Konstantin Boykachev

CEO Proforexea LLC

Honest Coder

Professional Trader


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Konstantin Boykachev

CEO Proforexea LLC

Honest Coder

Professional Trader

Blog Post

Financial Statement Falsification Techniques


falsification of financial statements

This information can be useful for those who invest on the stock exchange or Forex in securities of second-tier companies. The stocks of corporations like Facebook or Apple seem to be more reliable. But individual securities of second-tier companies may show profits 2-2.5 times higher. And the blue chips themselves are not immune from fraud. For example, the story of the bankruptcy of the US energy giant Enron.

One of the key fundamental factors affecting stock prices is financial results. If the company has shown revenue or net income above analytical forecasts, the stock goes up. The question is, are these statistics worth trusting? Read on to find out what methods of falsifying financial statements exist.

How financial statements are distorted

Financial statements are used to prepare accounting reports and generate statistical indicators such as EBITDA, etc. First of all, they are analyzed by independent audit companies, which, on their basis, assign ratings to companies. Both financial results and rating serve as a marker of investment attractiveness – investors are guided by them.

Motives for misrepresentation of reporting:

  • Growth in the value of shares… Capitalization growth is an inflow of new investments and a new round of price growth. And the growth of quotations is an opportunity for interested parties (management) to sell their stake at an inflated cost.
  • Getting a loan… An increase in the value of shares is an opportunity to attract a large lender. Also, one of the fraud options provides for a balance sheet overvaluation of assets that can be accounted for as collateral. In the future, credit funds can be withdrawn for the personal purposes of the owners of the company, the company itself is declared bankrupt.
  • Compliance with regulators and auditors… The higher the rating of a company, the less criticism from the regulator, the more attractive it is for investors.
  • Personal interest… We are talking about bonuses for top management, which will show shareholders in the reporting data improved in comparison with the previous period.

Falsification of financial statements is also on the lower side in terms of profit – to reduce the tax base.

A fictitious increase in profits is achieved by increasing revenue or reducing costs.

  1. Increase in revenue:
    • Conducting transactions through shell companies… A company that inflates profits sells goods only on paper, the goods remain in stock. Buyers pay money and report inflated profit margins. Then the buyers, again on paper, return the goods, the company returns the money and sells the goods to real buyers.

According to this model, Quantum worked from 2015 to 2018, having agreed with its partners on the accounting of goods for warehouse stocks. This suited the partners, since they could accumulate goods for future periods. Quantum “drew” revenue, goods were waiting in the wings. The essence of the violation was that only the proceeds that were received as a result of a transaction with a real buyer could be reflected in the accounting. Quantum simply moved money and goods on paper through its counterparties. The result is a fine of USD 1 million.

A similar situation was in 1998-2003 with Symbol. She showed in the reporting the profit from the sale of goods to intermediaries, and not to end customers.

  • Early entry of revenue into reporting… Falsification of financial statements consists in the posting of revenue and expenses for different reporting periods. For example, revenue is paid in December, and expenses are postponed to January.

Another option is to conclude an agreement with the right of subsequent redemption by the seller of the goods back. The seller sells the goods, fixes the proceeds, then, in accordance with the contract, buys the goods back. According to the rules, revenue should be reported only when the buyback period ends. That is, when the seller loses the right to buy back. And for the interim period in the reporting, this amount should be accounted for as a cash loan secured by goods.

Nevertheless, some companies contribute this money ahead of schedule to revenue. In 2001, Applix managers pre-accounted for over $ 1 million in additional revenue at the end of the reporting period for bonuses. The same scheme was done in 2002.

  • Revaluation of assets… International standards provide for the display of assets on the balance sheet only at their real value. The asset price has decreased – the difference is written off as a loss. Falsification of financial statements – no revaluation of assets.

In 2009-2010, such a scheme was used by St. Joe Company. The mortgage crisis hit the value of non-residential property hard. But it was not profitable for its owners to reflect this. Therefore, the revaluation was “forgotten”. The result is a fine of almost USD 3 million.

In 2010-2012, Trinity Capital Corporation deliberately overstated the value of real estate on its balance sheet in order to obtain a larger loan amount on its security. In 2009, Miller Energy Resources overstated the cost of oil and gas sites. Thanks to the artificial increase in profits, the share price temporarily increased by almost 8 times.

For a continuation of how falsification of financial statements occurs by reducing costs, read the next review.


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