1 / 79

Financial Statement Analysis:  Key to Identifying Fraud

Financial Statement Analysis:  Key to Identifying Fraud. Breakout Session # 803 Juanita M. Rendon, MBA, CPA April 7, 2009 11:00 AM – 12:30 PM. Learning Objectives. Understand general fraud concepts. Understand basic financial statements and ratio analysis.

derry
Télécharger la présentation

Financial Statement Analysis:  Key to Identifying Fraud

An Image/Link below is provided (as is) to download presentation Download Policy: Content on the Website is provided to you AS IS for your information and personal use and may not be sold / licensed / shared on other websites without getting consent from its author. Content is provided to you AS IS for your information and personal use only. Download presentation by click this link. While downloading, if for some reason you are not able to download a presentation, the publisher may have deleted the file from their server. During download, if you can't get a presentation, the file might be deleted by the publisher.

E N D

Presentation Transcript

  1. Financial Statement Analysis: Key to Identifying Fraud Breakout Session # 803 Juanita M. Rendon, MBA, CPA April 7, 2009 11:00 AM – 12:30 PM

  2. Learning Objectives • Understand general fraud concepts. • Understand basic financial statements and ratio analysis. • Understand the usefulness of ratio analysis as a tool in identifying potential fraud.

  3. Overview • Fraud • Common Thread in Definitions • Types of Fraud • Fraud Triangle/Fraud Diamond • Incentives To Commit Financial Statement • Fraud • Financial Statement Fraud Issues • Basic Financial Statements • Standard Setting • Components of Financial Statements • Ratio Analysis • Categories of Financial Ratios • Ratio Analysis Usefulness as a Tool

  4. WHY IS THIS IMPORTANT? • Fraudulent Activities Cost Billions of Dollars! • Contracting Managers Need To Be aware Of Potential Fraud.

  5. ACFE 2008 Report To The Nation On Occupational Fraud and Abuse Study was based on 959 cases of fraud investigations by CFEs between Jan. 2006 & Feb. 2008 (ACFE, 2008)

  6. ACFE 2008 Report To The Nation On Occupational Fraud and Abuse (ACFE, 2008)

  7. Fraud Definition Dictionary definition: • noun • deceit; trickery; cheating • LAW:intentional deception to cause a person to give up property or some lawful right • a person who deceives, is an impostor or a cheat http://www.yourdictionary.com/fraud

  8. ACFE Fraud Definition • Occupational fraud and abuse may be defined as: "The use of one's occupation for personal enrichment through the deliberate misuse or misapplication of the employing organization's resources or assets." (Wells, Joseph T., 2008; ACFE, 2006)

  9. DOD Fraud Definition • DOD defines fraud as follows: • Fraud is any intentional deception taken for the purpose of inducing DOD action or reliance on that deception. Fraud can be perpetrated by DOD personnel—whether civilian or military—or by contractors and their employees. (GAO,2006, June 19, Contract Management: DOD Vulnerabilities to Contracting Fraud, Waste, and Abuse, )

  10. IRS Fraud Definition • Fraudis deception by misrepresentation of material facts,… resulting in material damage to one who relies on it and has the right to rely on it… • Tax fraud is often defined as an intentional wrongdoing on the part of a taxpayer, with the specific purpose of evading a tax known or believed to be owing. Tax fraud requires both: • An underpayment; and • A fraudulent intent. (Internal Revenue Service, Internal Revenue Manual 25.1.1.2 (05-19-1999))

  11. GOVERNMENT PROCUREMENT FRAUD (Purchase Cards) TAX FRAUD (Federal Income Tax) MORTGAGE FRAUD (Sub-prime Loans) TYPES OF FRAUD EMPLOYEE FRAUD (Payroll Fraud) FINANCIAL STATEMENT FRAUD (Enron, WorldCom) CONSUMER FRAUD (Identity Theft) COMPUTER INTERNETFRAUD (Cyber Theft) HEALTHCARE FRAUD (Medicare Fraud)

  12. The Fraud Triangle • Criminologist Donald R. Cressey (1919-1987) • While researching his doctoral dissertation in the 1950s, developed a hypothesis to explain why people commit fraud. • Published “Other People’s Money: A Study in the Social Psychology of Embezzlers” • Dr. Cressey interviewed 200 inmates at prisons in the Midwest • Three key elements: • Incentive/Motivation/Pressure • Opportunity • Rationalization (Wells, Joseph T., 2008)

  13. Capability Traits: • Position/Function • Authority • Influence • Brains • Knowledge • Coercion Skills • Confidence/ego • Effective Lying (Wolfe, David T.,& Hermanson, Dana R., 2004, December)

  14. Understated Liabilities/Expenses Overstated Assets/Income Fictitious Revenue/ Accounts Receivable Fraudulent Financial Statement Issues Inventory/ Cost of Goods Sold Timing Or Classification Issues Disclosure/ Lack Of Transparency Improper Asset Valuation Other

  15. Overview of Financial Statements Most businesses prepare : • 1. Income Statement • 2. Balance Sheet • Statement of Cash Flows • Statement of Stockholders’ Equity • Statement of Retained Earnings In the U. S., financial statements are based on Generally Accepted Accounting Principles (GAAP). (Albright & Ingram, 2006)

  16. Overview of Financial Statements Standard Setting Organizations The Securities and Exchange Commission (SEC) and the Public Company Accounting Oversight Board (PCAOB) oversee the publically tradedcompanies. The Financial Accounting Standards Board (FASB) (American Institute of Certified Public Accountants -- AICPA) oversees the privatecompanies. (Albright & Ingram, 2006)

  17. Standard Setting Organizations The Governmental Accounting Standards Board (GASB)sets accounting standards for state & localgovernments The U. S. Government Accountability Office (GAO) oversees accounting in the federal government. The International AccountingStandards Board (IASB) is an independent, privately-funded board interested in global accounting standards(International Financial Reporting Standards). (Albright & Ingram, 2006)

  18. Overview of Financial Statements Sources of Accounting Regulations The Sarbanes-Oxley Act (SOX) was passed by Congress in 2002. This act affected the responsibilities of auditors, boards of directors, and corporate managers with respect to financial reporting. The primary purpose was to increase investor confidence. (Albright & Ingram, 2006)

  19. The Auditors’ Report Auditing standards include procedures used in conducting an audit to help auditors form an opinion about the fairness of the audited statements. (GAAS: Generally Accepted Auditing Standards). For the federal government, the Generally Accepted Government Auditing Standards (GAGAS) are used. (Albright & Ingram, 2006)

  20. Overview of Financial Statements The Income Statement (Statement of Earnings) reports revenues and expenses for an accounting period. (Albright & Ingram, 2006)

  21. ABC Company, Inc. Income Statement For the Year Ended December 31, 2008 Sales revenue $700,500 Cost of goods sold (450,200) Gross profit 250,300 Depreciation Expense (60,000) Selling, general, & administrative exp. (90,300) Operating income 100,000 Interest expense (5,000) Pretax income 95,000 Income taxes (40% tax rate) (38,000) Net income $ 57,000

  22. Overview of Financial Statements A Balance Sheet (Statement of Financial Condition) identifies a company’s assets and claims to those assets by creditors and ownersat a specific date. (A = L + SE) (a snapshot)

  23. ABC Company, Inc. Balance Sheet At December 31, 2008 Assets Current assets: Cash $ 12,600 Accounts receivable 9,600 Merchandise inventory 22,000 Supplies 800 Prepaid rent 1,000 Total Current Assets $ 46,000 Long-term (Fixed) Assets: Property and equipment, at cost 300,000 Less Accumulated depreciation (60,000) Total Long-term (Fixed) Assets $240,000 Total Assets$286,000 Continued

  24. Liabilities and Stockholders’ Equity: Current Liabilities: Accounts payable $ 8,500 Unearned revenue 3,800 Interest payable 700 Notes payable, current portion 4,000 Total Current Liabilities $ 17,000 Long-term liabilities: Notes payable, long-term 80,000 Total Liabilities$ 97,000 Stockholders’ equity: Common stock 150,000 Retained earnings 39,000 Total Stockholders’ Equity $189,000 Total Liabilities and Stockholders’ Equity $286,000

  25. Must Equal ABC Company, Inc. Balance Sheet At December 31, 2008 Assets: Total assets$286,000 Liabilities and Stockholders’ Equity Total Liabilities and Stockholders’ Equity $286,000

  26. Assets Stock-holders’ Equity Liabilities = + Economic Resources Owned by a Business The Financial Obligations or Debts of a Business Owners’ Claims on the Assets of a Business The Basic Accounting Equation (Albright & Ingram, 2006)

  27. Overview of Financial Statements The Statement of Cash Flows reports events that affected a company’s cash account during a fiscal period; has three sections: operating, investing, & financing. (Albright & Ingram, 2006)

  28. The Statement of Cash Flows Operating activities involve the buying or producing and the sale & distribution of goods and services to customers related to cash. Investing activities involve the buying and selling of long-term assets. Financing activities involve transactions between a company and its owners or creditors. (Albright & Ingram, 2006)

  29. The Statement of Cash Flows GAAP permits the statement to be presented in either of two formats: direct or indirect. GAAP requires a schedule to reconcile cash flows from operating activities with net income if the direct format is used. The differences between formats are in the operating section only. 99% of companies use the indirect method. (Albright & Ingram, 2006)

  30. From the income statement ABC Company, Inc. Statement of Cash Flows For the Year Ended December 31, 2008 Indirect Operating Activities Net income $ 57,000 Depreciation exp. (noncash) 60,000 Increase in accounts receivable (CA) (20,000) Increase in merchandise inventory (CA) (32,000) Increase in supplies (CA) (1,200) Increase in prepaid rent (CA) (5,000) Increase in accounts payable (CL) 6,600 Increase in unearned revenue (CL) 3,000 Increase in interest payable (CL) 400 Net cash flow from operating activities $ 68,800

  31. Carried forward $ 68,800 Investing Activities Payments for purchase of equipment (231,700) Receipts from sale of equipment 500 Net cash flow for investing activities(231,200) Financing Activities Receipts from sale of common stock 150,000 Payment of dividends(20,000) Receipts from borrowing 60,000 Repayment of debt (15,000) Net cash flow from financing activities 175,000 Net increase in cash 12,600 Cash balance, December 31, 2007 0 Cash balance, December 31, 2008 $ 12,600

  32. Statement of Stockholders’ Equity Statement of Stockholders’ Equity CCRETotal Balance at Jan. 1, 2008 $ 0 $ 2,000 $ 2,000 + Common Stock Issued 150,000 150,000 + Net Income 57,000 57,000 - Dividends ______ <20,000><20,000> = Balance at Dec.31, 2008 $150,000 $39,000 $ 189,000 This statement links the income statement to the balance sheet. It describes how much Net Income was reinvested as part of RE. (Albright & Ingram, 2006)

  33. Statement of Retained Earnings This shows the amount of Net earnings (NI) retained by the company and the dividends distributed to shareholders. RE is part of the B/S. (Albright & Ingram, 2006) ABC Company, Inc. Statement of Retained Earnings For the Year Ended December 31, 2008 • Retained Earnings, Jan. 1, 2008 $ 2,000 • Net income for 2008 57,000 • Less: Dividends (Pmt. to Stkhldrs) (20,000) 37,000 • Retained Earnings, Dec. 31, 2008 $39,000

  34. Overview of Financial Statements Title of Slide

  35. Financial Statement Analysis Methods (Brigham & Houston, 2007) • Vertical Analysis: involves measuring relationships between items for a single year. For example, % of sales on an income statement; % of total assets & % of total Liabilities & Stockholders’ Equity on a balance sheet • Horizontal Analysis: involves calculating the Dollar change and the Percent change for each line item on the Income Statement or Balance Sheet from the previous year to the current year. Current year – Previous year/Previous year x 100 = % change • Ratio Analysis:Various ratios

  36. Why are ratios useful? (Brigham & Houston, 2007) • Ratios can standardize numbers and facilitate comparisons. • Ratios can be used to highlight weaknesses and strengths. • Ratio comparisons should be over a period of time and with competitors in the same industry • Trend analysis • Industry analysis

  37. Five Major Categories Of Ratios (Brigham & Houston, 2007) Liquidity (Solvency): Can the company meet its short-term obligations? Asset management (Operating Efficiency): Is the company using its assets to generate sales? Debt Management: Does the company have the right mix of debt and equity? Is the company highly leveraged? Profitability: Is the company consistently making a profit? Is the company managing its expenses? Market Value: Do investors like what they see?

  38. Five Major Categories Of Ratios Prepared by Juanita M. Rendon, CPA

  39. 2008 100,800 900,800 2,148,800 3,150,400 1,800,000 - 899,400 900,600 4,051,000 2007 8,000 630,000 1,300,000 1,938,000 1,300,900 - 400,000 900,900 2,838,900 TYL, Inc.: Balance Sheet (Brigham & Houston, 2007) Cash Accts. Receivable Inventories Total Current Assets Gross L-T Assets Less: Acc. Depreciation Net L-T Assets Total Assets

  40. 2008 430,700 250,000 450,000 1,130,700 500,000 1,630,700 2,084,574 335,726 2,420,300 4,051,000 2007 530,100 600,800 490,000 1,620,900 800,000 2,420,900 387,500 30,500 418,000 2,838,900 Liabilities and Equity: (Brigham & Houston, 2007) Accts. payable Notes payable, current Unearned Revenue Total Current Liab. Long-term debt Total Liabilities: Stockholders’ Equity: Common stock Retained earnings Total Stkhldrs Equity Total Liab. & Equity

  41. TYL, Inc.: Income Statement 2008 7,000,600 (5,800,990) 1,199,610 (500,000) 699,610 (110,900) 588,710 ( 80,000) 508,710 ( 203,484) 305,226 2007 4,500,000 (3,500,000) 1,000,000 ( 500,900) 499,100 ( 100,900) 398,200 ( 130,000) 268,200 (107,280) 160,920 (Brigham & Houston, 2007) Sales COGS Gross Profit (GM) Other expenses EBITDA Depr. & Amort. EBIT Interest Exp. Earnings Before Taxes Taxes (40% tax rate) Net income

  42. 2008 150,000 $2.035 $12.57 2007 100,000 $1.609 $8.85 TYL, Inc.: Other data (Brigham & Houston, 2007) No. of shares EPS Stock price

  43. Financial Analysis: Liquidity Ratios TYL Inc.’s forecasted current ratio and quick ratio for 2008: (Brigham & Houston, 2007; Fraser & Ormiston, 2010) Current ratio = Current assets / Current liabilities = $3,150,400 / $1,130,700 = 2.79x Quick ratio = (CA – Inventories) / CL = ($3,150,400 – $2,148,800) / $1,130,700 = 1,001,600/1,130,700 = 0.89x

  44. Financial Analysis: Liquidity Ratios Comments on liquidity ratios • Measure short-run solvency—the ability of a co. to meet its short-term debt requirements as they come due. • For 2008, Co. had $2.79 of CA for $1 of CL; For 2008, Co. has $ .89 of cash & near cash assets for every $1 of CL. • Below industry average; Liquidity position is weak. • The higher the liquidity ratios, the better. (Brigham & Houston, 2007; Fraser & Ormiston, 2010)

  45. Financial Analysis: Asset Management Ratios The inventory turnover vs. the industry average: (2008) Inv. turnover = Sales / Inventories = $7,000,600/$2,148,800 = 3.26x = 3.3x (Brigham & Houston, 2007)

  46. Financial Analysis: Asset Management Ratios What is the inventory turnover vs. the industry average? • Indicates the number of times a company sells its average inventory level during the year. • Inventory turnover is below industry average. • The company might have old inventory, or its control might be poor. • A higher inventory turnover is usually better. (Brigham & Houston, 2007)

  47. Financial Analysis: Asset Management Ratios (Days Sales Outstanding) DSO is the average number of days after making a sale before receiving cash. (2008) (Brigham & Houston, 2007) DSO = Accounts Receivable / Avg sales per day = Accounts Receivable / (Annual sales/365) = $900,800 / ($7,000,600/365) = $900,800/19,179.73 = 47.0 days

  48. Financial Analysis: Asset Management Ratios Analysis of Days Sales Outstanding • Measures the number of days between the sale date and the cash collection date. • The company is below industry average; it collects on sales on account (A/R) too slowly • It appears to have a poor credit policy. • A lower DSO is usually better. (Brigham & Houston, 2007)

More Related