1. Chapter 13: Liability, Asset, and Inadequate Disclosure Frauds
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2. Learning Objectives
Identify fraudulent schemes that understate liabilities.
Discuss the understatement of liabilities fraud.
Describe fraudulent schemes that overstate assets.
Understand overstatement of assets fraud.
List fraudulent schemes that inadequately disclose financial statement information.
Explain inadequate disclosure fraud.
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3. Types of Financial Statement Fraud
Understating liabilities
Overstating assets
Inadequate disclosure
A few years ago, Waste Management, Inc., the leading provider of comprehensive waste and environmental services in North America, improperly inflated its operating income and other measures of performance by deferring current-period operating expenses into the future by netting one-time gains against current- and prior-period misstatements and current period operating expenses.
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© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

4. Understatement of Liabilities Fraud (slide 1 of 12)
Schemes that understate liabilities
Understating Accounts Payable
Understating Accrued Liabilities
Recognizing Unearned Revenue as Earned Revenue
Underrecording Future Obligations
Not Recording or Underrecording Various Types of Debt (Notes, Mortgages, etc.)
Omission of Contingent Liabilities
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5. Understatement of Liabilities Fraud (slide 2 of 12)
Understating Accounts Payable
Accounts Payable can be understated by a combination of
Not recording purchases or recording the purchases after the end of the year.
Overstating purchase returns or purchase discounts.
Making it appear as if liabilities have been paid off or forgiven when they have not.
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6. Understatement of Liabilities Fraud (slide 3 of 12)
Understating Accrued Liabilities
Common accrued liabilities accounts:
Salaries payable
Payroll taxes payable
Rent payable
Utilities payable
Interest payable
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© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

7. Understatement of Liabilities Fraud (slide 4 of 12)
Recognizing Unearned Revenue as Earned Revenue
Recognizing revenues instead of recording a liability has a positive effect on a company’s financial statements because it understates the company’s liabilities and overstates its revenues and net income.
By manipulating the timing of revenue recognition, a company can very easily either understate or overstate deferred revenue liabilities.
To understand the motivation of these types of frauds, remember that stock prices are affected by both risk and return.
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© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

8. Understatement of Liabilities Fraud (slide 5 of 12)
Underrecording Future Obligations
Future obligations examples include
Warranty
Service Obligations
This type of fraud is easy to perpetrate and results in overstated net income and understated liabilities.
© 2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website in whole or in part.
© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

9. Understatement of Liabilities Fraud (slide 6 of 12)
Not Recording or Underrecording Various Types or Debt (Notes, Mortgages, etc.)
Either not reporting or underrecording debt to related parties
Borrowing but not disclosing debt incurred on existing lines of credit
Not recording loans incurred
Claiming that existing debt has been forgiven by creditors
Claiming that debt on the company’s books is personal debt of the owners or principals, rather than debt of the business
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© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

10. Understatement of Liabilities Fraud (slide 7 of 12)
Omission of Contingent Liabilities
If likelihood of loss is reasonably possible, the contingent liability should be disclosed in the footnotes to the financial statements.
Contingent liabilities can be used to fraudulently misstate financial statements by underestimating the probability of occurrence and not recording or disclosing contingent liabilities in the financial statements.
© 2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website in whole or in part.
© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

11. Understatement of Liabilities Fraud (slide 8 of 12)
Ways to detect understatement of liabilities
Analytical symptoms
Accounting or documentary symptoms
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12. Understatement of Liabilities Fraud (slide 9 of 12)
Analytical Symptoms
Accounts Payable:
Balances appear too low
Purchase or cost of goods sold numbers are low
Purchase returns or discounts numbers are high
Unearned Revenue:
Payables or other accrued liabilities are low
Income that is “too smooth”
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13. Understatement of Liabilities Fraud (slide 10 of 12)
Analytical Symptoms
Recognition of Unearned Revenues:
Unearned liability balances appear too low and revenue accounts appear too high
Under- or nonrecording of service warranties:
Balances in warranty, repurchases, or deposits accounts appear too low
Unrecorded contingent liabilities:
Analytical symptoms are usually not particularly helpful to detect unrecorded contingent liabilities
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14. Understatement of Liabilities Fraud (slide 11 of 12)
Analytical Symptoms
Unrecorded Notes/Mortgages:
Unreasonable relationship between interest expense and recorded liabilities
Significant purchases of assets with no recorded debt
Significant decreases in recorded debt
Recorded amounts of notes payable, mortgages payable, lease liabilities, pension liabilities and other debts are too low
© 2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website in whole or in part.
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15. Understatement of Liabilities Fraud (slide 12 of 12)
Accounting or Documentary Symptoms
Photocopied records where originals should exist
Unusual discrepancies between the entity’s records and confirmation replies
Transactions not recorded in a complete or timely manner or improperly recorded amounts
Balances or transactions that lack supporting documents
Missing documents
Unexplained items on reconciliations
Denied access to records, facilities, or others from whom audit evidence might be sought
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16. Overstatement of Asset Fraud (slide 1 of 7)
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17. Overstatement of Asset Fraud (slide 2 of 7)
Overstatement of Fixed Assets by
Leaving worthless or expired assets on the books
Underreporting depreciation expense
Recording fixed assets at inflated values
Colluding with outside parties to overstate assets
Fabricating fixed assets to record on the financial statements
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18. Overstatement of Asset Fraud (slide 3 of 7)
Overstatement of Cash, Short-Term Investments, and Marketable Securities Schemes
Reporting restricted cash as unrestricted on the balance sheet
Having vendors or employees steal significant amounts of cash over time so that financial statements are misstated
Cash is quite hard to overstate because of verification from financial institutions
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19. Overstatement of Asset Fraud (slide 4 of 7)
Overstatement of Receivables and Inventory
Cover thefts of cash by overstating receivables or inventory
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20. Overstatement of Asset Fraud (slide 5 of 7)
Overstatement of Intangible or Deferred Assets
Startup companies can fraudulently capitalize intangible assets like start-up costs, advertising costs, salaries by writing them off as deferred charges.
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21. Overstatement of Asset Fraud (slide 6 of 7)
Use market values rather than book values to record assets.
Have the wrong entity be the “purchaser.”
Allocate costs among assets in inappropriate ways.
Record fictitious assets or inflate the value of assets in intercompany accounts or transactions
© 2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website in whole or in part.
© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

22. Overstatement of Asset Fraud (slide 7 of 7)
Ways to detect overstatement of assets
Compare changes and trends in financial statement account balances
Compare changes and trends in financial statement relationships
Compare financial statement balances with nonfinancial information or other information, such as the assets they represent
Compare financial statement balances and policies with those used by other similar companies
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© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

23. Inadequate Disclosure Fraud (slide 1 of 2)
Disclosure Fraud Schemes
Misrepresentation about the nature of the company or its products
Misrepresentations or omissions in the MD&A
Misrepresentations or omissions in the footnotes to the financial statements
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24. Inadequate Disclosure Fraud (slide 2 of 2)
Ways to Identify Disclosure Fraud
Look for inconsistencies between disclosures and information in the financial statements
Inquire of management concerning related-party transactions, contingent liabilities, and contractual obligations
Review a company’s files and records with the SEC and other regulatory agencies
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© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.