White-collar crime can be costly, but the form with the highest price tag? Financial statement fraud. According to the Association of Certified Fraud Examiners, it brings a median loss of $954,000. However, auditors and forensic accountants are skilled at assessing journal entries to hunt down financial manipulation.
Detecting questionable entries
When it comes to financial statement fraud, it can look a lot of different ways. Out-of-period revenue can be used to inflate revenue. Legitimate repair costs can be falsely capitalized as fixed assets, thereby increasing earnings. Accounts payable can be underrecorded when adding the post-closing journal entries to income. And expenses can be reclassified to reserves or intercompany accounts to increase earnings.
How do you detect these scams? Auditors use several different methods.
- Learning the reporting processes and controls for journal entries that a company uses
- Pinpointing journal entries and other adjustments to test them
- Determining the timing of the testing
- Interviewing the employees or service providers involved in the reporting process to assess inappropriate or unusual activity in handling journal entries.
If there are irregularities in financial records, a forensic accounting professional might be called on to provide further evaluation.
Testing journal entries
What do auditors and forensic accountants look for when reviewing journal entries for fraud? Professionals keep an eye out for the following red flags:
- Entries made to unrelated, unusual or seldom-used accounts
- Entries made by someone who doesn’t usually make one
- Entries made at the end of the period or post-closing with little or no explanation
- Entries made without account numbers before or during the preparation of financial statements
- Entries made to accounts with complex or unusual transactions and that have significant estimates and period-end adjustments
Another red flag that might catch an auditor’s eye is adjusting for intercompany transfers and entries in amounts made a bit below an individual’s approval threshold or containing large, round-dollar amounts.
Technology and expertise working together
Technology plays a big role in these evaluations. Thanks to computerized testing, auditors can asset entire datasets and avoid overlooking critical evidence. This makes it easier to devote time to other aspects of an investigation, like interviewing employees or learning about a business’ practices. Additionally, computerized testing helps when manual testing is cumbersome. For example, if data needs to be extracted from electronic formats.
However, technology doesn’t replace an experienced auditor or fraud expert. Rather, they provide them with more tools to do their job. If you’re concerned about possible fraud in your company’s financial statements, contact Smolin Lupin to schedule a consultation.