discovery usually lead to massive exposure of fraud.

The accounting fraud, which happens in the financial statements, is always high and is mostly prepared by top management staff. The main motive behind this is to present a failing company being profitable, as this will greatly influence the money that the managers will collect at the end of the day. This type of fraud could happens in the three types of the financial statements, they manipulate the balance sheet in order to raise their earnings power and assets .Justin Kuepper says in his article Spotting Creative Accounting On The Balance Sheet at www.investopedia.com '' Companies that manipulate their balance sheet are often seeking to increase their earnings power in future periods (or the current period) or create the appearance of a strong financial condition. After all, financially-sound companies can more easily obtain lines of credit at low interest rates, as well as more easily issue debt financing or issue bonds on better terms''.

For the income statement, companies manipulate it for two reasons; they maximize the net profit in order to make the company looks like gaining more profits or minimize it for paying fewer taxes. Fraud in the cash flow statement could happen by allocating dividend and interest payments to financing rather than operating cash flow and allocating dividends and interest received to operating rather than investing cash flow.

5. Famous Accounting Scandals:According to Barry Ritholtz he published on the big picture magazine about the most famous scandalsa. The Global financial services firm Hided over $50 billion in loans hidden as sales. Lehman executives and the company's auditors, Ernst & Young were the main players. : Allegedly sold poisonous assets to Cayman Island banks with the understanding that they would be bought back eventually. Created the impression Lehman had $50 billion more cash and $50 billion less in toxic assets than it did really did. They were caught because of the bankrupt. This was one of the largest bankruptcies in U.S. history. SEC did not sue due to lack of evidence. The funny fact was that In 2007 Lehman Brothers was ranked the #1 "Most Admired Securities Firm" by Fortune Magazine.

b. Madoff Investment Securities LLC was a Wall Street investment firm founded by Madoff. They had tricked investors out of $64.8 billion through the largest Ponzi scheme in history. The main players were Bernie Madoff, his accountant, David Friehling, and Frank DiPascalli. Investors were paid returns out of their own money or that of other investors rather than from profits. Madoff told his sons about his arrangement and they reported him to the SEC. He was arrested the next day. That has resulted in 150 years in prison for Madoff + $170 billion repayment and prison time for Friehling and DiPascalli. Madoff's fraud was revealed just months after the 2008 U.S. financial collapse.

c. In the Indian IT services and back-office accounting firm, Founder/Chairman Ramalinga Raju boosted revenue by $1.5 billion. They did it by fabricating revenues, margins and cash balances to the tune of 50 billion rupees. They were caught by admitting the fraud in a letter to the company's board of directors. Raju and his brother charged with breach of trust, conspiracy, cheating and falsification of records. They were released after the Central Bureau of Investigation failed to file charges on time. In 2011, Ramalinga Raju's wife published a book of his existentialist, free-verse poetry.

III. Project Objective:The objective of this project is to: 1. Examine the association between fraud in financial statements and other variables: Employee salary, the economic situation of the country, and rules and obligations of the organization through conducting a survey and collecting opinions.2. Analyzing manufacturing company financial statements in a certain area to identify a margin of fraud that has occurred in their financial statements.

IV. Research Methodology:The current research is an applied research. Different types of qualitative methodologies will be used in order to find out the causes, characteristics, the consequences and the lessons learned from the fraud in the financial statements.Data collection of the research depends on the following: 1. Questionnaire.2. Professional Interview.3. Case Study.The questionnaire is an important tool to understand and collect different opinions from different cultures and environments about fraud in financial statements and understand the impact of fraud in other variables.

The professional interview will be very beneficial in order to get in a direct contact with a professional who has been in a company that committed a fraudulent act and understand his opinion about fraud and how to prevent it.

The case study is one of the most important tools in this project. It will show the margin of fraud in a financial statement providing that the usage of financial statements analysis ratios is necessary.

V. Limitations of the Study:The current research is limited to: 1. A technological manufacturing industry rather than service or merchandising industries. That is because such industry has many opportunities in its transactions to face fraud in its financial statements. 2. Financial statements for years 2011, 2012, and 2013. 3. A South Korean company.

Chapter 2Literature Review1. Scott L. Summers and John T. Sweeney Study (1998): Fraudulently misstated financial statements and insider trading: an empirical analysis...In their abstract, they stated, This study investigates the relationship between insider trading and fraud. We find that in the presence of fraud, insiders reduce their holdings of company stock through high levels of selling activity as measured by either the number of transactions, the number of shares sold, or the dollar amount of shares sold. Moreover, we present evidence that a cascaded logit model, incorporating insider trading variables and firm-specific financial characteristics, differentiates companies with fraud from companies without fraud.They also mentioned, The purpose of this study was to analyze the relationship between financial statement fraud and insider trading activity to determine whether auditors could enhance financial statement fraud risk assessment by including insider trading activity in their model. Using a matched sample of fraud and no-fraud companies. They also stated, The results of this study indicate that insider trading and financial statement factors are useful in a model which distinguishes companies where fraud is found from companies where fraud is not found. This is a significant contribution to both auditors attempting to detect fraud and to regulators monitoring insider trading.At the end of their research, they stated the limitations of the articles as they mentioned, There are a number of limitations to this study. First, this study examines the population of companies for which fraud was discovered after an audit. Hence, two types of fraud are not included in the fraud sample: undiscovered fraud and fraud discovered during the audit. Second, this study may have a newsworthiness bias Third; this study did not use a hold out sample to validate the models that are presented. Further research with larger samples will be necessary to validate these results. Finally. This study is limited in that it does not address finer classifications of fraud. Turner (1980) proposes classification of management fraud into four classes, according to whether the distortion of the financial statements is the vehicle for the fraud or a disguise of the fraud. In addition, according to who benefits from the fraud: the company or the perpetrator? Our model does not assess the likelihood of a particular class of fraud.

2. Charalambos T. Spathis (2002): Detecting false financial statements using published data: some evidence from Greece He stated that This paper examines published data to develop a model for detecting factors associated with false financial statements (FFS) Most false financial statements in Greece can be identified on the basis of the quantity and content of the qualifications in the reports filed by the auditors on the accounts. A sample of 76 firms includes 38 with FFS and38 non-FFS. Ten financial variables are selected for examination as potential predictors of FFS. Univariate and multivariate statistical techniques such as logistic regression are used to develop a model to identify factors associated with FFS. The model is accurate in classifying the total sample correctly with accuracy rates exceeding 84 per cent. The results therefore demonstrate that the models function effectively in detecting FFS and could be of assistance to auditors, both internal and external, to taxation and other state authorities and to the banking system.In the introduction of his paper, he concluded by defining and explaining FFS, as References to false financial statement (FFS) are increasingly frequent over the last few years Falsifying financial statements primarily consists of manipulating elements by overstating assets, sales and profit, or understating liabilities, expenses, or losses.The data used in this research is extracted from Books, newspapers and financial reports from firms.Worth mentioning this is an applied research because he used financial statement ratios analysis to apply FFS.

3. Niamh Brennan and Mary McGareth (2007): Financial statement fraud: some lessons from US and European case studies. They stated that '' This paper studies 14 companies, which were subject to an official investigation arising from the publication of fraudulent financial statements. The research found senior management to be responsible for most fraud. Recording false sales was the most common method of financial statement fraud. Meeting external forecasts emerged as the primary motivation. Management discovered most fraud, although the discovery was split between incumbent and new management''.Fourteen companies are analyzed in the research nine US and five European. The nine US companies were selected following a search of the SECs Accounting and Auditing Enforcement Releases (AAER) relating to violations of Rule 10-b of the Securities and Exchange Act 1934 and Section 17(a) of the Securities Act 1933.These are the main rules relating to financial statement fraud. The AAER are available on-line at www.sec.gov.The European cases are UK companies with the exception of Lernout and Hauspie (L&H), a Belgian company. The main source for the European cases was the financial press. The SFO website, www.sfo.gov.uk, provided a summary of the results of successfully prosecuted cases.The approach to assessing the case studies is that suggested by Ryan et al (1992).Cases were deemed suitable for inclusion in the research where information about methods and motives was on the public record and where persons involved in the fraud had been publicly identified. The main source was documented evidence from SEC and SFO reports. Secondary evidence such as newspaper reports and articles was also used.

4. Alfred Bridi reviewed by Robin Hodess 2010):Corruption in tax administration and its effect on financial statements. The draft project document does not fully integrate and analyze aspects related to anti-corruption and how aspects related to anti-corruption could be included in the different activities proposed in the project and/or in the risk assessment. The main components included in the project are (1) taxpayer services (2) tax audit (3) efficiency in management (4) tax statistics.He stated that in his summary '' Revenue administration is often ranked as one of the poorest performing public sectors in terms of corruption and, as Transparency Internationals latest Global Corruption Barometer (TI 2009) illustrate, corruption continues to affect the sector in 2009. This sector is very important to a states development and economic health as it significantly affects its capacity to spend on public projects and programs, thus making problems of inefficiency and revenue leaking especially damaging. Corruption in tax administration also dissuades honest taxpayers by rendering them less competitive and making the black-market a more attractive alternative. Tax administration is an attractive sector for corruption to take place as the opportunities and incentives to engage in illicit activity are numerous. The complexity of tax laws, the high discretionary powers of tax officials, the low cost of punishment are only some factors creating opportunities for corruption in revenue administration''The author used the qualitative method in this research, which is used to reveal a target audiences range of behavior and the perceptions that drive it with reference to specific topics or issues (tax corruption).The author got most of his data from the internet and from several books and by reviewing many on fraud financial statements.He used many of samples as a case study for him; the Mexican experience, The Bulgarian experience, The Tanzanian experience and The Bolivian experience.

5. Javiriyah Ashraf (2011): The Accounting Fraud @ WorldCom: The Causes, The Characteristics, The Consequences, and The Lessons LearnedHe stated that '' The economic prosperity of the late 1990s was characterized by a perceived expansive growth that increased the expectations of a company's performance. WorldCom, a telecommunications company, was a victim of these expectations that led to the evolution of a fraud designed to deceive the public until the economic outlook improved. Through understanding what led to the fraud, how the fraud grew, and what its effects were, lessons can be derived to gain a better understanding of the reasons behind a fraud and to prevent future frauds from occurring or growing as big as the WorldCom fraud did''.This is a web based research by using the applied method which he made not for just be an informative research but to find out the causes , characteristics, the consequences and the lessons learned from the fraud in the financial statements.The author also used the case study analysis as purpose of the study involves in depth, contextual analysis about WorldCom as it was provider of long distance phone services to businesses and residents. It started as a small company known as Long Distance Discount Services (LDDS) that grew to become the third largest telecommunications company in the United States.As was mentioned before the source of his collected data was from the internet and by reviewing some of the company financial statements reports. Gene Morse, the internal auditor at WorldCom when all this happened, for his internal insight into the case, which was a face-to-face interview.

6. Mariana vlad, Mihaela tulvinschi and Irina Chirita (2011): The consequences of fraudulent financial reportingThey stated, Financial reporting frauds are a serious threat for the investors confidence in the financial information. The side effects of the financial frauds are affecting the integrity, quality and confidence in published financial reporting. Criminals who carry out such fraud, from management to employees, must understand that the interference of records is a crime that will be judged. Qualitative financial reporting, including reliable financial statements without mistakes, can be made when there is well-planned corporate governance. Although participants in corporate governance responsibilities vary depending on their level of preparation and on the presentation form of financial reporting, a well-defined working relationship among these participants should reduce the probability of financial fraud.After conducting their research they concluded by saying that Although the achievement of financial reporting by so-called "fraudulent scheme" refers to short-term achievement of "management earnings ", they may draw the following consequences in time: undermines the credibility, quality, transparency and integrity of financial reporting process; endangers the integrity and objectivity of the auditing profession, especially auditors and audit firms; diminishes the confidence in the capital markets, as well as in market participants and in the reliability of financial information; makes capital markets less efficient; adversely affects economic growth; huge lawsuit costs; destroys the careers of people involved in fraudulent financial statements; they cause bankruptcy or substantial economic losses for companies involved in financial statement fraud; encourages regulatory intervention; erodes public confidence and trust in accounting and auditing profession.

7. Ovidia Doinea and Gheorghe Lapadat (2012): Deterring Financial Reporting Fraud .They stated that The mainstay of the paper is formed by an analysis of the relationship between the importance of RPTs in auditing and in detecting fraud, the widespread adoption of Web-based financial and business reporting, the risk of fair value accounting fraud, the process of detecting fraud, and opportunities for fraudulent financial reporting based on misapplication of fair value accounting concepts. This research makes conceptual and methodological contributions to the role of the external auditor in detecting and deterring fraudulent or misleading financial reporting, increased globalization of financial and product markets, the pervasiveness of technology within the corporate financial data transmission structure, and managements involvement in the fraudulent financial reporting activity.They Concluded by saying that This paper seeks to fill a gap in the current literature by examining different aspects of the relationship RPTs conditional on the existence of fraud, the importance of accurate and credible financial reporting, the prevention or executive of fraudulent financial reporting, the flexibility of the Web as a medium for corporate disclosure, and the risk of financial reporting fraud. Our paper contributes to the literature by providing evidence on top managements ability to override internal controls, the content and presentation attributes of Web-based financial information, the likelihood of fraudulent financial reporting, industry as a potential inherent risk indicator in a financial statement audit, and properties of reported financial information.

8. Rajan Jupta and Nasib Singh Gill (2012): "Financial statement fraud detection using text mining". They stated that Data mining techniques have been used enormously by the researchers community in detecting financial statement fraud. Most of the research in this direction has used the numbers (quantitative information) i.e. financial ratios present in the financial statements for detecting fraud. There is very little or no research on the analysis of text such as auditors comments or notes present in published reports. In this study we propose a text mining approach for detecting financial statement fraud by analyzing the hidden clues in the qualitative information (text) present in financial statements".They presented a text mining approach for detection of financial statement fraud. Fraud detection model presented in their paper begins with collection of financial statements for both fraud and non-fraud organizations followed by preprocessing which involves lexical analysis of text present in financial statements. At the next step, bag of words approach has been selected for extracting information hidden in the text that results in vector spaces for both fraudulent and non-fraudulent organizations.They stated, Companies may present a rosy picture to the investors by manipulating the financial measurements and qualitative narratives of financial statements. These disclosures (qualitative narratives) may not contain fraud indicators explicitly; however, indicators of fraud can be constructed by understanding the syntactic as well as semantics of any natural language because perpetrators of fraud may camouflage the indicators by using semantic arsenal of the language. Therefore, in order to detect fraud, it is necessary to examine the qualitative disclosures in the footnotes in the financial statements, as well as the numbers (quantitative information) associated with financial statements.

9. Anuj Sharma and Prabin Kumar Panigrahi (2012): A Review of Financial Accounting Fraud Detection based on Data Mining Techniques. They stated that With an upsurge in financial accounting fraud in the current economic scenario experienced, financial accounting fraud detection (FAFD) has become an emerging topic of great importance for academic, research and industries. The failure of internal auditing system of the organization in identifying the accounting frauds has led to use of specialized procedures to detect financial accounting fraud, collective known as forensic accounting. Data mining techniques are providing great aid in financial accounting fraud detection, since dealing with the large data volumes and complexities of financial data are big challenges for forensic accounting. This paper presents a comprehensive review of the literature on the application of data mining techniques for the detection of financial accounting fraud and proposes a framework for data mining techniques based accounting fraud detection. The systematic and comprehensive literature review of the data mining techniques applicable to financial accounting fraud detection may provide a foundation to future research in this field. The findings of this review show that data mining techniques like logistic models, neural networks, Bayesian belief network, and decision trees have been applied most extensively to provide primary solutions to the problems inherent in the detection and classification of fraudulent data.

10. Rajan Jupta and Nasib Singh Gill (2012): A Data Mining Framework for Prevention and Detection of Financial Statement Fraud .They stated that Financial statement fraud has reached the epidemic proportion globally. Recently, financial statement fraud has dominated the corporate news-causing debacle at number of companies worldwide. In the wake of failure of many organizations, there is a dire need of prevention and detection of financial statement fraud. Prevention of financial statement fraud is a measure to stop its occurrence initially whereas detection means the identification of such fraud as soon as possible. Fraud detection is required only if prevention has failed. Therefore, a continuous fraud detection mechanism should be in place because management may be unaware about the failure of prevention mechanism. In this paper we propose a data mining framework for prevention and detection of financial statement fraud.They assumed the framework to conduct their research as collecting data from financial statements about a certain financial ratios 62 financial ratios.They also reprocessed data through data reprocessing techniques including normalization of the input variables and resolving inconsistencies in the dataset, now data are ready to be mined.

11. Rajan Jupta and Nasib Singh Gil (2012): A Solution for Preventing Fraudulent Financial Reporting using Descriptive Data Mining Techniques.They stated that In the present age of scams, financial statement fraud represents enormous cost to our economy. The deliberate misstatement of numbers in the accounting books with the help of well-planned scheme by an intelligent squad of knowledgeable perpetrators in order to deceive the capital market participants is termed as financial statement fraud. In order to reduce fraud risk which comprehends both detection and prevention of financial statement fraud, this paper implements descriptive data mining techniques such as Association rules and clustering as opposed to predictive data mining techniques used in the literature. Each of these techniques is applied on dataset obtained from financial statements namely balance sheet, income statement and cash flow statement of 114 companies.They collected data about the 114 companies in their research coming from www.wikinvest.com In order to identify companies accused of financial statement fraud, Accounting and Auditing Enforcement Releases published by S.E.C. (U.S. Securities and Exchange Commission) between 2007 and 2012, they also have removed all incidents of violation of the Foreign Corrupt Practices Act (FCPA) from their sample because FCPA prohibits the practice of bribing foreign officials and most of the AAERs issued because of FCPA do not reflect which financial statement, balance sheet or income statement, is affected.They also identified 29 fraudulent organizations by analyzing AAERs. Out of these 114 firms, 85 firms have not reported their financial statements fraudulently, however, absence of any proof does not guarantee that these firms have not falsified their financial statements or will not do the same in future. In order to identify organizations with probability of fraud.

12. Holger Rootzn (2012): The Enron Scandal.He stated that From the 1990's until the fall of 2001, Enron was famous throughout the business world and was known as an innovator, technology powerhouse, and a corporation with no fear. The sudden fall of Enron in the end of 2001 shattered not just the business world but also the lives of their employees and the people who believed that their soar to greatness was genuine. Their collapse was followed by a series of revelations on how they manipulated their success.Showing up some recommendations such as Incentives must be paid after a project is done or at least when the company is really profiting from that certain project, Operational Risk should be minimized and there should be some sort of checkup, Careful selection of accounting approach and financial structures to use, Minimized payment in stocks.

13. Hawariah Dalnial, Amrizah Kamaluddin, Zuraidah Mohd Sanusi, and Khairun Syafiza Khairuddin (2014): Detecting Fraudulent Financial Reporting through Financial Statement Analysis.They stated that Fraudulent financial reporting is a major concern for two primary regulators of Malaysias capital market - the Securities Commission (SC) and Bursa Malaysia. Both authorities continue to refine the parameters that will ensure rigorous surveillance over public listed firms. The objective of current study is to examine the association between financial statement analysis and fraudulent financial reporting. Many researchers found indication of financial ratios to detect fraudulent financial reporting but others also have concluded otherwise. Most of these studies were conducted outside of Malaysia. The sample comprises of the Malaysian Public Listed firms and data used ranged between year 2000 to 2011. The result indicated that several financial ratios such as total debt to total asset, and receivables to revenue were found to be significant predictors to detect fraudulent financial reporting. This reflects that, financial ratios maybe helpful in the detection of fraudulent financial reporting. These findings add to the extant literature on the ability of financial ratios to detecting fraud.In their study, they used a sample method as they stated, This study examined 130 samples consisting of 65 samples for fraudulent firms and 65 samples of non-fraudulent firms from the Malaysian Public Listed Firms available between the years 2000 and 2011 with financial data collected from DataStream. Moreover, they used a selection of fraudulent financial reporting firms as stated, Firms involving in fraudulent reporting are obtained from the Bursa Malaysia media center. This list summarizes firms according to the offences made against the Listing Requirements of Bursa Malaysia Securities Berhad, most of which were reporting material misstatements in the financial reports. This assessment resulted in 91 preliminary sample firms.

14. Anita R. Morgan and Cori Burnside (2014): Olympus Corporation Financial Statement Fraud Case Study: The Role That National Culture Plays On Detecting And Deterring Fraud.They stated that Recent cases provide insight into the role that an unethical corporate culture plays in financial statement fraud. The case of financial statement fraud in Olympus Corporation, a Japanese firm, provides the opportunity to examine how national culture plays a role in corporate governance and fraud detection. This case study focuses on the impact of Japanese culture on the corporate culture of The Olympus Corporation, and how that corporate culture resulted in financial statement fraud.

Chapter 3Reasons and Effects of Fraud in Financial Statements

I. Types of financial statement frauds and technical solutions:There are three types of the businesses fraud; corruption, asset misappropriation, and financial statements fraud. Corruption means dishonest behavior by those in positions of power, such as managers or government officials. Corruption can include giving or accepting bribes or inappropriate gifts, double dealing, under-the-table transactions, manipulating elections, diverting funds, laundering money and defrauding investors. Asset misappropriation involves third parties or employees abusing their position to steal from an organization through fraudulent activity. Finally the financial statements fraud, which will be discussed in the current study. It means intentional misrepresentation, misstatement or oversight of financial statement in order to mislead the reader and to create a wrong impression of an organization's financial position.

Public and private businesses do financial statement fraud in order to secure investor interest or obtain bank agreements for financing, as good reason for bonuses or increased wages and salaries or to meet expectations of the owners. Top management is usually the responsible of financial statement fraud because financial statements are made at the management level. The financial statement fraud will be divided into two types; overstatements and understatements according to the following diagram:

1. The over statements means that recording the assets and the revenues of the company more than its main value in order to show that the company is gaining profits to raise the price of its stocks in the stock market. As an example if an asset is overstated, the balance sheet shows assets as higher as they should be. For example, a bank might value a mortgage-backed security at $1M when it properly should be evaluated at $750K. There are also many types of the over statements including timing differences, fictitious revenues, cancelled liabilities and expenses, improper asset valuation and improper disclosures.

Everette Colby stated that "Financial statement fraud can take many different forms, but there are several methods that are considered most common. These include fictitious revenues, timing differences, concealed liabilities or expenses, improper disclosure of related-party transactions, and improper asset valuations. From an accounting perspective, revenues, profits, or assets are typically overstated Overstating revenues, profits, or assets reflects a financially stronger company".2. Fictitious revenues mean that recording sales that did not happen in real. Colby stated that '' fictitious revenues involves the creation or manipulation of transactions to enhance the organizations reported earnings. Fabricating revenue typically involves creating fake or phantom customers and sales. Artificial sales can also involve legitimate customers by creating phony invoices or increasing quantities or prices''.

Fictitious revenues could be done by making many of fake customers' accounts in the company system, which deceives any auditor by thinking that this company has many customers so it makes big revenues. Actually the purpose of this type of fraud is to have a big number of the net income in order to raise the company stock market shares. Another reason for the top management they do the fictitious revenue in order to prove that for the business owners that they are performing well so they keep their position. For the person who is concerned about the matter he should compare the sales invoices with the real one to be sure that everything is okay.

Colby also mentioned that '' there are several questions should the examiner ask himself such as: Can sales be confirmed with the customers? Were invoices at year end unusually high? Were there any sales to related parties in the last quarter? Related-party transactions are much more prone to manipulation. Have any documents been altered or forgeted and are they originals or photocopies? If management has created fictitious sales, they usually have to create phony documents (type of business papers which are fabricated to proof a kind of a fraud as it is real) to support those sales or alter legitimate documents to reflect the increased sales amount''.

We should also examine the latest transactions and adjustments because they have a big potential possibility of manipulation. Making gross margin ratio analysis (a profitability ratio that compares the gross margin of a business to the net sales, gross margin ratio = gross margin / net sales) will help also to prevent the fictitious revenues. Colby says that this ratio will often be out of line with other periods if this is the first year fictitious revenues were created. One of the most known cases of fictitious revenues is Cendant Corp.

Jamal Ahmad, David Jansen and Jonny J. Frank stated that '' Created $35 million in inappropriate restructuring reserves in 1996 that were reversed in 1997 to inflate income thus creating the illusion of a rapid turnaround. In 1997, reported over $70 million of revenue from bill and hold sales, channel stuffing and other inappropriate accounting practices. That's resulted in restating 1997 income from $109 million to $38 million. CEO charged with violating federal securities laws by misrepresenting material information about the company. CEO settled by paying a piece of a $141 million fine. Former controller and chief accounting officer each agreed to pay $100,000 in fines. Former Arthur Anderson partner also settled for undisclosed amount''.

3. Timing differences, (overstatement) is another way of creating overstatement revenues. It involves the recording of revenue and/or expenses in the wrong period. Recording revenue early, before it is made, will immediately increase the enterprises income using lawful sales, rather than making fake sales. The top management has several methods for using the time differences method to capitalize the revenue.

Colby also stated that '' Recording expenses in the wrong period is another way of increasing the organizations income. Expenses would typically be capitalized or recorded in the subsequent period so the effects are not taken into account on the income statement. Depreciating or amortizing assets too slowly is another method of delaying expense recognition". There are many methods to stop the timing differences fraud, one of them is to examine if the invoices are made in the true period or not. Examine the real time of purchases from the suppliers and the real time of selling from the clients. Examine the organizations capitalization policies. Examine changes in depreciable assets lives. Re-compute the depreciation and amortization for all assets. One of the most known cases of timing differences is Xerox company which Overstated revenue for over 4 years by accelerating the recognition of $3 billion in revenue and inflating earnings by about $1.5 billion. That's resulted in Co. agreed to pay $10 million in fines and restate its income for the years 1997-2000.

4. Concealed liabilities or expenses are made in order show that company has a big net profit and a stable financial position condition. Colby mentioned that '' Users of financial statements tend to look unfavorably at companies with significant amounts of debt. When liabilities or expenses are concealed, the companys equity, assets, and/or net earnings are inflated. Understating liabilities involves not recording accounts payable or accrued liabilities, recording unearned revenues as earned, not recording warranty or service liabilities, not recording loans or keeping liabilities off the books, and not recording contingent liabilities ".

In order to discover the concealed liabilities or expenses the auditor should examine the all liabilities and record the unrecorded liabilities by using the cut-off method including vendors invoices, receiving documents, and cash disbursements to know if these liabilities are recorded or not. Using the current ratio is also so helpful to detect the concealed liabilities or expenses (liquidity ratio that measures a company's ability to pay short-term liabilities, current ratio = current assets / current liabilities). If it is unordinary has high volume, it may be a sign of hidden liabilities.

In July 2002, the SEC filed suit against the Rigas family. Founders of Adelphia Communications, the suit alleged that between mid-1999 and the end of 2001, Adelphia fraudulently excluded from the Companys annual and quarterly consolidated financial statements over $2.3 billion in bank debt by deliberately shifting those liabilities onto the books of Adelphias off-balance sheet, unconsolidated affiliates. Failure to record this debt violated GAAP requirements and laid the foundation for a series of misrepresentations about those liabilities, including the creation of: (1) sham transactions backed by fictitious documents to give the false appearance that Adelphia had actually repaid debts when, in truth, it had simply shifted them to unconsolidated Rigas-controlled entities, and (2) misleading financial statements by giving the false impression through the use of footnotes that liabilities listed in the Companys financials included all outstanding bank debt.

5. Improper disclosure is actually based on not real presenting of the company and making wrong representations in documents and other company filings. Making wrong information in the attachment sections of annual reports of other filings are another purpose for improper disclosures. Many of wrong disclosures are intentionally made by top management and other improper disclosures are just errors and don't have prior intention to be made with illogical reasons. Examples of improper disclosure would include liability omissions, failure to disclose loan covenants, loan defaults or contingent liabilities, significant events; related-party transactions (include inflating inventory by purchasing from an affiliate at a price that is higher than market. Companies can also transfer liabilities to a related affiliate. Some of the methods to detect improper related-party transactions are to examine minutes of the board meetings), and changes in accounting policy methods.

6. Improper asset valuation (overstatement) simply it is maximizing the assets in the balance sheet of a company. The enterprises are usually use assets to pay their debts and their expenses that they are actually valued as inventory, accounts receivable, and fixed assets.

7. Manipulating in inventories is a well-known improper asset valuation.

Colby said that '' Inventory is also typically dispensed from several locations and is normally comprised of a large number of items. This makes it easier to create improper estimates for obsolete or slow-moving goods, to manipulate physical inventory counts, to create fictitious inventory, to fail to record the purchase of inventory, and for improper inventory capitalization ''.

Detecting inventory fraud needs the auditor to be more experienced. He can detect it by using several methods, Identify changes in organization operations that might have led to the neglected or slow-moving inventory. Watch the inventory itself. Examine the inventory detail in purchase and other inventory papers. Inventory turnover ratio (A ratio showing how many times a company's inventory is sold and replaced over a period, inventory turnover = sales / inventory) analysis to determine if the results are what is expected. Any variances should be followed up for explanation. One of the most noticeable red flags of unrecorded inventory is that the cost of goods sold is too low in relation to recorded revenues. This can be detected by using gross margin ratio analysis. The gross margin will typically be too high. Search for unrecorded liabilities that relate to inventory purchases and perform tracing from physical inventory count to inventory records.

8. Accounts receivable are typically falsified or manipulated in the same manner as revenue and inventory. MR Cobles says that accounts receivable fraud includes fabricated receivables and the failure to write off accounts receivable for bad debts. Accounts receivable are also prone to manipulation as a result of fraudulent revenue schemes because the fraudster will often create fictitious accounts receivable when creating fictitious revenues. Methods for detecting fictitious accounts receivable are to examine the accounts receivable aging report compare the yearend balance with the rest of the year and the previous month for unusual changes. Examine unusual sales and adjustments as well as subsequent period credit memos. Examine previous write-offs. Confirm accounts receivable with the purchasers. Calculate the accounts receivable turnover ratio (An accounting measure used to quantify a firm's effectiveness in extending credit as well as collecting debts, accounts receivable turnover = net credit sales / average accounts receivable ) . A slow turnover rate would be indicative of amounts that are uncollectible.

9. Fixed assets improper: valuation of fixed assets can occur in several ways. These include booking fictitious fixed assets, misrepresenting the asset value, improper capitalization, or the misclassification of assets.

Colby stated that '' The most common offset account when booking fictitious assets is owners equity. Land and building flips between related parties are often used to increase the value of the assets. Misclassification or the improper capitalization of fixed assets occurs when non- asset items are included in the fixed asset total''. Detecting the improper valuation of fixed assets can be accomplished using several techniques. You can see the documentation supporting the asset having, examine the title of assets, examine appraisers reports on value, trace assets on the floor to those in the books, and compute the current ratio since misclassification is typically done to improve current ratio. As an example for improper asset valuation In August 2002, it was revealed that the rot at WorldCom went even deeper than previously thought. The company reported that an internal audit had discovered that US$3.3 billion in profits were improperly recorded on its books from 1999 to the first quarter of 2002. That was in addition to the US$3.8 billion in expenses that had been improperly reported as capital investments in 2001.

10. The second type of the accounting fraud is the understatements means that recording the assets and the revenues of the company less than its main value in order to minimize the taxes which the company pay to the government. The IRS has detected the fraudulent activities that companies stating that underreporting or omitting income, Overstating the amount of deductions, Keeping two sets of books, Making false entries in books and records, Claiming personal expenses as business expenses, Claiming false deductions and Hiding or transferring assets or income are considered as criminal activities in violations of tax low. As an example if an asset is understated, the balance sheet shows assets as lower as they should be. For example - a bank might value a mortgage-backed security at $750K when it properly should be evaluated at $1M. There are also many types of the understatements including timing differences, understated revenues, overstated liabilities and expenses, improper asset valuation.11. Understated revenues mean that lowering the revenues of the company in order to reduce their tax liability or keep some money for the bad performance years that expected to happen in the future which is known as cookie-jar accounting.Arthur Pinkasovitch stated that '' cookie-jar accounting is disingenuous accounting practice in which periods of good financial results are used to create reserves that shore up profits in lean years. A company to smooth out volatility in its financial results, thus giving investors the misleading impression that it is consistently meeting earnings targets, uses Cookie jar accounting. Investors, who assign the company a premium valuation, generally reward this reliable earnings performance. Regulators frown on the practice since it misrepresents a companys performance, which may be very different in reality from what it purports to be''

One of the best-known cases of cookie jar accounting in recent years was that of computer giant Dell, which in July 2010 agreed to pay a $100 million penalty to the Securities and Exchange Commission (SEC) to settle SEC allegations that it used cookie jar reserves. The SEC maintained that Dell would have missed analysts earnings estimates in every quarter between 2002 and 2006 had it not dipped into these reserves to cover shortfalls in its operating results. The cookie jar reserves were created through undisclosed payments that Dell received from chip giant Intel in return for agreeing to use Intels CPU chips exclusively in its computers. (Intel made these payments to Dell to lock out rival chipmaker Advanced Micro Devices from Dell computers.). For the person who is concerned about the matter he should compare the sales invoices with the real one to be sure that everything is okay.

12. Timing differences (understatement), Expenses would typically be capitalized or recorded in the subsequent period so the effects are not taken into account on the income statement. If the objective is to decrease income to minimize the organizations taxes payable, it might accelerate expenses into the current period. This could involve increasing the rate of depreciation or amortization on assets. It can also include expensing capital expenditures. There are many methods to stop the timing differences fraud, one of them is to examine if the invoices are made in the true period or not. Examine the real time of purchases from the suppliers and the real time of selling from the clients. Examine the organizations capitalization policies.

13. Overstated liabilities and expenses the flusters use this method by maximizing the liabilities and expenses in order to do the tax evasion (Tax evasion is the illegal act of not paying the taxes that you owe, Tax evasion carries stiff penalties in practically every country in the world. In many countries, tax evasion will result in prison time and/or stiff penalties) so at the end of the day the company has a low net profit in its income statement. In addition, the Australian Taxation office stated, Tax evasion generally occurs when companies don't report all of their income, or they overstate their deductions. Companies do this to reduce the amount of tax they need to pay to gain a personal benefit''. . In order to discover the understated liabilities or expenses the auditor should examine the all liabilities and unrecorded the recorded liabilities. Using the current ratio is also so helpful to detect the understated liabilities or expenses. If it is unordinary has low volume, it may be a sign of capitalized liabilities.

14. Improper asset valuation (understatement) simply it is minimizing the assets in the balance sheet of a company to pay low taxes. As we said before any type of lowering the taxes is called tax evasion, which is illegal act arises when companies whether overstating their expenses and underestimating their assets to gain personal benefit that is faced by governments through penalties that might lead to prison or paying high damages. As a result of the assets could be converted to cash, lowering it would low the cash also. This could be done by minimizing the number of its inventories, receivables and fixed asset values.

15. Detecting inventory fraud needs the auditor to be more experienced. He can detect it by using several methods, Identify changes in organization operations that might have led to the capitalized or fast-moving inventory. Watch the inventory itself. Examine the inventory detail in purchase and other inventory papers. Auditors should do inventory turnover r ratio analysis to determine if the results are what is expected. Any unexpected high amounts should be followed up for explanation. About the receivables they should examine unusual sales and adjustments as well as subsequent period credit memos. Confirm accounts receivable with the purchasers. Calculate the accounts receivable turnover ratio. A fast turnover rate would be indicative of amounts that are highly collectible.

16. Detecting the improper valuation of fixed assets can be accomplished using several techniques. You can see the documentation supporting the asset having, examine the title of assets, examine appraisers reports on value, trace assets on the floor to those in the books, and compute the current ratio since misclassification is typically done to decrease current ratio.

II. The role of government to reduce tax fraud:Governments should act together to stop the immoral tax evasion done by taxpayer in different jurisdictions in the world, so we decided to give different solutions to minimize tax evasion and also that will not affect the profitability of governments and will be sensibly with the taxpayer not to make tax fraud in order to evade taxes and here are some recommendations:

1. Government should require companies and individuals to provide transparent country-by-country accounts. In addition, the accounting and tax deduction for the assessment and validity of charges would be strict sharing of national sales and actual costs.2. Government should automate information exchanges with other countries.3. Government should Change the strict culture. Leaders and government should be taking vital action. Not paying proper taxes and reconciling avoidance should cause explicit censure and sanctions.

III. Famous Tax Evaders:Daniel Bukszpan prepared a short list for famous celebrities who evaded taxes. This list includes::

1. Wesley Snipes: He failed to file tax returns between 1999 and 2006, and prosecutors claimed that during those years, $38 million worth of income had gone unreported. Snipes justified the nonpayment in a 2006 statement in which he claimed he was a nonresident foreign of the United States. In reality, he was born in Florida. He also stated the U.S. government had "no legal authority to impose any kind of criminal sanctions" and that he had no income for the U.S. government to legitimately tax. The courts did not see it that way, and on Feb. 1, 2008, he was convicted of three crime charges of failure to file income tax returns.

2. Richard Hatch: In September 2005, IRS accused him on charges of failing to report the money he had won in his 2000 tax return. The accusation was not only listed his unreported revenues but also unreported money from rental properties he owned, the car he won on a show and false statements that he had knowingly given about all of the above. In 2006, he was found guilty of tax evasion and sentenced to 51 months in prison.3. Leona Helmsley: Leona Helmsley and her husband, Harry, were New York real estate tycoons whose huge hotel empire included the Helmsley Palace on Madison Avenue in Manhattan. They had their Connecticut mansion; five years later, they were accused on charges of evading $4 million in income taxes for fraudulently billing work on the mansion to their hotels as business expenses. Leona Helmsley was finally convicted of evading $1.2 million worth of federal income taxes. Her husband was found not mentally competent to stand trial. They both have since died.4. Pete Rose: In 1990, Rose was sentenced to five months in prison and fined $50,000 for tax evasion, according to The Associated Press. He had failed to report more than $350,000 of income from autograph signings, sales of souvenirs and even the gambling that had cost him his career5. Kwame Kilpatrick: The youngest person ever elected mayor of DetroitKilpatricks durationwas famous for its many scandals and corruption claims, according to The New York TimesThe former mayor had created a charitable organization that received tax-exempt status, but authorities accused him of using the fund to pay for personal expenses, political consulting, On June 23, 2010, Kilpatrick was accused on multiple federal charges, including filing false tax returns. Each of the five tax amounts carried a possible sentence of five years and a $250,000 fine. The former mayor has arguednot guilty, and his case goes to trial in September 2012.6. Willie Nelson: In 1990, the IRS had served Nelson with a bill for $32 million in back taxes, one of the largest ever presented to an individual, because his accounting firm, PriceWaterhouse, had put his money into tax shelters of suspicious validity instead. The singer settled his debt with the IRS in 1993.

IV. Reasons of Financial Statement Fraud:There are many reasons leads to the financial statements frauds including many indicators. Fraud triangle, human greed, lack of transparency, company culture, lack of the internal controls and the Non-independent internal audit department are the most common reasons for the financial statement fraud.

Fraud triangle is a model for knowing the indicators that cause someone to do intentional fraud it is originated from Donald Cressey's hypothesis in 1973. It consists of three main important components, which, together, lead to fraudulent behavior. According to Romney & Steinbart (2008), three conditions exist in the occurrence of fraud: pressure, opportunity, and rationalization. Albrecht & Albrecht (2004) state that auditors focus more on the elimination of opportunity by ensuring strong internal controls, however, they often fail to focus on the motivation or rationalization of the perpetrators.

1. Rationalization is a crucial component in most frauds. Rationalization involves a person reconciling his/her behavior (stealing) with the commonly accepted notions of decency and trust. Some common rationalizations for committing fraud are:a. The person believes committing fraud is justified to save a family member or loved oneb. The person believes they will lose everything family, home, car, etc. if they do not take the Money; the person believes that no help is available from outside.c. The person labels the theft as borrowing, and fully intends to pay the stolen money back at some point; the person, because of job dissatisfaction (salaries, job environment, treatment by managers Believes that something is owed to him/her).d. The person is unable to understand or does not care about the consequence of their actions or of the accepted notions of decency and trust are also one of them.

2. Pressure or motivation is what makes a person to commit fraud. Pressure can include almost everything or anything including medical bills, expensive tastes, addiction problems, etc. always and most of the time; pressure comes from a significant financial need/problem. Often this need/problem is non-sharable in the eyes of the fraudster. That is, the person believes, for whatever reason, that their obstacle must be solved in secret. However, some frauds are committed simply out of greed alone.

Denise R. Tessier, regarding the fraud triangle theory, stated that '' Motivation or pressure is the second angle in examining what is driving the individual to commit the act. Just as with rationalization, the perception of a need or a pressure is the key factor, and it does not matter whether or not the motivation makes sense to others or is based in reality. Individuals may be facing financial or other personal problems such as gambling, drugs, alcohol addiction, or extreme medical bills. Pure greed also can factor into the equation but may be flavored with a sense of injustice. For example, the perpetrator may feel like the company should have paid me what my car was worth.

3. Opportunity is the ability to commit fraud. Because fraudsters do not wish to be caught, they must also believe that their activities will not be detected. Opportunity is created by weak internal controls, poor management oversight, and/or through use of ones position and authority. Failure to establish adequate procedures to detect fraudulent activity also increases the opportunities fraud for to occur. Of the three elements, opportunity is the leg that organizations have the most control over. It is essential that organizations build processes, procedures and controls that do not needlessly put employees in a position to commit fraud and that effectively detect fraudulent activity if it occurs.

Denise R. Tessier also said that "Finally, fraudsters must find an opportunity. This is defined as an environment or temporary circumstance that allows the fraud to be committed, typically with little perceived chance of being caught or penalized. Windows of opportunity exist for wrongdoing when companies have poor internal controls, weak processes and procedures, unauthorized or unchecked access to assets by employees, or a lack of management review and oversight.''

The second indicator of the financial statement fraud is the human greed and arrogance. Human greed is excellent old-fashioned human nature have hand when an individual, or group of individuals, sees an opportunity to make a fast buck. A wonderful example being those cases where people adjust their expense claims upwards. Arrogance is when some people believe that they are better than the system, and that they can get away with anything. The late Robert Maxwell (was a Czechoslovakian-born British media proprietor and Member of Parliament (MP). He rose from poverty to build an extensive publishing empire. His death revealed huge discrepancies in his companies' finances, including the Mirror Group pension fund, which Maxwell had fraudulently misappropriated) plundered his company pension scheme, arrogantly assuming that since he was chairperson of the company he could get away with it; he almost did!

Lack of transparency leads to direct financial statement fraud. Transparency term is the extent to which investors have ready access to any required financial information about a company such as price levels, market depth and audited financial reports. Classically defined as when "much is known by many", transparency is one of the silent prerequisites of any free and efficient market. Transparency helps to prevent the corruption that inevitably occurs when a select few have access to important information, allowing them to use it for personal gain. Reduced price volatility also tends to be a byproduct of a transparent market because all the market participants can base decisions of value on the same idea. Complex financial transactions that are difficult to understand are an ideal method to hide a fraud. The Barings fraud was perpetrated by use of an accounting dump account that no one understood.

Lack of the internal controls of the company is one of the most famous reason leads to the financial statement fraud. Internal controls are policies and procedures that will protect your business assets and reduce the risk of fraud. They can be simple, little to no cost ways that may prevent or minimize financial problems. Where are the accounting controls, such as a monthly reconciliation (Reconciling an account often means proving or documenting that an account balance is correct. For example, we reconcile the balance in the general ledger account Cash in Checking to the balance shown on the bank statement) of the bank account, are lapse the signals that a fraud has occurred will be missed.

The corporate governance is one of the important tools of the internal controls. The system by which companies are directed and controlled, it is also the process by which corporations are made responsive to the rights and wishes of stakeholders. Corporate governance is also the manner in which management and those charged with oversight accountability meet their obligations and fiduciary responsibilities to stakeholders.

Company culture can lead to the frauds in several ways. Managers can unknowingly create an environment where fraud runs highly. To protect the organization from the fraud, it is important that management understands their role in fostering an ethical, healthy work environment.

Robyn Barrett says in her article how company culture can lead to fraud '' Establishing a positive company culture is a key component in keeping fraud at bay. It begins with cultivating a company culture that fits the values most vital to the companys success. This can be achieved by clearly defining what behaviors will be accepted and encouraged within the company and which will not.''

According to the CPAs Handbook of Fraud and Commercial Crime Prevention, a guide published by the American Institute of Certified Public Accountants, there are certain elements of a companys culture that can make it more susceptible to fraud. Amongst these are autocratic management styles, centralized distribution of authority and overwhelmingly negative feedback.

Autocratic managers often make decisions without involving the employees in the decision-making process and put unnecessary pressure on employees to perform. According to the AICPA, this pressure can lead to internal fraud.

Robyn Barrett stated that '' Much like companies with autocratic managers, companies who implement a centralized distribution of authority harbor an environment for fraud by taking power away from employees and allowing all decisions to be made by higher-ups. Stripping employees of their ability to offer any insight or feedback makes it easier for employees to rationalize internal fraud''.

Lack of clear moral direction from senior management where the senior management indulges them in semi corrupt behavior, e.g. This won't give the employees the green light to work in environment full of the morals and ethics. This will make them more liable to the fraud behavioral more than other organizational environment which have clear moral and ethical standards from the high management staff.

The last reason of the fraud is the Non independent internal audit department where an organization's internal audit department is not independent, e.g. where it does not report to a truly independent audit committee but to the Finance Director, the more likely that when there are signals that a fraud is occurring the more likely they will be ignored. It is indeed interesting to note that Cynthia Cooper (Head of Internal Audit at WorldCom) had to bypass her boss (the CFO) and go directly to the audit committee to report the discovery of the capital expenditure fraud.

V. Consequences and Effects of Financial Statement Fraud:Financial statement fraud will have an effect on the employees or the organization that includes a monetary interest within the success or failure of an organization. A manipulation of the corporate reported earnings or assets will have an effect on a bank that extends credit to the company, a shareowner who invests cash within the company, and the employees who actually work in the company.

1. Banks lose lots of money, which affects other bank customers and clients who always make up for those losses and affects the banks investors. Creditors can lose large sums of money, which may not have been risked if the creditors knew the true financial condition of the company. Many of top management who make frauds leads their companies to collapse at the end of the day, those companies after collapsing can't pay back their loans to the banks and this has a dangerous effect on the national economy itself.

2. Financial statement fraud will cause shareholders to overpay for their investment in the company and they will get less value for their money than they are aware. They may lose part or all of their investment if the company ultimately fails or has to go through some sort of reorganization in order to remain viable. Shareholders also lose the opportunity to invest their money in other companies which may have better actual financial results or which may be more honest in their operations.

3. The manipulation of financial statements additionally affects staff. It is the ability to place staff out of work once the fraud is exposed or collapses. It additionally has the ability to complement staff principally those concerned with in the fraud, however probably people who are not. Sensible financial results (actual or fabricated) will be coupled to promotions, raises, increased profit packages, bonuses, and therefore the value of stock option awards. Another important effect that the employees will lose their moral and ethics towards to their company and this will badly affect the organization itself.

There are also many other effects of the financial statement frauds have a direct effect on the company itself including financial loss, External Confidence, Company Morale and increased audit costs according to John Freedman, Demand Media in their article How Fraud Hurts You & Your Organization.

1. Financial Loss: Financial loss is an obvious effect of both types of fraud. When someone misappropriates company assets, the loss is easy to quantify. For example, if a cashier takes $60 from the cash register, the company loses $60. The costs of fraudulent financial reporting are harder to determine. If a small-business owner perpetrates financial statement fraud, an explicit dollar figure might not be obvious. However, fines assessed for misleading investors, civil suits to recoup investor and creditor losses and the unwillingness of companies to extend credit to the business in the future all add up to a severe financial loss for the company.

2. External Confidence: Once a fraud has been uncovered, the company faces an ongoing problem of public trust in the organization. While a small business scandalized by fraud might never be the victim or perpetrator of another fraud, its public image might be irreparably tainted. Consequently, the company may have to pay a higher price for credit, may be refused membership in trade associations or might not be considered for a strategic alliance.

3. Company Moral: The effect of fraud on a company's culture and morale can be shattering. Any association with a company that has perpetrated or suffered fraud can be troubling and embarrassing for the people who work there. This may be especially true in a small-business setting where workers feel more connected with one another. Even if employees leave the company, they may carry an association with a fraudulent company into their next place of employment, even if they were not involved with the fraud at all.

4. Increased Audit Costs: Small businesses that are subject to audit and have experienced fraud, especially if the fraud was perpetrated by company management, are likely to be assessed as a high audit risk. That means auditors will more closely scrutinize company books before signing off on a company's financial statements. When an auditor is required to perform more procedures, the cost of the audit will increase. This can often be mitigated by demonstrating that the offending managers or employees have left the company and the company has instituted strict procedures to thwart future attempts at fraud.Chapter 4Indicators and ways to prevent Fraud in Financial StatementsAs Albert Einstein has said meanwhile We cannot solve our problems with the same thinking we used when we created them. We will adopt this approach in trying to understand the indicators and ways to solve the existing problem of fraud and to understand the behavioral aspects of fraudsters through understanding the behavioral red flags and business indicators and reviewing ingenious solutions to this problem.I. Behavioral Red Flags:Behavioral red flags; means there are many attitudes done by the fraudster when these attitudes happen it make doubts about the fraudster.

According to the article "Theft, Fraud and Dishonest Employees Do you really know whats happening in your business?" By Erika Lucas, stated, "Of course the vast majority of employees are upstanding, honest citizens. However, if you are concerned that there might be some rogues in the pack, there are some red flags to look out for. Warning signs include people who appear to be living beyond their means (flash cars, big houses, five star holidays) although there can of course be rational explanations for this, such as a family inheritance or win on the lottery! Other signs to look out for are people who are always first and last in the office, rarely take holiday and are overly protective of their workload. An unhealthy closeness with customers, suppliers or competitors is another sign that something may be amiss. None of these mean that anything untoward is definitely taking place but they are signs that can indicate you ought to be taking a closer look at whats happening ".

Another warning signs to look for is when the person who is the first one who goes to the office and also he is the last one who leaves it, he goes first one and leaves last one in order not to give a chance to get doubted.

In addition, when the person rarely takes holidays, the perpetrator will often exhibit unusual behavior, which is one of the strongest indicators of fraud. The fraudster may not ever take a vacation or call in sick in fear of being caught. He or she may not attribute out work even when overloaded. That individual does not want anyone of his employees nor manager to identify how the discs are being manipulated, by granting others the chance to over review his own study in this absence. There are other signs to look for like:1. Refuses or does not seek promotion or rotation and gives so reasonable explanation: Career progression or work rotation is highly desirable for the majority, but if an employee refuses this on more than one occasion, it could be another indicator that something is going on. Management must take the time to see how their employees play with others in the department, if an employee insists on playing in isolation when this is not always appropriate this is a solid indicator of fake.

2. Suspected to have over-extended personal finances or excessive lifestyle: Selfishness and greed is one of the key motivations for committing fraud. Management should be alert to the fact that overnight inheritances, newly established luxury lifestyles and excessive personal consumption may all point to fraudulent conduct. Most people who perpetrate fraud are under fiscal pressure and sometimes these pressures are real. The minority of the perpetrators steals and save most immediately spends everything they steal or in better language, everything they embezzle. As they become more positive in their fraud schemes, they slip and spend increasingly larger amounts until they are living lifestyles far beyond what they can reasonably afford, for examples getting new cars, exotic vacations, home improvements or they even move into a more expensive home, purchase of expensive jewelers or clothes.

3. Defensive Mechanism: Perpetrators use the defense mechanisms, or manners in which they behave or think in certain ways to better protect or defend themselves. Although this is an area slightly controversial, managers should be able to utilize their best assessment. There have been many examples of employees inventing illnesses as a mechanism to behave as a buffer to question. If an employee is creating defense mechanisms to prevent questioning over transactions or performance, there may be reason to be extra careful and observant. This is especially the case where answers to straightforward questions are ever shifting and inconsistent.

4. Senior managers with unusual spheres of influence: When the CFO Banks cash takings or a senior manager is required in purchasing decisions outside of his function, ask the question: Why? In recounting to the first of these, it is important that all businesses can trace all fund inflows from source to bank with appropriate segregation of responsibilities.

II. Business Indicators:1. Accounts not reconciled to underlying records: The most recent Fraud Barometer attests, that 55% of the management fraud were performed at senior levels. One of the common management frauds is introducing the business as performing in the best image and better than it is truly is. It is frequently the case in such situations that key accounting reconciliations are set aside to enable the manipulation to pass undetected.

2. Elsewhere in the industry: As mentioned or as known that complete performance against peers is generally good news, however, independent directors and the board must get comfortable as to estimate how this has been accomplished.

3. Excessive secrecy about a role and its operations: Certain business leaders deliver a mysterious habit of avoiding or postponing scrutiny, such as internal audit reviews, for credible reasons. Such avoidance activity should not be accepted on a repeated or continuous basis.

4. Posting to vulnerable balance sheet accounts: When funds are stolen or accounts are manipulated the perpetrator will need to process an accounting entry to cover the underlying transaction. In every lawsuit or on every social function, certain balance sheet accounts are utilized such as suspense accounts or other histories (such as VAT or PAYE) that are rarely fully reconciled. Unexpected buildup of balances on such accounts requires a challenge.

III. Other miscellaneous indicators: As mentioned in studies done by PwC "A business is placed at risk for fraudulent activity if an in-house accountant works without proper supervision on every aspect of the businesss financial operations, e.g. payroll, receivables, deposits, payments etc.

In house accountant works without supervision : if the accountant takes his work to do it in his house without supervision in his work so it is high risk to do fraud and also if the accountant does his job in his office but without supervision there is also high risky.

Accountant insists on handling activities that other department: other cases shows that the accountant can be handling more than one jobs on accounting department and on another department and this increase the doubts towards this person.

IV. Internal Auditor Responsibility:The internal audit activities inside a firm should be done in a professional way, and according to recognized standards of practice within the internal audit industry. To make sure that the level of performance is achieved all auditors in the internal audit department must share responsibility for the accomplishment of all delegated jobs in a professional manner.

1. Main Internal Auditor Responsibility:a. Declaring any deficiency to independence or objectivity that may exist.b. Performing assigned jobs in an independent and self-directed way.c. Completing assigned jobs in a timely, detailed, accurate and well-documented way.d. Submitting all completed work papers to the Director of Internal Audit for final evaluation and approval.e. Conducting oneself in a professional manner at all times; evading those situations that would lead to criticism by the area being audited, or by the public.f. Assuming a friendly and cooperative behavior with the audited areas staff. Disagreements should be reported to the Director of Internal Audit.g. Conducting work to reduce disruption of the audited areas workflow or ability to service their customers.h. Advising oneself with the premises, responsible employees, and the location of records early in the audit.i. Requesting any documents that may be needed. Management of the audited area should be made conscious that the Internal Auditor has those documents.j. Protecting all files / records that have been assigned to the Auditors control.k. Returning all files / records to the person or area, they were obtained from.l. Maintaining all records in the same or better condition than that in which they were found.m. Retaining all records on premises - never removing vital documents from the premises.n. Returning all documents taken to the Internal Auditors work area to the records custodian by the end of the day if such return is requested.2. Additional Internal Auditor Responsibility:a. Developing a knowledge with the organization and functions of the unit to be audited.b. Pre-planning the audit in accordance with the opportunity and difficulty of the area under review.c. Guaranteeing that an assessment of risks is combined into, or forms the basis of all audit work planned and performed.d. Accepting responsibility for the audit work performed on assigned assignments.e. Managing the audit in relation to time and resource budgets.f. Ensuring that audit results and recommendations made during the course of the audit are on time communicated to management.g. Ensuring that all Worksheets issued are correctly constructed, supported, and communicated.h. Ensuring that all objectives have been accomplished and all conclusions are properly supported.i. Ensuring that the audit or review is conducted with the least amount of disturbance to the audited area as is possible.j. Conducting an Exit Review or briefing at the conclusion of fieldwork.k. Drafting and seeking approval for a formal Audit Report.l. Finalizing the audit files and ensuring that all supporting documentation is properly taken.m. Performing follow-up work as necessary successive to the audit.

3. The Auditors Responsibility to consider Fraud and Error in an audit of financial statement:After reading a report called The Auditors Responsibility to Consider Fraud and Error in an Audit of a Financial Report, we discovered that there are some essential limitations of audit the report stated, An audit does not guarantee all material misstatements will be detected because of such factors as the use of judgement, the use of testing, the inherent limitations of internal control and the fact that much of the evidence available to the auditor is persuasive rather than conclusive in nature.

For these reasons, the auditor is able to obtain only reasonable assurance that material misstatements in the financial report will be detected. And The risk of not detecting a material misstatement resulting from fraud is higher than the risk of not detecting a material misstatement resulting from error because fraud may involve sophisticated and carefully organized arrangements designed to hide it, such as forgery, deliberate failure to record transactions, or intentional misrepresentations being made to the auditor. Such attempts at concealment may be even more difficult to detect when accompanied by complicity.

Complicity may cause the auditor to believe that evidence is persuasive when it is, in fact, false. The auditors ability to detect a fraud depends on factors such as the skillfulness of the perpetrator, the frequency and extent of manipulation, the degree of collusion involved, the relative size of individual amounts manipulated, and the seniority of those involved. Audit procedures that are effective for detecting an error may be ineffective for detecting fraud.

The risk of the auditor not detecting a material misstatement resulting from management fraud is greater than for employee fraud, because those charged with governance and management are often in a position that assumes their honesty and enables them to prevail the formally established control procedures. Certain levels of management may be in a position to prevail control procedures designed to prevent similar frauds by other employees.

The report includes by stating that The auditors opinion on the financial report is based on the concept of obtaining reasonable assurance; hence, in an audit, the auditor does not guarantee that material misstatements, whether from fraud or error, will be detected. Therefore, the succeeding discovery of a material misstatement of the financial report resulting from fraud or error does not, in and of itself, indicate: a failure to obtain reasonable assurance, inadequate planning, performance or judgement, the absence o