Preventing corporate scandals
| DOI | https://doi.org/10.1108/13590790410809202 |
| Published date | 01 July 2004 |
| Pages | 268-276 |
| Date | 01 July 2004 |
| Author | Mohammed B. Hemraj |
| Subject Matter | Accounting & finance |
Journal of Financial Crime Ð Vol. 11 No. 3
Preventing Corporate Scandals
Mohammed B. Hemraj
INTRODUCTION
Over the years, the quality of ®nancial reporting has
varied widely. Some of the companies did the bare
minimum to meet accounting standards, while others
were more cautious. Most of the recent emerging
corporate scandals that rocked US companies from
Enron to WorldCom were a result of accounting
problems and board oversights. In the case of
Enron, the board bore signi®cant responsibility
for the company's collapse, as Enron's high-risk
accounting practices were not hidden from them.
1
WorldCom was reclassifying expenses as capital
spending, which led to US$3.9bn fraud at the US
telecommunication company by boosting operating
cash ¯ow margins. Xerox Corporation, a US photo-
copier company, had overstated its operating earn-
ings by $1.4bn by using accounting practices to
in¯ate its pro®ts. In a nutshell, `the accounting scan-
dals at Enron, WorldCom and Xerox have all come
in dierent forms and guises. At Enron it was illicit
use of o-balance sheet partnership; WorldCom
executives booked routine costs of business invest-
ments; and Xerox got too aggressive in its account-
ing of equipment leases'.
2
The common misconception relates to the public
perception that the primary role of employing an
auditor is to detect fraud.
3
It is the management (direc-
tors), rather than the auditors, who are responsible for
ensuring that proper accounting records and state-
ments are prepared and maintained. The growing
concern over fraud leads to a false perception by the
®nancial statement users of the auditor's role as
extending to the detection of all sorts of fraud. This
paper is mainly concerned with fraud, based on the
author's thesis that it is possible to prevent corporate
scandals by tackling fraud.
The question remains: whose duty is it to detect
fraud Ð company directors or auditors? In this
respect the paper will analyse the various facets of
®nancial fraud, what constitutes auditors' breach of
duties to their clients, responsibility for the monitor-
ing and reporting of fraud, the provisions of the UK
Auditing Practices Committee (APC) guidelines and
fraud detection and prevention.
WHAT IS FRAUD?
Fraud is `deliberate steps by one or more individuals to
deceive or mislead with the objective of misappro-
priating assets of a business, distorting an organisa-
tion's apparent ®nancial performance or strength, or
otherwise obtaining an unfair advantage'.
4
Fraud
involves the use of deception to obtain an unjust or
illegal ®nancial advantage,
5
and encompasses white-
collar crime, defalcation, irregularities and embezzle-
ment. With regard to company administration fraud
is `an intentional deception, misappropriation of a
company's assets or the manipulation of its ®nancial
data to the advantage of the proprietor'.
6
Fraud, in whatever nature and guise, has to be
detected ®rst, since detection is an important pre-
requisite of rooting out any sort of fraud.
7
On their
own, auditors are not necessarily the most suitable
group to perform the task of fraud detection. The
company, by instituting appropriate fraud prevention
measures within its organisation, can detect and
prevent non-management fraud.
Management fraud is dicult to detect due to coer-
cion and collusion. Fraud may be perpetrated within a
company by an employee or manager or outside the
organisation by a business contact or a member of
the general public, or a combination of the two.
Also if a genuine mistake when discovered later is
not recti®ed but covered up, it may become a fraud.
Examples of fraud include `creation, alteration or
suppression of the accounting records, vouchers and
documents',
8
thereby misappropriating an asset.
Fraud may be divided into management fraud and
employee fraud. Management fraud involves circum-
venting internal control procedure and `often escapes
detection until an enterprise has suered irreparable
damage'.
9
Skilfully executed fraud is hard to detect.
A `bite' fraud occurs when an individual in an organ-
isation takes money and disappears. A `nibble' fraud
occurs when a small amount of money or asset is
taken each time, thereby making the risk of detection
low. In the USA it takes an average of two years before
`nibble fraud' is detected.
10
Some of the causes that enable fraud to occur include
failure to allocate responsibility for the prevention of
Page 268
Journalof Financial Crime
Vol.11,No. 3, 2004,pp.268±276
#HenryStewart Publications
ISSN1359-0790
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