1

LIABILITIES FINANCIAL STATEMENTS FRAUD

YUSNAWATI BINTI MAT ISA
JUNAIDA BT ADAN
NADIA ATIQAH BINTI ZULKIFFLY
MAIZUN AZILA BINTI MISNAN

- 2015620366
- 2015423618
- 2015249588
- 2015670102

TOPICS & LEARNING OBJECTIVES

2

Topics:

Ways to Manipulate Liabilities

Identifying Understatement of Liability

Fraud Exposures

Detecting Understatement of Liability

Fraud Symptoms

Proactively Searching for the Symptoms

Related to the Underreporting of Liabilities

L.O.:- Identify
fraudulent
schemes that
understate
liabilities &
discuss the
understateme
nt of liabilities
fraud

LIABILITY & LIABILITY FRAUD

3

LIABILITY
Liability is amounts that the
Company owes and will have
to settle in the future
Present obligation of the
Company, and are the result
of past transaction, and will
result to future cost to the
Company

LIABILITY FRAUD
An intentional act where
the fraudster
understates the liability
amounts that the
Company owes, so that
the financial position of
the company shown
good performance by
having less debts or
liability.

What Makes It Hard For Auditors to

Detect Fraud
4

Collusion
First Time
Fraudsters

Forger
y

Small
Frauds

Complex
Audit
Trails

Misleading
Documents

Lies

Off-Book
Frauds
Silence

Normal
Looking
Transaction
s

FINANCIAL RELATIONSHIPS
5

Assets vs LIABILITIES
Understanding
relationships
between certain FS
balances is
necessary to identify
relationships that
appear unusual.

Financial healthy company tries to maintain a

consistent balance between assets and liabilities

Sudden change from historical norms means

something has changed with managements
view of business/ trying to hide something

Sudden increase in the ratio could mean that

liabilities such as long term debt have been
hidden in off-balance sheet entities

If the value of liabilities rises and the ratio spike

downward, it could reveal that the company is
borrowing heavily to finance operations and the
risk of fraud is acute.

WAYS TO MANIPULATE LIABILITIES

6

IMPROPERLY USE
RESTRUCTURING
AND OTHER
LIABILITY
RESERVES

GAAP compliance in establishing

reserves; Recording reserves only if
liability exist.

Once a reserve is established, payments

made by the company properly related to
the reserve are offset against the reserve
and not reported as expense in the
current period

UNFORTUNATELY reserves have been

fraudulently used by companies to
manage earnings

WAYS TO MANIPULATE LIABILITIES

7

Create excess reserves in one accounting period

and then reduce the excess reserves in later
accounting period
The reserves commonly created: During

good times
When new management takes over to turn around a
company that experienced poor performance under
the previous management

HOW THESE
COMPANIES DO
THAT?

After its creation in one period, the reserve is

used in future periods to inflate profits and to
make it appear that the company is turning
around or to meet or exceed earnings
expectations
Overstated reserves
cookie jar

WAYS TO MANIPULATE LIABILITIES

8

CASES

XEROX CORPORATION
SUNBEAM CORPORATION
W.R.GRACE & CO
Charged

by the SEC for using cookie

jar reserves to manipulate income
Recorded extra liabilities (recording
income as deferred income) when
results were better than expectedBig Bath

WAYS TO MANIPULATE LIABILITIES

9

IMPROPERLY USE
RESTRUCTURING
AND OTHER
LIABILITY
RESERVES

companies also reported the

creation of the reserves as nonoperating expenses and reversed
the liability to income as operating
income.

Thus, overstated liabilities in one

period and understated them in
subsequent period.

IDENTIFYING UNDERSTATEMENT OF
LIABILITY FRAUD EXPOSURES
10

Understating accounts
payable

Not properly record purchase transaction done

by credits

Understating accrued
liabilities
Recognized unearned
revenue as earned
revenue
Under recording of
future obligations

Not properly accrued expenses in the current

period

Not recording various

type of debts

Omission of Contingent
liabilities

Recognised the liability as earned revenue

Record the liability in subsequent period
Not properly record future obligation
according to period
Claiming the debts has settled
Debts: loan, borrowings or related party

Non disclosure of contingent liabilities

IDENTIFYING UNDERSTATEMENT OF
LIABILITY FRAUD EXPOSURES
11

Accounts Payable can be understated by a combination of:

o Not recording purchases or recording the purchases in the
subsequent period
o Overstating purchase returns or purchase discounts
o Making it appear as if liabilities have been paid off or forgiven
when they have not

Understating Understating Recognised

accounts
accrued
unearned
payable
liability
revenue as
earned
revenue

Under
recording of
future
obligations

Not
recording
various type
of debts

Omission of
Contingent
liabilities

IDENTIFYING UNDERSTATEMENT OF
LIABILITY FRAUD EXPOSURES
12

Not properly accrued the liabilities in the correct

period
Common accrued liabilities accounts:
o Salaries payable
o Rent payable
o Utilities payable
o Interest payable

Understating Understating Recognised

accounts
accrued
unearned
payable
liability
revenue as
earned
revenue

Under
recording of
future
obligations

Not
recording
various type
of debts

Omission of
Contingent
liabilities

IDENTIFYING UNDERSTATEMENT OF
LIABILITY FRAUD EXPOSURES
13

o Recognizing revenues instead of recording a liability has a

positive effect on a companys financial statements because it
understates the companys liabilities and overstates its
revenues and net income.
o By manipulating the timing of revenue recognition, a company
can very easily either understate or overstate deferred revenue
liabilities.
Understating Understating Recognised
accounts
accrued
unearned
payable
liability
revenue as
earned
revenue

Under
recording of
future
obligations

Not
recording
various type
of debts

Omission of
Contingent
liabilities

IDENTIFYING UNDERSTATEMENT OF
LIABILITY FRAUD EXPOSURES
14

Delaying to record future obligations

Future obligations examples include:
o
o

Warranty
Service Obligations

Understating Understating Recognised

accounts
accrued
unearned
payable
liability
revenue as
earned
revenue

Under
recording of
future
obligations

Not
recording
various type
of debts

Omission of
Contingent
liabilities

IDENTIFYING UNDERSTATEMENT OF
LIABILITY FRAUD EXPOSURES
15

o
o
o
o
o
o
o
o
o
o

Not reporting or under recording debt to related parties

Non disclosure of debt incurred on existing borrowings lines of credit
Not recording loans incurred
Claiming that existing debt has been forgiven by creditors
Recording the personal debt of the owners, rather than debt of the
business

Understating Understating Recognised

accounts
accrued
unearned
payable
liability
revenue as
earned
revenue

Under
recording of
future
obligations

Not
recording
various type
of debts

Omission of
Contingent
liabilities

IDENTIFYING UNDERSTATEMENT OF
LIABILITY FRAUD EXPOSURES
16

o
o

o
o

If likelihood of loss is reasonably possible, the contingent liability

should be disclosed in the footnotes to the financial statements.
Underestimating the probability of occurrence and not recording
or disclosing contingent liabilities in the financial statements.

Understating Understating Recognised

accounts
accrued
unearned
payable
liability
revenue as
earned
revenue

Under
recording of
future
obligations

Not
recording
various type
of debts

Omission of
Contingent
liabilities

DETECTING UNDERSTATEMENT OF
LIABILITY FRAUD SYMPTOMS
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EFFECTIVE METHOD
Analytical

symptoms
Accounting/documentary
symptoms

DETECTING UNDERSTATEMENT OF
LIABILITY FRAUD SYMPTOMS
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LIABILITY
FRAUD
SYPMPTOMS

ANALYTICAL SYMPTOM

Accounts
Payable

Understatements of AP
relate to reported
balances that appear
too low
Purchase
returns/discounts that
appear too high
Purchase/ COGS too low

ACCOUNTING/
DOCUMENTARY
SYMPTOMS
Received vendor
invoices but no liability
recorded
Goods received before
year end but recorded
after year end
Large payments made
in subsequent years

DETECTING UNDERSTATEMENT OF
LIABILITY FRAUD SYMPTOMS
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LIABILITY
FRAUD
SYPMPTOMS

ANALYTICAL SYMPTOM

Premature
recognition of
unearned
revenues

Involve unearned
liability balances that
appear too low and
revenue accounts that
appear too high

ACCOUNTING/
DOCUMENTARY
SYMPTOMS
Large reclassifications
entries near year end
that results increase in
revenue and lower
liabilities
Revenue recognized
before customers are
billed
Differences between
confirmation amounts

DETECTING UNDERSTATEMENT OF
LIABILITY FRAUD SYMPTOMS
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LIABILITY
FRAUD
SYPMPTOMS
Under / non
recorded
service
Warranties or
future
commitments

ANALYTICAL
SYMPTOM

ACCOUNTING/
DOCUMENTARY
SYMPTOMS

Balances in such
Differences between the
warranty,
amount of warranty/
repurchases or
service costs expensed &
deposits appear too
the amount that should
low ( comparing with
have been expensed
Differences between the
other accounts e.g.
warranties and
way deposits are treated &
sales)
the way they should be
treated
Differences between what
contracts imply should be

DETECTING UNDERSTATEMENT OF
LIABILITY FRAUD SYMPTOMS
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LIABILITY
FRAUD
SYPMPTOMS
Unrecorded
Notes /
Mortgage
Payables

ANALYTICAL
SYMPTOM
Unreasonable
relationships
between interest
expense and
recorded liabilities
Significant
decreases in
recorded debt
Significant
purchases of assets
with no recorded

ACCOUNTING/
DOCUMENTARY
SYMPTOMS
Interest expense with no
recorded debt
Significant repayment of
debt immediately prior to
year end & new borrowing
immediately after year end
Significant purchase of
assets without a
comparable decrease in
cash/increase in liabilities

DETECTING UNDERSTATEMENT OF
LIABILITY FRAUD SYMPTOMS
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LIABILITY
FRAUD
SYPMPTOMS
Unrecorded
Contingent
Liabilities

ANALYTICAL
SYMPTOM
NOT particularly
helpful
Hard to project
because balances to
compare with or
ways to develop an
expectation of a
contingent liability
balance normally do
not exist

ACCOUNTING/
DOCUMENTARY
SYMPTOMS
BEST opportunity to find
contingent liabilities that
should be recorded
Identification of lawsuits
Payments to attorneys
without acknowledged
litigation
Correspondence with
governmental agencies
Correspondence from
previous auditors, banks,

DETECTING UNDERSTATEMENT OF
LIABILITY FRAUD SYMPTOMS
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ANALYTICAL
SYMPTOMS

Reported payroll, payroll tax, rent, interest,

utility or other accrued liabilities that appear
too low
Recorded amounts of notes payable,
mortgages payable, lease liabilities, pension
liabilities and other debts that appear too low
Compare these balances in other companies
within the same industry to determine
whether its too low

DETECTING UNDERSTATEMENT OF
LIABILITY FRAUD SYMPTOMS
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ACCOUNTING
or
DOCUMENTA
RY
SYMPTOMS

Large purchases receive before year end >

recorded after year end
Photocopied purchase record > should be
original
Transactions not recorded in complete or
timely manner or improperly recorded as to
amount
Lack supporting documents for transactions,
including adjustments by the entity that
significantly affect financial results
Unexplained items on reconciliation
Denied access to record, facilities, certain
employees, vendors, customers or others from

PROACTIVELY SEARCHING FOR

SYMPTOMS RELATED TO THE
UNDERGOING OF LIABILITIES
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Searching for
accounts that are
unusual in some
way (too high, too
low)

26

PROACTIVELY SEARCHING FOR

SYMPTOMS RELATED TO THE
UNDERGOING OF LIABILITIES
1) Analyzing financial balances & relationships within financial
statements
Focusing on changes in recorded liability balances from
period to period

Focusing on changes in the

actual financial statement
numbers.

Studying the statement of

cash flows (which looks at
actual change numbers but
ay not separately list every
liability account)

Using the horizontal

analysis.Ex :can quickly
examine percentage
changes in liability
accounts & determine if

Example :
27

If long term notes payable changes from $2.1 million to

$1.1 million and back to $2.1 million in 3 consecutive
years, we have to concern for the year 2 especially
considering the possibilities the liabilities were paid off to
be immediately restored after the end of the year.
Similarly,if service or warranty liabilities decreased from
$3.2 million to $2.2 million to $ 1.7 million at the same
time total sales were increasing. Therefore we should
concern that warranty liabilities were understated

PROACTIVELY SEARCHING FOR

SYMPTOMS RELATED TO THE
UNDERGOING OF LIABILITIES

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1) Analyzing financial balances & relationships within

financial statements (continuation)
) Focusing on changes in relationships from period to
period

Computing relevant
ratios and examining
changes in the ratios
from period to period

Using vertical analysis

PROACTIVELY SEARCHING FOR

SYMPTOMS RELATED TO THE
UNDERGOING OF LIABILITIES
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List of ratios that are used to detect these types of fraud

Acid test ratio
Current ratio
A/c Payable to Purchases
A/c Payable to COGS
A/c Payable to Total liabilities
A/c Payable to Inventory

Under recording
Accounts payable
(A/P)

Under recording
Accrued Liabilities

Various accruals to number of days to accrue compared to

same ratio in prior years
Various Accruals to related expenses

Under Recording
Unearned revenues

Unearned revenues to revenue

PROACTIVELY SEARCHING FOR

SYMPTOMS RELATED TO THE
UNDERGOING OF LIABILITIES
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List of ratios that are used to detect these types of fraud

(continuation)

Under recording
Service
Liabilities
Under recording
Various
Liabilities
Not Recording
Contingent
Liabilities

Warranty Expenses to Sales

Interest expenses to Notes Payable

Long-Term Debt to Stockholders Equity
Various types of Debt to Assets
Total liabilities to Total Assets
Pension Expenses to Salary Expense
Lease Expense to Total Fixed Assets

Generally no ratios to help unrecording Contingent

liabilities- have to look for documentary evidence

Example :
31

Decrease in liabilities but increase in

expense or vice versa
Purchasing significant amounts of fixed
assets and not incurring additional long
term debt is unusual especially the
company does not have a large cash
balance

PROACTIVELY SEARCHING FOR

SYMPTOMS RELATED TO THE
UNDERGOING OF LIABILITIES
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2) Comparing financial statement amounts or

relationships with related information
Compare financial results and trends of the company
with those of similar firms in the same industry

Examp
le

If a companys
warranty expense and
liability were only 1%
of sales but other
companies in the
same industry
recorded warranty

PROACTIVELY SEARCHING FOR

SYMPTOMS RELATED TO THE
UNDERGOING OF LIABILITIES
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2) Comparing financial statement amounts or

relationships with related information (continuation)
Compare recorded amounts in the financial statement
with nonfinancial statement amounts

Exam
ple

To examine assets on which

mortgage are incurred.
(mortgage liabilities)
Eliminating a mortgage
payable /finding no
mortgages on new building
(when the company practice
is to mortgage all buildings)

PROACTIVELY SEARCHING FOR

SYMPTOMS RELATED TO THE
UNDERGOING OF LIABILITIES
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3) Actively searching for Accounting and Documentary

Systems

(Types of liabilities
understatement)
Liabilities to pay
money (Notes
Payable, Mortgage
Payable , Pension
Liabilities ,Lease
Liabilities , etc)

(Documentary symptoms to
search for:)
Approval of loans by board
directors but not listed as
liabilities
Loans listed by banks on bank
confirmations but not recorded
by the company.

PROACTIVELY SEARCHING FOR

SYMPTOMS RELATED TO THE
UNDERGOING OF LIABILITIES
35

Documentary Symptoms Of Fraud

Accounts
Payable
Unearned
Revenues
Contingent
Liabilities

Payments made in subsequent period for liabilities that existed

at the balance sheet date and were not recorded
More inventory counted than identified through purchasing and
inventory records
Discrepancies in cutoff tests
Reclassification entries near the end of the period that increases
earned revenues and decrease unearned revenues
Difference between customer confirmations and company
records about how much revenue has been earned

Discussion of contingent liabilities in board minutes

Contingencies discussed in footnotes
Significant payments to lawyers
Lawsuits brought to your attention for the first time in attorney
letters

WAYS TO MANIPULATE LIABILITIES

36

CASES

XEROX CORPORATION
SUNBEAM CORPORATION
W.R.GRACE & CO
Charged

by the SEC for using cookie

jar reserves to manipulate income
Recorded extra liabilities (recording
income as deferred income) when
results were better than expectedBig Bath

XEROX CORPORATION- ACCOUNTING

SCANDALS THROUGH HISTORY
37

Xerox, a name well known for copy machines, charged by the SEC for deceiving
the public between the years of 1997 to 2000. The Securities and Exchange
Commission issued a $10 million penalty and restatements from the years 1997
to 2000. During this time Xerox misled and betrayed investors by disguising the
company's correct operating performance.
Xerox's manipulative schemes brought the attention and investigation of the
SEC. The first method of deceit called the "cookie jar" method, stored revenue
off of the balance sheet. When funds were short for a current period, the "cookie
jar" was dipped into to accommodate the difference so investors would believe
Xerox's revenues were meeting the expectations of Wall Street.
The second method, the larger of the two methods, recorded an acceleration in
short-term equipment rentals. Theses revenues were documented as long-term
leases meaning the entire value can be recorded as revenue only in the first
year of agreement. Short-term rental revenues are documentedthroughoutthe
agreed contractand revenues expireon the expiration date.
Senior management devised the two schemes that cost Xerox $10 million in
penalties. However, since the SEC investigation in 2002, stock prices fell from
$60 a share in 1999, the highest the company has been at, to $7 a share.