Detecting Fraudulent Transactions Affecting Financial Report Integrity

In this chapter, we will delve into the crucial topic of detecting fraudulent transactions that have the potential to undermine the integrity of financial reports. Fraudulent transactions can have devastating consequences for businesses and stakeholders that would negatively impact trust and cause financial losses in the organization. We will explore various concepts, techniques, and solutions that can be implemented to identify and mitigate fraudulent transactions.

In this chapter, we will cover the following main topics:

• Understanding the major causes of fraud
• Common myths and misconceptions about financial fraud
• Interpreting financial reports
• Learning how fraudulent transactions affect overall financial report integrity
• Detecting and preventing fraudulent transactions and anomalies

By the end of the chapter, you will have a better understanding of how financial reports are interpreted...

Technical requirements

This chapter builds on concepts introduced in Chapter 1, Recognizing the Importance of Data Integrity in Finance, under the A quick tour of concepts relevant to data integrity management section. You may revisit this part to better appreciate our discussion in this chapter.

At the same time, we will be using datasets from a fictional company for our hands-on exercise using Microsoft Excel. If you do not have Microsoft Excel, you may use Google Sheets, which is free with a Google account, instead. Our sample datasets are saved in the Packt GitHub repository, which can be accessed at https://github.com/PacktPublishing/Managing-Data-Integrity-for-Finance/tree/main/ch07. Save the file on your computer, as we will use it in the Interpreting financial reports section of this chapter. You may proceed once these are ready.

Understanding the major causes of fraud

Based on interviews conducted by a newspaper (specifics withheld for anonymity), the GST fraud that was promoted on TikTok was very simple to execute. All that the person needed to do was to apply for a business number, lodge the claim on the government website or app, and submit it to get the GST refund after a specified number of days. What made matters worse was that a number of social influencers on TikTok made people believe that it was okay, saying that it was a temporary loan.

The use of social media aggravated the situation and more than 50,000 people in that country took advantage of the weakness in the government agency's platform. As a result of these fraudulent claims, more than a billion US dollars were paid out (converted using today's exchange rate). The expectation was for people to submit a claim for their business expenses and be reimbursed for the allowable limit of the GST to help businesses with their cash flow...

Common myths and misconceptions about financial fraud

Understanding the myths and misconceptions surrounding financial fraud is critical for safeguarding assets and also for maintaining the integrity of financial reports. This section dives deep into common misconceptions and illustrates them with real-world examples and scenarios to give you a better understanding and awareness to counteract fraud effectively.

Myth 1—the impact of fraud is insignificant

The incorrect belief that financial fraud is immaterial or insignificant can lead to a complacent outlook toward financial monitoring and control. Such an attitude can set a bad starting point, allowing fraudulent activities to go unnoticed.

Note

For example, imagine yourself being a business owner who unfortunately overlooked minor discrepancies in the cash register only to discover months later that a significant sum had been embezzled by an employee over time! The accumulation of these small discrepancies would...

Interpreting financial reports

In Chapter 1, Recognizing the Importance of Data Integrity in Finance, we covered the most common types of financial statements: the balance sheet, income statement, and cash flow statement. In this section, we will build on these concepts and discuss how they are interpreted. I recommend going back to the basic concepts we discussed in that chapter to help familiarize yourselves with these topics further.

Financial statement analysis is a skill that business professionals and leaders need to equip themselves with. Understanding what these financial reports are and how to read them effectively will help you better understand what impacts a business’s key drivers and how to make better decisions based on the data.

Here are the types of analysis that can be done to further understand the financial reports that we will cover in this chapter:

• Horizontal or trend analysis
• Vertical analysis
• Competitor and industry analysis
• Cash...

Learning how fraudulent transactions affect overall financial report integrity

In this section, we will discuss fraudulent transactions and their damaging effects on the overall integrity of financial reports. Fraudulent transactions, characterized by deceit, manipulation, and misrepresentation, pose a significant threat to the credibility and accuracy of financial information.

There are governing bodies all over the world that are involved in fraud prevention to safeguard the interests of investors, uphold a fair and productive market, and aid in capital investments. Some of the major regulatory bodies in the world include the Securities and Exchange Commission (SEC) in the United States, the Financial Conduct Authority (FCA) in the United Kingdom, the Financial Services Agency (FSA) in Japan, and the Australian Securities and Investments Commission (ASIC) in Australia.

According to the SEC, the most common reasons for committing fraud are as follows:

• Fulfilling earnings...

Detecting and preventing fraudulent transactions and anomalies

While the impact of fraudulent transactions on financial report integrity is significant, there are measures that organizations can take to mitigate such risks, which we will discuss in this section.

Tone at the top

The tone at the top significantly impacts the level of fraud risk within an organization. When leaders and top management demonstrate a strong commitment to ethical behavior and integrity, it sets the foundation for a culture of honesty and transparency throughout the organization. This influences employees’ attitudes and behaviors and ultimately shapes the organization’s overall approach to fraud prevention. A positive tone at the top sends a clear message that unethical conduct, including fraud, will not be tolerated. It establishes the expectation that employees are expected to adhere to high ethical standards in their work. This tone should be consistently communicated and reinforced...

Summary

Detecting fraudulent transactions that affect financial report integrity is a critical challenge faced by organizations worldwide. In this chapter, we covered the fraud triangle to understand potential causes of fraud. Next, we talked about how financial reports are interpreted and discussed the different kinds of financial analysis that can be done. In the next part of the chapter, we discussed how fraudulent transactions affect overall financial report integrity. We explored the most common examples of financial statement fraud in the forms of fictitious revenues, improper capitalization of expenses, and misrepresentation of liabilities and debt. As we closed the chapter, we learned about the different ways to detect and prevent fraudulent transactions and anomalies. This chapter has given you the foundational skills and capabilities to understand financial reports and fraud detection.

In the next chapter, we will learn how to use database locking techniques for financial...

Further reading

We have barely scratched the surface of this topic. For more information on what we covered in this chapter, feel free to check out the following resources:

• Forensic Analytics and Management Accountants Report:

  https://asiapac.imanet.org/research-publications/statements-on-management-accounting/forensic-analytics-and-management-accountants?

• Committee of Sponsoring Organizations of the Treadway Commission (COSO) Internal Control – Integrated Framework:

  https://www.coso.org/guidance-on-ic

• Enron: The Smartest Guys in the Room:

  https://www.youtube.com/watch?v=_0vRuHn9MmI

• Speech by SEC Staff: Why Does Fraud Occur and What Can Deter or Prevent It:

  https://www.sec.gov/news/speech/2008/spch090908lar.htm

• PwC’s Global Economic Crime and Fraud Survey 2022:

  https://www.pwc.com/gx/en/services/forensics/economic-crime-survey.html