Accounting Information Systems (AIS) and Fraud

Accounting Information Systems (AIS) and Fraud
Key factor determining success in an organization is its accounting information system. Many fraud schemes could have been prevented if the victim organization had had an adequate and efficient accounting information system in place. In fact, many of them have been labeled as “recklessly keeping records” as reflected in the case below.

If it at any time appears that any business of a corporation was or is being carried on recklessly, with gross negligence or with intent to defraud any person or for any fraudulent purpose, a court may on the application of the law, or any creditor, member or liquidator of the corporation, declare that any person who was knowingly a party to the carrying on of the business in any such manner, shall be personally liable for all or any of such debts or other liabilities of the corporation.

To prevent these instances, an effective information system that provides control, compatibility, flexibility, and a favorable cost/benefit relationship is paramount for any organization.

What is an Accounting Information System?

It is the combination of resources: people, procedures, and business records that a company maintains to provide financial data. This system should be developed to suit individual needs of each type of organization.

An important part of the accounting information system is its internal control system. Internal controls are methods and procedures used by an organization to safeguard assets, authorize transactions, and ensure accuracy of the accounting records.

Information system is described by James A. Hall as the set of formal procedures by which data are collected, processed into information, and distributed to users. He specifically defines the AIS as subsystems that process financial transactions and non-financial transactions that directly affect the processing of financial transactions.

AIS and the Forensic Accountant

In general, accountants are primarily involved with information system in three ways:

1. As system users
2. As system designers
3. As system auditors

The SEC (Securities and Exchange Commission) investigated a case where the accounting principles were not followed and the computer information was manipulated to attain results. In this investigation, examiners, among them, forensic accountants established that:

o With no regard for generally accepted accounting principles (GAAP) or their financial reporting obligations, the defendants manipulated information at a quarter end cutoff to align the organization reported financial results with market expectations.

o During the period during at least three years, the organization prematurely recognized over $3.3 billion in revenue from contracts that the company, its customers, or both parties, had not yet executed, in violation of GAAP.

o Executives, held the company’s books open for several days after the end of each quarter to improperly record in that quarter revenue from contracts that were not executed by customers or the company until several days or more after the expiration of the quarter. As a result of this improper practice, this organization made material misrepresentations and omissions about its revenue and earnings in SEC filings and other public statements. For example, in the first, second, third and fourth quarters of FY2000, respectively, the company inflated its properly recorded revenue by approximately 25%, 53%, 46%, and 22% by improperly including prematurely recognized revenue.

o After the company substantially refrained from recognizing revenue prematurely from contracts that its customers had signed after quarter end during the first quarter of its fiscal year 2001, the company missed its earnings estimate and its stock price dropped over 43% in a single day.

o This company continued the improper practice of improperly recognizing revenue from contracts that it signed after quarter end through the fiscal quarter ending Sept. 30, 2000.

While the accounting fraud was occurring, defendants Smith, Doe and Jones received ill-gotten gains in the form of compensation they received from Company WXZ, Inc. In addition to committing securities fraud, the defendants interfered with the SEC's investigation. During the course of the SEC's investigation, one of the executives made materially false and misleading statements. During the same relevant period, Smith, another executive, made materially false and misleading statements in sworn investigative testimony and Jones encouraged several Company WXZ, Inc. employees to make false and misleading statements to the SEC and/or Company WXZ, Inc.' outside counsel.

Jones consented to a partial judgment imposing a permanent injunction prohibiting him from violating the antifraud reporting, books and records and internal control provisions of the federal securities laws. The partial judgment also permanently bars Jones from serving as an officer or director of a public company. A price as a result of a recklessly maintained information system tailored to commit securities fraud. WXZ, Inc. had to make restitution to its shareholders for over 200 million.

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