By Guest Blogger Glenn Helms, CPA, PhD, CIA | AICPA
Fraud schemes are often categorized in three ways: fraudulent financial reporting; misappropriation of assets; and other (for example, corruption frauds). It is, however, sometimes difficult to assign a specific fraud scheme to a particular category. For example, some misappropriation of asset schemes are so material they result in fraudulent financial statements. That being said, there are 10 specific types of schemes that are most prominent. The top 10 fraud schemes were selected based upon an extensive review of landmark studies on fraud, professional publications, and current events.
1. and 2. Recording revenues prematurely and recording fictitious revenue
3. Preparing fraudulent top-sided and other journal entries
4. Overstatement of assets
5. Manipulating estimates
6. Misappropriation of assets
7. Ponzi schemes
8. Asset flips
9. and 10. Bribery and conflicts of interest
Recording Revenues Prematurely and Recording Fictitious Revenue
These two revenue schemes were selected since the COSO’s studies, Fraudulent Financial Reporting: 1998-2007 — An Analysis of U.S. Public Companies (2010) and Fraudulent Financial Reporting: 1987-1997 — An Analysis of U.S. Public Companies (1999), found that there is an increase in revenue fraud schemes in the time period covered by the two studies. Also, revenue fraud schemes occurred in a significant number of cases in the two studies. Revenue fraud was reported in 50 percent of the financial statement fraud cases in the first study, and over 60 percent in the second study.
Preparing Fraudulent Top-Sided and Other Journal Entries
False journal entries were used in several recent large, landmark cases to perpetrate fraudulent financial reporting. This type of scheme could also be classified in the other two major fraud categories as fraudulent journal entries have also been recorded to hide misappropriation of assets and to aid in perpetrating Ponzi and related schemes.
Overstatement of Assets
Fifty-one percent of financial statement frauds identified in the most recent COSO study were overstatements of assets. An overstatement of assets occurs when accounts are manipulated, especially in a favorable manner. Accounts receivable and inventory are typical areas where asset overstatements occur.
Numerous recent incidents of fraudulent financial reporting were due to management’s manipulation of estimates. Professional guidance is provided throughout auditing standards regarding the audit of estimates due to both the inherent and control risks associated with estimates (management subjectivity in the assumptions surrounding estimates). For example, AU-C 240, Consideration of Fraud in a Financial Statement Audit (AICPA, Professional Standards) addresses fraud risks associated with estimates and the audit procedures that can be performed to mitigate this fraud risk.
Misappropriation of Assets
The two most recent studies performed by the ACFE — Report to the Nations on Occupational Fraud and Abuse (in 2012 and 2014) — found that asset misappropriation accounts for about 90 percent of the fraud cases studied. Asset misappropriation schemes typically occur in billing, check tampering, payroll, and reimbursements.
This type of scheme was selected because of the historical and continued use of Ponzi schemes to scam investors. One infamous example was perpetrated by Bernie Madoff, resulting in a loss to investors of more than $65 billion.
Historically, this has been a popular form of fraud. It has been on the rise in recent years to create unrealistic real estate prices.
Bribery and Conflicts of Interest
Bribery and conflicts of interest are corruption schemes, and significant per the ACFE’s studies. The percentage of reported cases for corruption schemes was more than the percentage of cases for fraudulent financial reporting and, in the most recent ACFE studies, the median loss was greater than the median loss for misappropriation of assets.