Wednesday, February 22, 2012

Accounting treatment for fraud- losses

We received question from our Accounting & Auditing readers on what would be the accounting entries for losses arising from fraud incidence.

In most of the circumstances, the losses arising from fraud wil be recorded in profit & loss statement. For instance, if a Company sufferred misappropriation of cash, the following accounting entries should be recorded:

Dr. Loss (Profit & Loss)
Cr. Cash

If the losses arising from fraud incident is material, this fact (i.e. fraud incident) need to be disclosed in the financial statement of the Company. Management of the Company need to consider the local laws & regulations on the disclosure requirement of fraud.

Thursday, February 16, 2012

What is financial auditing?

We received a lot of question asking us what is financial audit? What does a financial audit involved? We will try to explain in a layman term.


Company ABC is a publicly listed company. They have hired their own accountants to preare the financial statements, including: income statement, balance sheet, cash flow statement on a monthly basis.


How does the public know if the financial statement prepared by Company ABC is appropriate and in accordance with accounting standard.

Financial audit:

This is when the financial auditor come in and play a major role, where they review the financial statemetn close process of the Company's, review the accouting treatments and policies, and give you their own opinion on the financial statement. The opinion of the auditor is whether " the financial statement is fairly stated". "Fairly stated", in substance, implies that certain tolerable errors are expected.

Life without auditor:

The financial statement prepared by Company ABC may be prepared on a inappropriate manner/ not in accordance with accounting standard. However, since no professional personnel is conducting a review on the financial statement, the inappropriate financial statement will be accepted by the public.

Consequence of life without auditor:

The incorrect financial statement led to wrong decision being made by financial statement user.

Treasury Shares

Definition of a Treasury Shares

What is a Treasury Share?

A company may hold its own equity instruments, often referred to as “treasury shares”. Such treasury shares may be acquired and held by the issuing enterprise itself or by its subsidiaries, depending on the jurisdiction.

Presentation of Treasury Shares on the financial statement

Treasury shares should be presented in the balance sheet as a deduction from equity. The acquisition of treasury shares should be presented in the financial statements as a change in equity.

IAS 32 paragraph 33 states that: If an entity reacquires its own equity instruments, those instruments (‘treasury shares’) shall be deducted from equity. No gain or loss shall be recognised in profit or loss on the purchase, sale, issue or cancellation of an entity’s own equity instruments. Such treasury shares may be acquired and held by the entity or by other members of the consolidated group. Consideration paid or received shall be recognised directly in equity.

As evidenced above, under International Financial Reporting Standard: no gain or loss should be recognised in the income statement on the sale, issuance, or cancellation of treasury shares. Consideration received should be presented in the financial statements as a change in equity.

The amounts of reductions to equity for treasury shares held should be disclosed separately either on the face of the balance sheet or in the notes.

In addition, an enterprise should provide disclosure, in accordance with IAS 24, if the enterprise or any of its subsidiaries re-acquires its own shares from parties able to control or exercise significant influence over the enterprise.

Tuesday, February 14, 2012

Fraud- Nortel trial- Nearly billiton dollars in reserves "incorrectly" booked

It is reported that Nortel conducted a comprehensive review and found out that nearly a billion dollars worth of accounting reserves ``incorrectly'' booked, dating to as far back as 1999. The internal review also found two ``material weaknesses'' tied to the use of the accrued liabilities, the first being a breach in public disclosure rules, the second a violation of Nortel's own accounting practices.

It is evident that certain management of Nortel had manipulated the results by using the accrued liabilities account.

$952 million in accrued liabilities were set up without the appropriate documentation, and weren't filed in accordance with generally accepted accounting practices (GAAP). Citing one account, called the ``out-of-balance'' provision that was stored within the firm's corporate or non-operating books, the accountant said: ``It's not warranted to have an out-of-balance account.''

Tens of millions of dollars in backlogged provisions were entered to cover anticipated costs such as contract liabilities and lawsuits. When those costs weren't realized, Nortel flowed the provisions back into earnings in later periods. Yet, they ``should have been recognized in real-time,'' not deferred.

This so-called ``earnings management'' practice was used by the three top executives in Nortel to tip the flagging tech giant back into profitability in 2003, triggering $73-million in bonuses, of which they collected $12-million combined.

Sunday, February 12, 2012

Accounting Joke: Sexy Management Accountant

Something to share with our accounting & auditing blog's reader

Did you hear about the Sexy Management Accountant?

She went to see her fitness trainer to talk about stretch targets.

Thursday, February 9, 2012

Inappropriate accounting for payment- Diamond Foods, Inc

As published in Diamond Foods' website on 08 February 2012. Diamond Foods, Inc announced that audit committee's investigation of the Company's accounting for certain crop payments to walnut growers is substantially completed. The findings shows that financial statement for FY 2010 and FY 2011 will need to be restated.
"The Audit Committee has concluded that a "continuity" payment made to growers in August 2010 of approximately $20 million and a "momentum" payment made to growers in September 2011 of approximately $60 million were not accounted for in the correct periods, and the Audit Committee identified material weaknesses in the Company's internal control over financial reporting." [ Quoted from the Company's announcement]

It is not mentioned on the accounting treatment for the payment to walnut growers. Questions we are interested in is:
- what was the accounting treatment that had been recorded for payment to Walnut Growers
- what should be the appropriate accounting treatment
- how would the financials been affected
- will the profit & loss of the Company been affected immediately
- are there any interested party relationship between Diamond Foods, Inc and those walnut growers
- had a proper review of the financials been reviewed earlier

For the 12-month-ended July 2011, Diamond Foods recorded a net profit before tax of about US$69mil. Shareholder's Equity amounted to US$495mil as at 31 July 2011. In our opinion, US$80mil of payment ( i.e. US$20mil + US$60mil) represents a significant amount to the Company's financial statement.

In addition, the audit committee also identified mateiral weakness in the Company's internal control. As evidenced, it is crucial to have a sound internal control environment to support the financial statement closing process of the Company.

Wednesday, February 8, 2012

Fraud- Improper segregation of duties in handling cash

Misappropriation of cash is one of the common fraud reported in the corporate world.

In Nov 2010, it is reported that Malaysian unit sufferred a loss of RM 1.5million (approximately S$622k) due to the issuance of unauthorised cheque. It's not clear how this had occurred.

In general, one of the possibilities a cash fraud could occur is when certain individual forge the authorised signatories on the cheque. By forging the authorized signatories, the individual is able to direct the fund to his / her bank accounts. How can the internal controls of the Company helps to minimize the risk of cash fraud then?

Possible solutions are:
- to set dual authorized signatories requirement for the Company's cheque facilities
- existence of proper segregation of duties between cheque book-keeper, preparer of cheque, review of cheque amount, approver of cheque
- cash book review be performed by appropriate senior finance personnel
- review the cash movement by bank account on a monthly basis

The existence of above controls and/or procedures can help to mitigate the risk of cash fraud.

Tuesday, February 7, 2012

Fraud- fictitious employee been created

One of the common fraud we have encountered / read on the news relates to payroll fraud, where fictitious employees were been created by individual to earn additional salaries on the fictitious employees been recorded.

One of the famous cases occurred in Singapore Airlines, whereby fictitious employees' hours were clocked in by payroll officer. Payroll officer pocketed the money successfully by entering the bank account details into the system to earn the extra hours clocked.

To minimize the risk of fraud arising from fictitious employees been created. There should be proper segregation of duties between:

a) personnel who have the access right to payroll system to create and employee
b) personnel who have the access right to enter bank acccount details of individual employee into the system
c) a reviewer ( who should not been entitled the right to edit, but been entitled the right to view) to ensure that the bank account details is input correctly
d) a reviewer who review the monthly payroll costs ( by department, by employee name); this reviewr should do a random testing to tally the summary of payroll cost details to timesheet submitted / revised letter of incremenet

The segregation of duties mitigate the risk that a fictitious employee can be created by individual.