Financial accounting is defined as the process directed to prepare financial statements useful to internal and external users, also called stakeholders. Stakeholders are composed the by government, investors, bankers, employees, etc. The language of financial information is stated in the financial statements, which should be a reliable representation of management actions. It is not always the case. No a day goes by without a case where stakeholders have been deceived by careless and fraudulent financial reporting.
This recent case illustrates the need for standards and regulations. Several advisers were charged because of complaints detailing recorded conversations among members of financial teams along with other evidence reflecting the planning and implementation of the sham transaction. A component of fraud is the knowledge by the fraudster that he or she is incurring in a wrongful practice. These advisers understood from the beginning that they were structuring a sham transaction involving the creation of phony documents for the purpose of providing apparent support for false accounting entries a company made on its books. As a result of this company’s accounting treatment for these transactions, the company’s financial results showed false increases in reserves that such company touted in its quarterly earnings releases. Without the phony loss reserves, XZL Inc, financial results would have shown further declines in its loss reserves.
These wrong practices usually trigger a restatement of an organization’s financial statements, through which these transactions must be recharacterized to reflect the proper accounting treatment.
With the purpose of preventing sloppy or fraudulent accounting standard-setters have issued principles created with the purpose of enabling comparability of financial statements across organizations and industries. The bodies participating in the development of these standards, commonly known as GAAP, Generally Accepted Accounting Principles, are:
1) Securities and Exchange Commission, SEC
2) American Institute of Certified Public Accountants, AICPA
3) Financial Accounting Standards Board, FASB
4) Governmental Accounting Standards Board, GASB.
When financial statements are audited, the objective is to provide an opinion on the fairness, in all material respects, of these financial statements. The auditor issues a standard report stating that an entitiy’s financial position, result of operations, and cash flows are in conformity with GAAP.
AU 410 (Auditing – United States) clarifies that the term “generally accepted accounting principles” when used in reporting standards is construed to include not only accounting principles but also the methods of applying them.
The AICPA Code of Professional Conduct requires that members prepare financial statements in accordance with GAAP. The Rule 203 of the Code prohibits a member from expressing an opinion that financial statements conform with GAAP if those financial statements contain a material departure from generally accepted accounting principles.
When standards are overridden investigations arise to determine guilt on fraudulent reporting. Fraudulent reporting is a conduit to deceitful maneuvers that have destabilized credibility in accounting professionals. When it happens forensic accountants are called to determine the amount of losses that stakeholders have suffered as a result of sloppy and fraudulent accounting practices. Forensic accountants play an important role in helping investigators when bringing fraudsters to justice.