Deterring and Detecting Fraud at a Time of Heightened Risk
Fraud experts expect the next few years to be a time of heightened risk as the damaging economic effects of the coronavirus pandemic create pressure and motive that can lead to wrongdoing.
A new analysis by the Anti-Fraud Collaboration provides insight on the most common types of financial statement fraud that were discovered in an analysis of SEC enforcement actions related to accounting and auditing issues from 2014 through mid-2019.
The study focused on a time of economic stability when the motivations and rationalizations associated with fraud were relatively low. It took place after the 2008 recession and before the economic downturn related to the pandemic, said Julie Bell Lindsay, the executive director of the Center for Audit Quality (CAQ), which is a member of the Anti-Fraud Collaboration and affiliated with the AICPA.
“You’re talking about a period of relative calm in the market, and yet you still see opportunities for fraud, and fraud transpiring,” Lindsay said. “It is a reminder in this environment that you should be ever vigilant.”
Lindsay said the report illustrates that financial statement fraud at public companies is real, and the risk has increased during the pandemic. She said fraud deterrence and detection require extreme vigilance from all participants in the financial reporting system. The responsibilities extend to internal and external auditors, audit committees, regulators, and company management, she said.
She added that public companies can fight fraud by exercising ongoing, continuous professional skepticism; focusing attention on high-risk areas for their company, their industry, and companies in general; and conducting regular quantitative and qualitative risk assessments.
Lindsay said once-a-year risk assessment and enterprise risk management activities no longer are frequent enough.
“That was the way it was typically done in the past,” she said. “You’re seeing that change a lot. You certainly saw it last year with the onset of COVID and the pandemic.”
The Anti-Fraud Collaboration report calls on parties throughout the financial reporting process to:
Pay attention to high-risk areas. Focusing on components of the financial statements that are most often associated with fraud can reduce the risk. The Anti-Fraud Collaboration study showed that improper revenue recognition, which is a well-known trouble spot, was by far the most common source of SEC fraud findings, with nearly twice as many instances as any other source. Other high-risk areas were reserves manipulation (for example, inadequate reserves for known liabilities), inventory misstatement, and impairment issues.
Consider the impact of pandemic-related changes and disclosures. Lindsay is watching with interest to see what disclosures companies make about changes in internal control over financial reporting that might have a material impact on the financial reports. “You’ve got to be continually looking at these things as the facts on the ground change,” she said.
Monitor the tone at the top and the culture. Tone at the top has long been a focus in fraud deterrence. The impact of culture on fraud is becoming more of an emphasis, particularly at large companies where the finance staff rarely interacts with top management. “We’re also starting to talk about tone in the middle,” Lindsay said.
Reduce the pressure in the environment. Pressure to meet forecasted targets can tempt staff to manipulate numbers, particularly in the areas of revenue recognition and expense reporting. These areas need to be watched carefully by management and audit committees that are committed to accuracy. “Those folks as well need to stay on the message of, ‘Yes, there’s a lot of pressure here, but we’re going to tell our story as it comes in,’” Lindsay said.
Maintain appropriate personnel in key areas, including accounting staff. Staff also needs to be kept up to date on changes in standards. “Revenue recognition has gone through a big change in the past two or three years,” Lindsay said. “The standards change. Make sure that you have the appropriate training and continual reinforcement of that training as well.”
Approach issues with professional skepticism. While skepticism is a core competency for auditors, it may be a less familiar topic for audit committee members and management. “Emphasizing the role skepticism can play and asking the right questions, pushing back, and doing your diligence about the numbers being reported to you is important whether you’re an audit committee member, CEO, or CFO,” Lindsay said. The Anti-Fraud Collaboration recently published a report on the importance of skepticism and posted a webcast devoted to the issue.
Ensure strong executive and board oversight. Management and the board need to ask the right questions, assess the identified risks, consider corporate culture, and pay attention to red flags, according to the report.
Take advantage of data analytics opportunities. The often cited quantitative example is auditors’ use of full datasets rather than samples. Qualitative analysis also can help. Lindsay said some auditors are using online product reviews to evaluate the accuracy of reported warranty reserve liabilities. If the reviews are overwhelmingly negative and the reported liabilities are small, auditors will follow up with more questions.
(Source: AICPA – CPA :Letter Daily - Journal of Accountancy – January 12, 2021)