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How to Detect Fraud in Company Balance Sheet

Fraud in the company balance sheet or any financial statement is also known as cooking the company books. Fraud is the deliberate overstating of revenues, assets, and profits or understating losses, expenses, and liabilities. When audit firms in Dubai, UAE investigate financial fraud in businesses, they look for warning signs or red flags which indicate poor accounting practices. 

How to Detect Fraud in Balance Sheet?

  • Continuous high levels of current assets, cash, and cash equivalents – there are businesses that report high cash balances over a long period of time. This becomes a problem when forensic accounting is done and it turns out that they aren’t inflating both bank balances and cash. 
  • Reported earnings are always higher than the cash flow – when cash flow from a company’s operating activities is always less compared to what is reported as the net income, then it definitely is a red flag. An investor must always ask why the company's operating earnings aren’t turning into cash. 
  • A sudden increase in the sales/inventory ration – it indicates a company is inflating assets like inventories. 
  • Frequent changes in the company policies – assets and earnings may be inflated with the use of alternative accounting policies. When an audit firms in UAE sees that there are frequent changes to the policies adopted by a company’s accounting department, then there may be something wrong with the company’s books. 
  • Spurt in other revenue – revenue sources that are recorded under ‘other revenue’ are often non-recurring. They may include revenue from the sale of an asset and debt restructuring or closures of debt. But, sources of earnings aren’t disclosed under the head and this sudden spurt can raise eyebrows. 
  • Financial rations that aren’t in line with the competition – this can be because of inflated earnings, understating liabilities and expenses or asset valuation. 
  • Off-balance sheet transactions – when a company is expanding through the creation of special-purpose entities plus it entered many leasing contracts, it’s possible that lots of liabilities aren’t reflected in the balance sheet. There shouldn’t be too many transactions that are not recorded in the company's balance sheet. 

We've seen a lot of renowned and respected companies charged with manipulating accounting books. Investors must always stop treating the financial statements that are issued by businesses as gospel truth. Instead, they must be scanned carefully in order to detect potential foul plays. 

Read More: How to Prepare for a Financial Audit?

How do businesses in UAE commit fraud in Financial records?

There are a lot of items in a company's financial statements for which different policies are used. These are fixed assets and investments, inventory valuation, asset depreciation, and foreign currency conversion. A company often manipulates any of them in order to inflate cash flow, assets, revenue, and understate cash outflow, liabilities, and expenses in financial statements. 

Inflation of earnings 

  • Customer or client lending – a company may lend money to a client or customer to purchase their products. This way, a company can report a higher revenue in its income statement, including high receivables which are treated as a company asset in a balance sheet. 
  • Trade stuffing – a company can use this prior to the end of the current reporting period. With trade stuffing, goods are shipped to customers even when they don't need them yet. It is going to increase the sales ahead of a reporting period. 
  • Understating provisions – a company can allow credit sales with generous terms. This can even happen to clients that have poor credit histories. In such sales, a company sets aside an even larger amount to bad debt provisioning. The amount will be recorded in the books as a liability. When understating such liability, it’s another way for a business to enhance its financial statement. 
  • Getting into false or fictitious transactions – is also referred to as round-tripping. This means getting the business into a false transaction with a related party with the purpose of inflating the revenue. With round-tripping, companies sell the unused assets with a promise of getting them back at a much later date and at the same exact price. 

Read more: What is the Difference Between a Qualified and Unqualified Audit Report?

Understating of company expenses 

  • Spreading out the expenses – as per accounting norms, when an expense is made for the acquisition of an asset that benefits a company, it is to be recorded in the books spread out if it will be used by the company on a long-term basis. The process is referred to as capitalizing. A company can use this in delaying the recognition of a short-term expense. 
  • Off balance sheet transactions – assets or liabilities aren’t fully recognized as the transactions involved are too complicated. This can include assets and liabilities from joint ventures, lease agreements, and unconsolidated subsidiaries. A lot of companies make use of off-balance sheet financing as a way to enter joint ventures and lease contracts. As risk or liabilities involved with the transactions aren’t reflected in the company’s books, an investor may draw a wrong conclusion regarding the health of a company. 

To know more about forensic auditing in UAE, call us here in Farahat & Co