New Class: Accounting

Okay, so. I am a Marketing major (my undergrad degree). I am currently in an MBA program for a concentration in Project Management. Let's be honest and say that I'm not interested in the numbers side of business - I like theory and practice.

My accounting class for my MBA started this past week. I am nervous, especially since I did so badly in accounting as an undergrad (I did pass). I make no pretensions at being good with numbers - but hopefully I'll be able to come out of this unscathed.

Luckily, we are still doing discussions (which should be a great grade boost, hopefully). Here's my first one:

PROMPT: After reading the report, “Control Overrides in Financial Statement Fraud: A Report to the Institute for Fraud Prevention,” tell your colleagues what you have learned about financial statement fraud. What does it mean to “engineer financial results?” What are the challenges associated with this practice, and is there ever any “grey area?” Are there any situations in which it might be considered ethical to engineer financial results? Does your answer change in the context of a small, family-owned business versus a major global corporation?

The most important piece of information I drew from this article was actually a strong, concise definition of what exactly financial statement fraud is. Everyone knows of this fraud; it is prevalent in many aspects of modern business reporting, both in terms of discovery and its repercussions in the market. However, as with any other disease or ailment, this sickness of modern business can be made a lot less scary by properly naming it.

Authors Robert Tillman and Michael Indergaard quoted William Black in concisely explaining the nature of financial statement fraud:

"Situations in which those who control firms or nations use the entity as a
means to defraud customers, creditors, shareholders, donors, or the general
public." (Black, 2005)

Engineering financial results is the equivalent to working with statistics. Numbers can be interpreted to mean almost anything that you want them to mean - engineering results is simply presenting facts and data in such a way as to support your particular view or opinion of the results. While many people believe that facts are 'cold and hard', unfortunately the "Law and Order" version of reality only exists on television. The prompt for this discussion asked us to address whether there was ever a 'grey area' in financial reporting. I believe that any financial reporting can be in a grey area. The truest information can always be found in the simplest presentation that is closest to the information's original source - the further you get from that point, the grayer the area is.

When we speak of distance from the point of information integrity, an important quantifying aspect is time. While scandals like Enron and Fannie Mae remain in the public consciousness, one of the key problems I see in addressing issues of financial statement fraud is the passage of time. While bodies such as the SEC do move to enforce regulations and dole out penalties, the time that elapses between the point of discovery and the point of enforcement speaks loudly to both those who consider committing fraud and those who are victims of it. With an average response time of 4.7 years between the act of fraud itself and an enforcement release from the SEC, there is little incentive in the short term to avoid the temptations of fraud (Deloitte, 2008).

Other major points that must be considered when considering the engineering of financial information are its most popular manifestations. According to a study by Deloitte, 'revenue recognition' fraud schemes are by far the most prevalent (at 41%), and of those the recording of fictitious revenue is the most common offshoot (at 35%). While it can be said that falsification of revenue is a pretty straightforward and (one would think) relatively easy to detect form of fraud, authors Tillman and Indegaard demonstrate that fraud draws strength from numbers.

"Groups that once acted as control agents who enforced formal rules of
accountability on firms are now part of an array of "reputational
intermediaries"

These intermediaries create a network of conspirators in which no-one feels 'directly' responsible for allowing fraud to pass through the cracks - though everyone may be peripherally aware of it, there is no one point at which someone feels directly accountable.

Regardless of whether we are talking about a large or small industry, small or large market, or any other factor, fraud is always an indicator that something is wrong with the way you are doing business. If numbers need to be falsely inflated in order to get to the next quarter, it's like robbing Peter to pay Paul. The continued tolerance our current business world has for this sort of behavior continues to breed new and more damaging ways to commit fraud.

Resources:
Black, William K. "Control Frauds' as Financial Super-Predators". The Journal of Socio-Economics. 34:734-55
Deloitte Forensic Center. "Ten Things About Financial Statement Fraud". June 2007. Accessed 1/7/2009. http://www.deloitte.com/dtt/cda/doc/content/us_forensic_tenthings_fraud01072008.pdf