Fraud can manifest itself in the following general forms:
- Distorting, falsifying documents and papers related to financial reports;
- Modifying accounting documents and vouchers to distort financial reports;
- Embezzlement of assets;
- Concealing or intentionally omitting information, documents or economic transactions that distort financial reports;
- Recording economic transactions that are not true;
- Intentionally misapplying accounting standards, principles, methods and regimes, and financial policies;
- Deliberately miscalculating arithmetic.”
(According to the fraud research of the Association of Certified Fraud Examiners (ACFE).
There are three types of fraud as follows:
+ Asset misappropriation: Occurs when employees misappropriate the organization's assets (typical examples include embezzlement of money, theft of inventory, and payroll fraud).
+ Embezzlement: Occurs when managers abuse their responsibilities and powers to embezzle company assets or act contrary to their obligations to the organization to benefit themselves or a third party.
+ Fraud on financial statements: Is the case where information on financial statements is distorted, reflecting the financial situation dishonestly in order to deceive information users. (For example, falsely declaring revenue, reducing payable debt
– or cost).
Thus, fraud and error are both wrongful acts; in the field of finance and accounting, these acts distort information and misrepresent reality. However, these two acts differ in terms of awareness and the level of "substance" of the violation.
In terms of consciousness, error is an unintentional behavior, the cause of the error can be due to limited capacity or due to negligence, lack of care in work; meanwhile, fraud is an intentional behavior that intentionally causes a difference for personal gain. Due to the difference in consciousness, fraud is very sophisticatedly hidden and difficult to detect, while error is easier to detect.
Another difference between fraud and error is the degree of materiality. According to Vietnamese auditing standards 320 (BTC, 2012, section I: General provisions) , information is considered material if the lack of that information or the lack of accuracy of that information will affect the economic decisions of users of financial statements. If the act of fraud is always considered serious, the level of materiality of error is considered based on the scale and nature of the violation.
Motives and opportunities to commit financial reporting fraud.
(According to Vietnamese Auditing Standard No. 240 (BTC, 2012, Appendix 1), the motives and opportunities for committing financial reporting fraud are presented below.)
Financial stability or profitability is affected by the economic situation, the industry or the operating conditions of the unit.
The financial situation or unstable profitability of a business is always the most common reason why businesses have to manipulate financial statements.
High pressure on management to meet the requirements or expectations of third parties.
Normally, if a company wants to receive investment capital from third parties, it is necessary for the company to have reasonable financial statements and demonstrate the good financial health of the company. For this reason, the board of directors, whether they want it or not, always tends to manipulate financial statements to receive support from third parties.
Information showing that the personal financial situation of the Board of Directors or Management is affected by the performance of the business.
Much of the compensation of the Board of Directors and the Board of Management (such as bonuses, stock options and profit-based payment arrangements) is contingent and depends on the achievement of targets regarding stock prices, business results, financial position or cash flows. Such compensation is contingent on the achievement of targets relating only to specific accounts or selected activities of the entity, even though these accounts or activities may not be material to the entity in the aggregate.
Because the recording of information in financial statements is of a temporary nature, depending on the characteristics and circumstances of the business, managers tend to
Beautify financial statements to match the objectives set at the time of financial statement publication.
2.2 Financial reporting fraud techniques.
Over-declaration (or under-declaration) of revenue
Overstatement of revenue is the act of recording in the books a transaction of selling goods or providing services that does not exist. The technique often used is to create fake customers and create fake documents. Overstatement of revenue is also done by intentionally increasing factors on the invoice such as quantity, selling price... or recording revenue when the delivery conditions are not completed, the ownership and responsibility for risks of goods and services have not been transferred to the buyer.
Example in Vietnam:
Northern Liquefied Petroleum Gas Joint Stock Company (PVG) announced its audited consolidated financial statements for 2010. PVG's net profit in the audited consolidated report reached VND35.83 billion, down VND1.2 billion compared to the pre-audit report. Notably, the auditors have expressed concerns that, except for the recognition of dividends from the 2010 profit of Low Pressure Gas Distribution Joint Stock Company (PGD), PVG temporarily recorded the VND9.28 billion dividend of PGD in the 2010 financial operating revenue. As of December 31, 2010, the above dividend distribution has not been approved by PGD's shareholders' meeting. According to Vietnamese Accounting Standard No. 14 (VAS 14) - Revenue and other income, dividends and profits distributed are recorded when shareholders are entitled to receive dividends. If the company applies VAS 14, its revenue from financial activities and pre-tax profit for 2010 will decrease by VND9.28 billion, respectively.
Wrong year recorded
Fraud in Financial Statements can be committed by the technique of misrecognition in which revenue or expense is recorded in a period other than the period in which it was incurred. Revenue or expense of one period can be carried forward to the next period or vice versa to increase or decrease income as desired.
Example in Vietnam:
During the 2010 audit season, the Auditing Unit had an exception opinion regarding the fact that Da Lat Real Estate Joint Stock Company (DLR) recorded 31.15 billion VND in revenue with a cost price of 27.98 billion VND from the Construction Project of the Residential Cluster - Yersin Apartment Complex in Da Lat City.
Lat. According to the agreement, the company will hand over each part of the project to the company after completion and when it is eligible for resettlement. The People's Committee will pay the company when the project is finalized and audited by an independent agency. However, in the 2010 Financial Report, the company estimated and recorded revenue and cost of goods sold as above based on the completed data between the company and the company's construction team while the People's Committee of Lam Dong province has not issued a document assigning the People's Committee of Da Lat city to accept. The auditor said that on February 22, 2011, the People's Committee of Lam Dong province issued a document agreeing to assign the People's Committee of Da Lat city to be the unit to receive each project item according to each stage of the completed project value so that DLR can record revenue.
This shows that DRL recorded revenue and cost of goods sold for the Yersin Residential Complex Construction Project in Da Lat City in the wrong fiscal year. This revenue and cost of goods sold should have been recorded in the fiscal year 2011, but the enterprise recorded it in 2010.
Hide debts and expenses
Concealing liabilities to reduce costs is one of the common techniques of fraud on financial statements with the purpose of overstating profits. Pre-tax profits will increase correspondingly to the amount of hidden costs or liabilities. This method is easy to implement compared to the methods of falsifying sales transactions. On the other hand, it is very difficult for auditors to detect because it often leaves no trace. There are three main methods of concealing fraud and costs:
Derecognition of liabilities and expenses; Capitalization of expenses;
Sales returns - allowances and warranties;
Example in Vietnam:
Tien Len Steel Group Joint Stock Company (TLH) started the confusion of many investors with the announcement of a nearly 30% decrease in audited net profit. Compared to the pre-audited results, TLH's financial expenses increased by VND30.3 billion due to having to set aside additional provisions for devaluation of securities investments, leading to a corresponding decrease in pre-tax profit. The initial provision for devaluation of securities investments was VND27.74 billion, which increased to more than VND58 billion. The after-tax profit of the parent company's shareholders reached VND55.97 billion, down VND22.8 billion (-29%) compared to the initial result of VND78.8 billion.
According to the 2010 financial report of Basa Joint Stock Company with stock code BAS, the company capitalized the borrowing cost of VND 1.04 billion into the value of the basic construction project, while this project had stopped construction in 2010. If applied correctly according to VSA, this borrowing cost must be temporarily stopped capitalizing and included in the business expenses of the period. If implemented correctly according to VSA, the company will increase the loss by the corresponding amount of VND 1.04 billion.
Incomplete declaration of information.
Failure to fully disclose information limits the ability of users of financial statements to analyze. Information that is often not fully disclosed in the notes includes potential liabilities, events after the balance sheet date, related party information, and changes in accounting policies.
Example in Vietnam:
In the audit report on the financial statements of Southern Container Joint Stock Company (VSG), the auditor noted to users the unrealized exchange rate loss due to the revaluation of the year-end foreign currency balance of the long-term loan with the amount of VND 33.16 billion being recorded in the "exchange rate difference" indicator. This helps users understand that the application of Circular 201/2009 helps the company reduce the loss of VND 33.16 billion. If VSA 10 is applied, the after-tax profit indicator on the company's financial statements in 2010 is not the loss of VND 40.66 billion but the loss of VND 73.82 billion. This shows users that a part of the profit generated (or a part of the loss reduction) is due to the change in accounting method and not due to the company's production and business activities.
Mispricing of assets
Misapplying valuation methods is a common fraud technique. Misappraising often applies to the following items: Inventory, receivables, assets acquired through business combinations, fixed assets, failure to fully capitalize intangible costs, and incorrect classification of assets.
Example in Vietnam:
Nam Mu Hydropower Joint Stock Company (HJS) announces the audited financial report for 2010. It is worth noting in the audit report that the original price of fixed assets and depreciation costs of Nam Ngan Hydropower Plant may change when the final settlement of capital investment for basic construction is approved. In the explanatory table of the report
Consolidated financial statements: The Nam Ngan Hydropower project invested in according to Decision No. 28ACT/HĐQT dated December 1, 2004 of the Board of Directors of Nam Mu Hydropower Joint Stock Company has been completed, handed over and put into use but the investment capital settlement has not been approved. The company bases on the actual basic construction investment costs, temporarily calculates the original price to account for the increase in fixed assets.
2.3 Models for identifying financial reporting fraud.
2.3.1 Logit and probit models
Beneish Model (Probit Model)
The Probit model of Beneish (1997) (1999) is specified as follows:
Mi = β i X i + ε i
Mi : dummy variable, takes the value 1 if it is a fraudulent company and the value 0 for a non-fraudulent company β i : correlation coefficient for each independent variable in the model X i : matrix of explanatory variables
ε i : error
Some of the key explanatory variables in the above model include:
- Profit margin
- Asset quality
- Depreciation
- Revenue growth index
- Number of days of inventory
- Abnormal returns of stock prices
According to Dechow, Sloan and Sweeney (1996), the Beneish model provides financial statement users with the opportunity to evaluate a company from different perspectives by capturing a complete picture of the financial situation of other companies. In addition, the variables used in the model are not only relevant to identifying fraudulent transactions that have been made in the company, but can also identify transactions that may be fraudulent in the future.
Spathis Model (Logit Model)
different from the indexes used in the Beneish model in 1997 and 1999,
Spathis focused on financial ratios in his 2002 study. Instead of probability regression, he emphasized logistic regression in his analysis. Accordingly, the model
The model developed by Spathis in 2002 has the following formula:
E(y) = 1+ exp( b 0 +b 1 X 1 + b 2 X 2 +…+ b n X n
This model uses logistic regression analysis for fraud and non-fraud firms according to independent variables.
E(y): dependent variable, takes the value 1 if it is a fraudulent company and the value 0 for a company that does not commit fraud
b 0 : slope coefficient
b 1 , b 2 , …, b n : correlation coefficients of independent variables X 1 , X 2 , …, X n : independent variables, specifically as follows:
FFS = b 0 + b 1 (Debt/Equity) + b 2 (Revenue/Total Assets) + b 3 (Gross Profit/Revenue) + b 4 (Accounts Receivable/Revenue) + b5(Gross Profit/Total Assets) + b 6 (Working Capital/Total Assets) + b 7 (Revenue/Total Assets) + b 8 (Inventories/Total Assets) + b9 (Total Debt/Total Assets) + b10 ( Financial Expenses/Operating Expenses) + b11 (Taxes/Revenue) + b 12 (AltmanZ-score).
2.3.2 Multivariate, multi-criteria model
The UTADIS method, which is commonly used in financial management, credit risk analysis, country risk calculation, portfolio selection, etc., has been used in detecting financial information fraud by the study of Spathis, Doumpos and Zopounidis (2004). This study used the variables in the Logit model of Spathis (2002) and established another curve to classify fraudulent companies or not through the upper and lower bounds of the curve.
2.3.3 Model according to Benford's law
Durtschi, Hillison, and Pacini (2004) studied the application of Benford's law in detecting fraud in financial information. This law is based on the characteristic observation that some numbers appear more frequently than others. For example, in a certain group of data, it is observed that more than 30% of the numbers begin with the number 1. The study has shown that analyzing numbers based on Benford's law can be effectively used by auditors in detecting fraud.
2.3.4 Neural network model
The neural network model consists of 3 parts: the input is where the nerves connect to each other - these are the independent variables in statistics, the output - these are the dependent variables in statistics and the hidden part - located between the input and the output, has the function of transmitting signals from the input and transferring signals to the output.
The study by Kucukkocaoglu, Benli and Kucuksozen (2005) used a neural network model to detect financial reporting fraud of 126 non-financial companies listed on the Istanbul Stock Exchange during the period 1992-2002. The study used inputs including independent variables of the Beneish (1997), (1999) model and variables: inventory ratio/sales ratio percentage and financial expense ratio percentage/sales ratio percentage. The output of the study is to classify whether a company has committed financial reporting fraud or not.
2.4 International research on fraud.
DeAnglo's Modified Accrual Model (1986)
DeAngelo's (1986) model assumes that the components of non-adjustable accounting (NDA) variables in period t are random and equal to the number of accrual accounting (TA) variables in period t-1, so the author argues that the change in the total number of accrual accounting (TA) variables between period t and t-1 may originate from earnings management behavior.
= | Accrual accounting variable year t | - | Accrual accounting variables year t-1 | |
(DA t ) | (TA t ) | (TA t-1) | ||
Accrual accounting variable product (TA) | = | Profit after tax | - | Net cash flow from operating activities |
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According to DeAngelo, the adjustable accounting part (DA) or the change in the number of accrual accounting variables is the profit adjusted by the administrator. In other words, DA≠0 is equivalent to fraud. However, DeAngelo's model is only valid in the hypothetical case, that is, the non-adjustable accounting variable (NDA) of year t is random and equal to the number of accrual accounting variables (TA) of year t-1. In the case of a company in the growth stage, the non-adjustable accounting variable will change continuously from year to year, making it impossible to apply the model.