Among all kinds of profit manipulation methods, asset fraud occupies the main position. In recent years, most of the cases of financial statement fraud that have great influence in China are related to asset project fraud, among which listed companies such as Qiongminyuan, Lantian, Dongfang Boiler and Chengdu Hong Guang are typical. Fake companies generally use five means to illegally increase asset value and inflated profits, namely, fictitious income, false time difference, concealment of liabilities and expenses, false disclosure and asset pricing fraud. Among them, asset appraisal fraud is the usual method of asset fraud. However, due to its variety, strong liquidity and diverse pricing methods, inventory overvaluation constitutes the main part of asset pricing fraud. The analysis of it is the focus of this paper.
Among Chinese and foreign listed companies, there are many cases involving inventory fraud, including mckesson & Robbins, Swindon Salad Oil Company, Stock Fund, ZZZZ Best Company, Fallmo Company, China Hong Guang Industrial Company, Tianjin Xia Guang (Group) Co., Ltd., etc. The fraud schemes planned by these companies have brought great audit risks to certified public accountants. Here will introduce the typical case of Fallmo Company in the United States.
Second, the case of Fallmo Company.
Mickey Monas likes almost all sports since he was a child, especially basketball. However, due to the limitation of talent and height, he has no chance to play in a professional team. However, Monas does have a characteristic that all top players have, that is, he has an irresistible desire to win.
Monas shifted his endless energy from the court to his chairman's office. He first managed to buy a pharmacy in Yangtu town, Ohio, and in the following ten years, he bought another 299 pharmacies, thus forming a national chain Fallmo company. Unfortunately, all these glories are based on asset fraud-unchecked inventory overvaluation and false profits, which eventually led to the bankruptcy of Monas and his company. At the same time, it also caused the "Big Five" firms providing audit services to lose millions of dollars. The following is the story of this case:
Since opening the first drugstore, Monas dreamed of developing his small shop into a huge pharmaceutical empire. His strategy is what he calls "forced buying", that is, selling goods by offering big discounts. The first thing Monas did was to bring the unaudited pharmacy statements that were actually unprofitable and add non-existent inventory and profits to them with his own pen. Then, with his talent for empty talk and a set of exaggerated statements, he defrauded enough investment to buy eight pharmacies within one year, laying the foundation for his small drug empire. The empire later developed to the size of 300 chain stores. For a time, Monas became a man of the hour in the financial circle, and his company won an admirable position in Yangtu Town.
Monas and his company have been fabricating false profits for ten years, until an accidental opportunity led to the surface of this well-planned financial fraud, which caused losses of at least 500 million dollars. This is really not an easy thing. At that time, the financial director of Fallmo Company believed that the company's sales of goods at a lower cost caused serious losses, but Monas believed that through "forced purchase", the company could get enough development, so that it could successfully adhere to its sales methods. Finally, under the strong pressure of Monas, the CFO was involved in this fraud case. In the following years, he and several subordinates kept two sets of account books, one to cope with the audit of certified public accountants and the other to reflect the bad reality.
They first put all the losses into a so-called "bucket account", and then redistributed the amount of the account to the company's hundreds of member pharmacies by inflating the inventory. They imitate purchase invoices, make false accounting vouchers to increase inventory and reduce sales costs, and at the same time confirm purchases without confirming liabilities, and count or double inventory. The reason why the financial department can hide the shortage of inventory is because the certified public accountants only supervise four of the 300 pharmacies, and they will inform Fallmo which pharmacies to check several months in advance. Then, the managers filled the actual inventory in these four pharmacies and distributed these inflated parts to the remaining 296 pharmacies. If accounting fraud is not considered, Fallmo Company is actually on the verge of bankruptcy. In the recent audit, it was so short of cash that the supplier threatened to cancel the supply because it did not pay the payment in time.
Certified public accountants failed to find this kind of fraud, and they paid a high price for it. The audit failure caused the accounting firm to lose $300 million in civil litigation. The CFO was sentenced to 33 months in prison, while Monas himself was sentenced to 5 years in prison.
Third, case analysis: How to identify inventory fraud
Why didn't CPA find any signs of corporate fraud in Fallmo? Maybe they trust their customers too much. They read articles about it in the newspaper and reports about Monas's hard work on TV, thus paying the price for this deceptive propaganda; They may also audit under the false assumption that their clients have no motivation to cheat in accounting statements because they make a lot of money. Looking back on the whole incident, as long as someone asks such a basic question, that is, "How can companies that sell goods below cost make money?" Certified public accountants may find this kind of fraud.
This case is a wake-up call for us. Inventory audit is so important and complicated that inventory fraud can not be found by simple supervision. However, if certified public accountants can figure out how these deceptive manipulations are carried out, it will be of great help to discover these frauds, which means that certified public accountants must master the technology of identifying inventory fraud.
(A) manipulation of inventory value
The determination of inventory value involves two elements: quantity and price. It is usually difficult to determine the quantity of existing inventory, because goods are always being bought and sold; Constantly transfer between different storage locations and put them into production process. There may also be problems in the calculation of inventory unit price, because the inventory value calculated by FIFO, LIFO and average cost method will inevitably be quite different. Because of this, complex inventory account systems often become attractive targets of fraud.
Dishonest enterprises often use a combination of the following methods to forge inventory: fictitious non-existent inventory, inventory counting manipulation and incorrect inventory capitalization. All these well-designed schemes have the same purpose, which is to inflate the value of inventory.
1, fictitious inventory
As Monas has done, an easy-to-think method to increase the value of inventory assets is to fabricate false information about various items that do not actually exist, such as accounting vouchers that are not supported by original vouchers, exaggerating the inventory quantity on the inventory list, forging delivery acceptance reports and false purchase orders, thus inflating the inventory value. Because it is difficult to effectively identify these forged materials, certified public accountants often need to prove the existence and valuation of inventory through other channels.
2. Inventory control
Certified public accountants rely heavily on the supervision of customers' inventory to obtain audit evidence about inventory. Therefore, it is very important for certified public accountants to conduct inventory tests and keep records. Unfortunately, in some inventory fraud cases, audit clients changed the working papers of certified public accountants within a few hours. Therefore, certified public accountants must take adequate measures to ensure the credibility of audit evidence.
For example, suppose an audit client receives a large amount of goods five days before the end of the accounting period, and then pulls out all relevant acceptance reports and invoices and their copies, and hides them during the audit period. Then in the physical inventory, employees will count these goods and count them into the batch of goods tested by certified public accountants.
Obviously, in the above example, the physical inventory will be overvalued and the liabilities of the same amount will be underestimated. For customers, the advantage of this method is that the overvalued amount of inventory will be mixed into the calculation of the whole cost of sales. In this case, certified public accountants need to analyze the ratio or trend to find possible fraud. In addition, you can also view the payment expenses within a period of time after the end of the accounting period. If the CPA finds that any direct payment to the supplier is not recorded in the purchase journal, he should make further investigation.
3. Inventory capitalization error
Although there may be improper capitalization in any deposit and loan project, this problem is particularly prominent in finished goods projects. The capitalized parts of finished products are usually sales expenses and management expenses. In order to find these problems, certified public accountants should interview relevant personnel in the production process to obtain information about whether the collection and distribution process of expenses classified as inventory costs is appropriate. Audit clients can usually list many seemingly sufficient reasons to support the process of increasing profits by capitalizing inventory items. This kind of fraud is often carried out by the chief financial officer at the behest of the president. Therefore, in formal interviews with key people, if they are suspected of being instructed to exaggerate the information about inventory, certified public accountants should take a straightforward approach and force them to tell the truth with a reproachful attitude.
(B) the limitations of inventory
The most effective way to determine the inventory quantity is to conduct a comprehensive inventory. Certified public accountants must arrange the inventory procedures reasonably and carefully, and conscientiously implement them. The inventory time should be as close as possible to the year-end closing date. Measures should be taken as far as possible to improve the effectiveness of inventory, such as conducting inventory at all storage points at the same time, stopping inventory flow and achieving a reasonable inventory ratio. However, even if certified public accountants seriously implement this procedure, there is no guarantee that all major frauds will be discovered. This is because the inventory count test has the following limitations:
(1) The management authorities often send representatives to follow the certified public accountants, on the one hand, to record the test results, on the other hand, to grasp the location and progress of the test. In this way, audit customers have the opportunity to add fictitious inventory to untested projects, thus wrongly increasing the overall value of inventory.
(2) When carrying out the inventory test procedure, the certified public accountant will generally inform the customer of the time and place of the test in advance, so that the customer can get ready before the inventory. However, for companies with multiple storage locations, this kind of advance notice gives management an opportunity to hide the inventory shortage of those storage locations that CPA has not checked.
(3) Sometimes the CPA does not perform additional audit procedures to further check the sealed packing box. In this way, in order to overstate the inventory, the management will fill the warehouse with empty boxes.
(3) Identify possible inventory fraud through analysis procedures.
Since all major frauds cannot be discovered through supervision, certified public accountants must carry out analysis procedures.
Dishonest customers can manipulate inventory information in many ways. Certified public accountants must look at those data from a variety of perspectives in order to find relevant fraud as much as possible. It is necessary to speculate not only on how fraud is carried out, but also on why customers cheat and why customers take this illegal behavior as their first choice. In other words, certified public accountants should evaluate the motivation and opportunity of major inventory fraud by management authorities in order to find asset fraud.
1, motivation of management fraud
There are various motives for customers to commit fraud, and it will be helpful to find possible fraud by analyzing and considering them during the audit. The following are several common reasons that lead to the fraudulent impulse of management authorities:
(1) The client company is facing financial difficulties.
(2) The customer management authorities are under pressure to complete the financial plan.
(3) Inventory is a major item in the balance sheet.
(4) Supply pressure specified in the contract.
(5) The client company tries to obtain financing through deposits and loans.
(6) The management authorities are faced with pressure from the capital market, such as falling stock prices and the risk of delisting or acquisition of the company.
2, the opportunity to manage fraud
Not all companies can inflate their profits by forging inventory and cheating the counting program of certified public accountants. In fact, it is very difficult for some companies, such as those with small scale and simple business, to cheat certified public accountants and fiddle with inventory. However, under the following circumstances, the possibility of inventory fraud by management authorities will increase:
(1) The customer company is a manufacturing enterprise, or it has a complex system to determine the inventory value.
(2) The client company is involved in high-tech or other rapidly changing industries.
(3) The client company has many inventory storage locations.
3. Signs of management fraud.
Fictitious assets will unbalance the company's accounts. Compared with the previous period, the sales cost will be too low, while the inventory and profit will be too high. Of course, there may be other signs. When evaluating the risk of overvaluation of deposits and issuance, certified public accountants should answer the following questions. The more you answer "Yes", the higher the risk of inventory fraud.
(1) Is the growth of inventory faster than the growth of sales revenue?
(2) Does the percentage of inventory in total assets increase year by year?
(3) Does the inventory turnover rate decrease year by year?
(4) Is the proportion of transportation cost in inventory cost reduced?
(5) Is the growth of inventory faster than that of total assets?
(6) Is the percentage of sales cost to sales revenue gradually decreasing?
(7) Does the account book record of sales cost conflict with the tax return?
(8) Are there any major adjustment entries to increase the inventory balance?
(9) After the end of an accounting period, do you find that any important write-off entries have been posted to the inventory account?
Four, the enlightenment and lessons for the CPA industry
Because of its own complexity, inventory items have long been the ideal target of fraudsters, and have also attracted the special attention of certified public accountants. Since 1938, the audit case of the famous mcpherson Robbins medicinal materials company occurred, the American Institute of Certified Public Accountants listed inventory counting as one of the important procedures that must be carried out in the company audit. However, due to the limitation of audit bureau, the negligence of certified public accountants and the improvement of fraud technology of customer management authorities, many accounting firms still suffer from inventory audit. The case of Fallmo Company is a good proof. As the saying goes, "the magic is one foot high and the Tao is one foot high." As long as certified public accountants keep drawing lessons from the past, strive to improve audit techniques and effectively improve their ability to investigate and deal with fraud, the risk of failure in inventory audit will be minimized. So, what enlightenment and lessons can we get from Fallmo's case?
1. Pay full attention to the motives and opportunities of fraud.
Because fraud has the risk of being discovered and moral pressure, that is to say, fraud also has costs, so in general, rational people prefer to respect objective facts. However, once faced with some pressure and temptation, the impulse of customers to cheat will become strong. It is precisely because of the pressure of loss and Monas' eagerness to expand financing that Fallmo took risks and embarked on the road of no return to fraud. It can be seen that CPA's analysis of fraud motivation is helpful to reduce audit risk.
2. Pay attention to the application of analysis program.
In view of the limitations of the inventory procedure, certified public accountants cannot expect to solve all problems through inventory. If we want to find clues of fraud, the analysis program is a very effective audit method. This program compares and analyzes all kinds of data provided by customers with internal cross-checking relationship from a global perspective, which is helpful to find major errors. As mentioned above, inventory fraud will make some items abnormal. By analyzing the proportion and trend of inventory and sales revenue, total assets, transportation costs and other items, and tracing those abnormal items, it is likely to reveal major fraud.
In addition, financial statements can be cross-checked with notes, financial statements, tax reports and other similar documents to minimize audit risks.
3. Correct application of the principle of materiality.
The principle of materiality is an important principle in audit work. Certified public accountants must pay special attention to the items that occupy an important proportion in the balance sheet, especially those items with weak internal control system that occupy a considerable proportion in the balance sheet. Special detailed investigation methods should be implemented instead of general routine audit procedures. For a commercial enterprise like Fallmo, inventory should be an extremely important project. Certified public accountants should have designed special spot checks or detailed investigation procedures for deposits and issuance, but in fact, they only adopted routine inspection procedures with a few months' notice in advance and a small number of samples. It is this simple treatment that gives Monas and others a chance.
4. Provide off-the-job training for certified public accountants to improve their ability to detect asset fraud.
Through the above case analysis, we should see that the fraud level of audit clients is constantly improving, and its means have changed from simple violation of discipline to premeditated and organized technical fraud; From simple account book fraud to comprehensive accounting information fraud, from summons to statements. At the same time, the anti-investigation awareness of fraudsters has been enhanced, and the auditing methods commonly used by auditors have been understood and mastered. Therefore, the current demand can no longer be met by simple methods. In order to be competent for professional work, certified public accountants must constantly improve their ability to investigate and deal with fraud. Therefore, in order to maintain the healthy development of the CPA industry and reduce the litigation risk of accounting firms, professional groups should provide full-time training for CPAs to improve their ability to detect asset fraud.