AHAM NZENWATA
ABSTRACT
A
financial statement is supposed to show a company’s true financial position at
any given time. It enables investors to take informed decisions on their
investments. But over time, management, either through fraud or negligence has
manipulated the content of financial statements to achieve their own
objectives. This paper investigated the effect of financial statement fraud on
the economy of Nigeria. The paper show that fraud in all ramifications is very
detrimental to the economy as it affects business confidence and integrity
which takes. More specifically, financial statement fraud robs investors of
their hard earned cash and discourages them from investing in the future
instead prefering to hold their funds in safe savings accounts and such other
schemes. The paper conclude that financial statement fraud is perpatrated i
most cases with the full knowledge and consent of top management. The paper
thus recommend that: A statute or law should be made mandating management to
certify corporate financial statements; Criminal sanctions should be imposed on
management who certify inaccurate financial statements; Management should be
liable to third parties who rely on their certified financial statements.
Management liability for corporate financial statements should be applicable to
all companies in Nigeria whether big or small, quoted or unquoted; Chief
Executive Officers (CEOs) and Chief Financial Officers (CFOs) should be liable
in the main for corporate financial statements both criminally and for third
parties civil liabilities.
INTRODUCTION
Financial
statement fraud is deliberate misrepresentation, misstatement or omission of
financial statement data for the purpose of misleading the reader and creating
a false impression of an organization's financial strength. Public and private
businesses commit financial statement fraud to secure investor interest or
obtain bank approvals for financing, as justification for bonuses or increased
salaries or to meet expectations of shareholders. Upper management is usually
at the center of financial statement fraud because financial statements are
created at the management level.
Financial
statement fraud is one of the biggest challenges in the modern business world
as it distorts the earnings of companies and will possibly rob investors of
their hard earned resources. When corporations engage in certain practices
designed to hide or maneuver the accounts of a corporation to help it continue
to remain attractive to investors, it is engaging in financial statement fraud.
The
most common occurrence of financial statement fraud is when losses are
underplayed or deliberately hidden by corporations. Financial statement fraud
comprises deliberate misstatements or omissions of amounts or disclosures of
financial statements to deceive financial statement users, particularly
investors and creditors, outright falsification, alteration, or manipulation of
material financial records, supporting documents, or business transactions,
material intentional omissions or misrepresentations of events, transactions,
accounts, or other significant information from which financial statements are
prepared, deliberate misapplication of accounting principles, policies, and
procedures used to measure, recognize, report, and disclose economic events and
business transactions and also intentional omissions of disclosures or
presentation of inadequate disclosures regarding accounting principles and
policies and related financial amounts.
There
are massive issues that emanate from financial statement fraud. Financial
statement fraud undermines the reliability, quality, transparency, and
integrity of the financial reporting process and jeopardizes the integrity and
objectivity of the auditing profession, especially auditors and auditing firms.
Financial statement fraud diminishes the confidence of the capital markets, as
well as market participants, in the reliability of financial information and as
a consequence makes the capital markets less efficient.
In
the bigger picture it adversely affects the nation's economic growth and
prosperity, results in huge litigation costs, destroys careers of individuals
involved in financial statement fraud and causes bankruptcy or substantial
economic losses by the company engaged in financial statement fraud. It causes
devastation in the normal operations and performance of alleged companies and
erodes public confidence and trust in the accounting and auditing profession.
Ultimately financial statement fraud translates to massive stockholder losses
and debts to creditors, not to mention emotional trauma to employees who lose
their jobs and retirement funds.
Financial
statement fraud may be committed by the senior and mid-level management of a
corporation to fraudulently enhance the financial health of a business and
enrich one's own net worth. Senior management may indulge in fraudulent
cover-ups to exceed the earnings or revenue growth expectations of stock
market, to comply with loan agreements, to increase the amount of financing
available from asset-based loans and to meet a lender's criteria for
granting/extending loan facilities. They may also fudge the statements to
create a rosy picture for the shareholders.
Some
of the red flags that signal a financial statement fraud include: First and
foremost, despite tight cash flows, the company will report profits which mean
that gross profit levels will remain high despite pricing pressure. The
statement will show that accounts receivable, accounts payable and stock levels
are increasing even when sales are declining. Keep an eye out for payments as
bonuses to senior management in a down economy. This also is indicative of
financial statement fraud.
Bearing
in mind the adverse effect of financial statement fraud on the economy, the
firm, individual investors and auditors, this research paper has the objective
of investigating and determining the processes through which it affects
economic growth.
CONCEPTUAL
FRAMEWORK
Black's
law dictionary (1990) defined fraud as 'an intentional perversion of truth for
the purpose of inducing another, relying upon it to part with some valuable
thing belonging to him or to surrender a legal right. A false representation of
a matter of fact, whether by words or by conduct, by false or misleading
allegation or by concealment of that which deceives and is intended to deceive
another so that he shall act upon it to his legal injury. Anything calculated
to deceive, whether by a single act or combination or by suppression of truth
or suggestion of what is false whether it be by direct falsehood or innuendo,
by speech or silence, word of mouth, look or gesture.
Fraud
is described as an act of deliberate deception with the intention of gaining
some benefit, in other words it is the act of dishonestly pretending to be
something that one is not (Chamber English Dictionary, 2002). Wikipedia (2008)
defines fraud as whenever a person knowingly executes, or attempts to execute,
a scheme or artifice to defraud a financial institution; or to obtain any of
the moneys, funds, credits, assets, securities, or other property owned by or
under the custody or control of, a financial institution, by means of false or
fraudulent pretences, representations, or promises.
Also
from the legal point of view, Fagbemi (1989) perceived fraud as 'the act of
depriving a person dishonestly of something which is his or something to which
he is or would or might but for the perpetration of fraud, be entitled”. The
view of Adewumi (1986) is that fraud is a conscious premeditated action of a
person or group of persons with the intention of altering the truth and or fact
for selfish personal monetary gain. It involves the use of deceit and trick and
sometimes highly intelligent cunning and know-how. The action usually takes the
form of forgery, falsification of documents and authorizing signatures and an
outright theft.
Nwankwo
(1991) also opined that fraud occurs when a person in a position of trust and
responsibility, in defiance of norms, breaks rule to advance his personal
interests at the expense of the public interest, which he has been entrusted to
guide and promote. It occurs when a person through deceit, trickery or highly
intelligent cunning ways, gains an advantage he could not otherwise have gained
through lawful, just or normal process. It is evidence from the
multiple-definitions given by various scholars that the word fraud is generic in
nature.
However
fraud is generally considered to be anything calculated to deceive. This
include all acts, omissions, and concealments involving a breach of legal or
equitable duty, trust or evidence justly reposed which result in damage to
another or by which undue and conscienceless advantage is taken of another.
Fraud is distinctive from any other term that looks like it such as forgery and
errors in that, it shows a more affirmative action, evil in nature such as
intentionally and deliberately proceeding or acting dishonestly with a wicked
motive to cheat or to deceive another.
According
to Adebisi (2009), there are three forms of fraud. They are the internal,
external and a combination of internal and external frauds. Internal fraud: This is a fraud made against
an organization by an insider- say a staff. If the staff is not capable of
starting and concluding the whole process, he may carefully select a 'TEAM'
within the organization External Fraud: This is a fraud perpetrated by
outsiders. This is the exact opposite of internal fraud. Combination of
Internal and External Fraud: This is often referred to as 'collusion'.
Financial Statement fraud is typically an internal
fraud which may require 'collusion' with some parties external to the organization.
Financial statement fraud is the misrepresentation of financial information
that is communicated to the investing public. Public companies primarily report
significant events to the public via a press release and a current report and
their financial condition via quarterly filings with the SEC, for each of the
first three quarters and for the fourth quarter and fiscal year end. Common
financial statement frauds include:
1) Improper
revenue recognition
2) Failure
to record incurred liabilities, and
3) Failure
to disclose contingent liabilities.
Improper
Revenue Recognition
Fictitious
revenue: More than 40% of all financial statement fraud involves revenue
recognition schemes, and approximately 35% of all revenue recognition schemes
involve recording fictitious revenues. Fictitious revenue schemes typically
involve fabricating invoices for phantom customers or improperly billing
legitimate customers for items that they never ordered. There is no economic
basis for fictitious revenue recognition schemes. In simple terms, company’s
record and report fabricated revenue, thereby overstating revenue and earnings
in their financial statements.
Revenue
Timing Schemes: Intentionally recording revenue in the wrong accounting period
is an earnings management method whereby a company manipulates its revenue for
a number of reasons, including meeting analyst estimates.
Premature
revenue recognition results in overstated revenue and earnings: If a company
records revenue for items that were not yet shipped or when services are still
due, the company is prematurely recognizing revenue. The relevant transaction
is real, but the company records the sale in the wrong reporting period.
Improperly
deferring earned revenue: If a company’s earned revenue significantly exceeds
estimates for a reporting period, the company may improperly defer recording
some of the earned revenue for a future unfavorable reporting period.
Unrecorded
Liabilities
Unrecorded liabilities fraud typically involves
one of two schemes: (1) intentionally and improperly omitting a material
liability (unrecorded liabilities) from the books and financial reports, and
(2) manipulating a previously reported liability (e.g., an inventory or
accounts receivable reserve).
Unrecorded
liabilities include unpaid obligations for goods or services received as well
as contingent obligations for probable liabilities that can be reasonably
estimated (e.g., liabilities involving pending litigation).
Accounting
reserve manipulations are enticing to fraudulent reporters since there is no
external party of accountability (e.g., a bank or vendor) to confirm accuracy.
Instead, the company is required to establish the reserves using professional
judgment pursuant to relevant accounting standards.
Undisclosed
Contingent Liabilities
Public
companies are required to disclose risks of loss or liability such as pending
litigation, claims or assessments.
EMPIRICAL
REVIEW
According
to Ogiedu and Odia (2013) financial statements are prepared by the management
of a company for the usage of various stake holders. These financial statements
indicate the state of the financial well-being of the company. They are usually
the window into a company’s financial affairs available to the average
investor, and sometimes the only information available to banks and other
institutional investors. Consequently, potential investors and other
stakeholders rely on these financial statements to assess the type of dealing
they could have with the company.
An
accurate assessment of a company could only be carried out if the financial
statements are accurate. Recent events, particularly the sudden collapse of
companies with very healthy financial statements, have showed that most
financial statements are not prepared in line with generally accepted
accounting principles (GAAP) and accounting standards (Ogiedu & Odia 2013).
Odunayo
(2014) wrote on Fraudulent Financial Reporting: The Nigerian Experience. The
study which investigated the likely incidence of fraudulent financial reporting
among Nigerian quoted companies utilized data from 70 quoted companies head
quartered in Lagos. the study used questionnaire as survey instrument. The
result of the study revealed that there exist the likely incidences of
fraudulent financial reporting in Nigerian quoted companies. The study using
statistical tools to evaluate the responses from Nigerian quoted companies
revealed that there is a relationship between financial reporting fraud and
company size, weak audit committees, internal control, and auditor’s
independence. The study established a positive relationship between these
variables.
Owolabi
(2010) researched on Fraud and Fraudulent Practices in Nigeria Banking
Industry. The paper reviews the various forms of fraudulent practice their
impact and inducement for various reforms in banking industry. The paper which
was descriptive in nature advocated ways through which fraud and forgeries can
be reduced in the Nigeria banking industry.
Ogiedu
and Odia (2013) investigated Fraudulent Reporting in Nigeria: Management
Liability for Corporate Financial Statements as an Antidote. The paper examined
the issues involved in making management liable for corporate financial
statements from the perspectives of both the management and the users of
financial statements. It concluded that there was need to make management
liable for corporate financial statements but within certain defined
restrictions defined by statute. The paper also recommended that apart from the
Chief Executive Officer and the Chief Finance Officer, other Board members
should be liable. In addition, the paper recommended that management liability
for corporate financial statements should be applicable to all companies in
Nigeria irrespective of size or quotation status.
DISCUSSION OF
FINDINGS AND CONCLUSIONS
A
financial statement is supposed to show a company’s true financial position at any
given time. It enables investors to take informed decisions on their
investments. But over time, management, either through fraud or negligence has
manipulated the content of financial statements to achieve their own
objectives. In the past and up to the present in some jurisdiction including
Nigeria, auditors have been blamed for the inaccuracies in corporate financial
statements.
But
the world is becoming wiser and it is being increasingly realized that auditors
alone cannot solve the problem of inaccurate corporate financial statements.
This is why attention is being justifiably shifted to management. Management
has control over the preparation of financial statements within the company,
and is better placed to monitor the process for the preparation of financial
statements.
The
implication of the present system is that management may deliberately device
ingenious and carefully laid schemes of fraud in preparing financial statements
and thereafter call in the auditor who is expected to detect those frauds/schemes.
This is tantamount to to sending the auditor into a dark unfamiliar room and
expecting them to identify the contents of the room. In this case, the
auditor(s) may be lucky to identify the contents of the room but no guarantees
can be made in such a situation.
The
certification requirements introduced by the Sarbanee Oxley Act of 2002 in the
U.S is novel and quite commendable. Management (particularly the CEO and the
CFO) must have primary responsibility for the content of financial statements.
However, in making management responsible and liable for financial statements,
care must be taken to ensure that working for a corporation is not rendered
absolutely unattractive through heavy liabilities. Thus, there has to be a
proper balance between management liability for corporate financial statements
and the need to protect management from liability traps.
RECOMMENDATIONS
To
ensure quality financial statements and credibility in financial information
given by corporations therefore, the following recommendations are made for
application in Nigeria and other developing nations.
·
A statute or
law should be made mandating management to certify corporate financial
statements;
·
Criminal
sanctions should be imposed on management who certify inaccurate financial
statements;
·
Management
should be liable to third parties who rely on their certified financial
statements. However, the scope and limitation of third party liabilities should
be fixed by a statute;
·
Management
liability for corporate financial statements should be applicable to all
companies in Nigeria whether big or small, quoted or unquoted
·
Chief
Executive Officers (CEOs) and Chief Financial Officers (CFOs) should be liable
in the main for corporate financial statements both criminally and for third
parties civil liabilities. However, the dragnet should be extended to other
directors found to have contributed to the inaccuracies in financial
statements.
REFERENCES
Fagbemi, O.A. (1989). Fraud in Banks: The Law and
the Legal Process. Lagos, FITC.
Normah O.; Ridzuan, K.K.; Zuraidah, M.S. and Nur,
A.S. (2014) Financial Statement Fraud: A Case Examination Using Beneish Model
and Ratio Analysis, International Journal of Trade, Economics and Finance, Vol.
5, No. 2.
Nwankwo, G.O. (2005): Bank Management, principles
and practice. Malt House Press Ltd. Lagos.
Nwankwo, O.(2013) Implications of fraud on
commercial Banks’ performance in Nigeria. International Journal of Business ang
Management. Vol. 8 (15).
Ogiedu K.O and Odia, J. (2013) Fraudulent
Reporting in Nigeria: Management Liability for Corporate Financial Statements
as an Antidote, European Journal of Business and Management, Vol.5, No.15, 2013
Owolabi, S. A. (2010) Fraud and Fraudulent
Practices in Nigeria Banking Industry, International Multi-Disciplinary
Journal, Ethiopia Vol. 4 (3b)
Odunayo B.A. (2014) Fraudulent Financial
Reporting: The Nigerian Experience, The Clute Institute International Academic
Conference San Antonio, Texas, USA.
For comments, observation
or other feedback or if you need assistance with your research projects/papers,
you can contact the author via E-mail: researchmidas@gmail.com or call/Whatsapp
(+234)0803-544-6622
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