Financial Statement Fraud Detection

Financial Statement Fraud Detections

Financial statement fraud is defined as any intentional misrepresentation of an organization’s financial situation that is done via the intentional omission in the organization’s financial statements to deceive financial statement users, creditors, and investors. “Association of Certified Fraud Examiners Fraud Training Education & Certification”, 2016. This illegitimate task that any management performs significantly lowers investor confidence and harms the global economy. Even though there were fewer cases than usual during the research, financial statement fraud cases have caused the largest loss of approximately $1 million. These issues pose a grave risk equivalent to any economic crime. Since 2003, both financial and non-financial damage and related financial statements cases have been increasing (PWC 2007, 2007). All organizations around the world have become concerned about the prevention and detection of financial statements fraud. While prevention is the best way to reduce financial statement fraud, detection of fraudulent financial reporting can be very useful in cases where this method fails. This paper discusses the prevention and detection of financial statement frauds, as well as how they can be detected.


There are many definitions of fraud. You can also be charged with theft, embezzlement, and fraud. Legally, this is:

  • False statements made by a person
  • Victims make false statements and rely on them.
  • Criminal benefits (Biegelman & Bartow 2006).

Fraud can be committed by anyone inside or outside the organization. Fraud can be committed by an employee, outsiders, or even the management. It may benefit one person, a specific department, or the entire company. The most costly and difficult frauds for auditors to handle are those committed by senior management, especially if they are beneficial to the organization. If the manager of an organization provides false financial information, it is considered financial statement fraud. This fraud is done to ensure that the financial reports of the company are free from fraud and misstatement (Zack 2013, 2013).
Financial statement fraud: What are the consequences?
Rezaee (2004) identifies the potential dangers of financial statement fraud.
It is a threat to the integrity and quality of financial reporting processes.
The integrity and objectivity of the accounting profession are at risk.
Market participants’ confidence in the reliability and accuracy of financial information is declining.
The efficiency of the capital market decreases, and so the country’s growth, as well as its prosperity, is affected.
Other consequences include lawsuit losses and the destruction of careers of those involved in fraud.
The Company’s Responsibilities to Prevent Financial Statement Fraud
This section discusses the company’s responsibility for preventing fraudulent financial reporting. It also explains how fraud can be prevented. These controls can be used by the company to prevent financial statement fraud.

Internal controls

Strong control over internal accounting is the first step to preventing financial statement fraud. Internal controls are usually at the transaction level and dictate employees and how they can accomplish the tasks within the organization. An example of internal control is allowing certain employees to authorize purchase orders. For the sake of strengthening company operations, one method towards internal control is also possible outside of the accounting office. Employees who authorize the purchase must not have the ability to choose where they will be purchased. This control can be achieved by either setting dollar limits or using approved vendors (Financial Statement Fraud Prevention and Detection 2004).
Internal control of accounting can also be done by segregating the duties. This ensures that more than one person is responsible for a particular financial transaction. The cash account is where segregation is common. As one employee cannot perform all of these functions, multiple employees are responsible for signing checks and reconciling the bank statement. This control helps prevent embezzlement and can be easily spread across the accounting department (Caplan 1999).


To ensure accuracy, the company should have its financial statements audited. This allows the company to quickly identify and correct any weaknesses in their accounting department. Audits should verify the control objectiveness. Audits should consider important questions such as the completion of transactions and their validity in terms of data and information, reasonability, and other pertinent issues. Audits should also examine the limitations of internal control and determine whether or not the information has been reported. Audits must also test the activities. Audits should also examine the internal control processes. The Securities and Exchange Commission (SEC), asks large enterprises that have outside auditors to attest those auditors to ensure effectiveness in internal controls. (Du and Roohani 2007).
The internal auditors also oversee the quality of the financial statements and the internal control adequacy. These auditors are the first line of defense against fraudulent financial reporting. Companies must have an internal audit function to reduce the chance of fraud.
Professionally certified auditors are also required. Much emphasis should be given to the development and maintenance of internal auditing standards. This ensures that all internal auditors have the technical skills necessary to provide the company with a first-line defense. (Brown 2004).
Management Review
The final step in preventing financial fraud is to have the management review the financial statements prepared for the company.
Sarbanes-Oxley Act of 2002 (SOX), requires publicly held companies that they provide a written statement to company management to validate the accuracy and completeness of financial statements. This is done to inform investors outside of the company that the management has reviewed the financial statements and approved all data and information. (Zhang, N.D.
The National Commission on Fraudulent Financial Reporting requires that the company’s management acknowledge its responsibility for the accuracy and completeness of its financial statements. This type of acknowledgment will help to eliminate the perception that independent auditors are the ones responsible for the accuracy and reliability of financial statements. (Financial Statements, 2012)
Increase the Sanctions against Perpetrators

To reduce the likelihood of frauds like these, strict sanctions should be imposed on those who make the financial statements. According to a recent survey, 83 percent of corporate secretaries, lawyers, and auditors, as well as financial executives, public accountants, recommended that financial statement frauds be punished with a severe penalty. The perpetrators of financial statement fraud in an organization are more likely to be caught and punished. For those who are guilty of such frauds, fines may be used.
Confidentiality in the Auditor-Client Relationship
Any proposal that requires an independent auditor to report any errors or irregularities in the report to the government authorities will, most often, foster the growth and development between the client and the auditor. Even honest clients will be more inclined to provide less disclosure to their auditor in the belief that the auditor may suspect an illegal or irregular act and report it to the enforcement authorities. (Cahan et al., 2014)


There are many ways to stop financial statements fraud in an organization. These include internal controlling, Confidentiality between the Auditor-Client Relationship, and Increasing the Sanctions Implied on Perpetrators. These issues were thoroughly discussed in the paper.