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STOP: Spot Fraud Warning Signs

StopWouldn’t it be great if you had this guy to warn you? “Stop…these are fraudulent documents!”

CPAs, in planning their audits, consider the risk of fraud with a variation on these three questions:

  • Is the opportunity to commit fraud high? (ie. Poor internal controls)
    • I’d suggest that if your borrower is a small to medium size business the answer is always yes. After all, who is handing you the financial statements and tax returns? Even if CPA-prepared, they are still the company’s numbers.
  • How desperate is the borrower?
  • Has this person/owner/borrower shown a willingness to deceive third parties for financial gain before?
    • Consider that if they are willing to mislead the IRS in significant ways (cheat on their taxes) they have demonstrated such a willingness.

Patricia Dechow, an accounting professor at UC Berkely has added to the profile. Her group found the following common characteristics for companies alleged to have manipulated financial statements, according to an analysis of SEC enforcement releases:

  • weakening operating performance
  • unusually high growth in cash sales combined with declines in cash profit margins and earnings growth
  • declines in order backlog
  • declines in employee head count
  • abnormally high increase in financing and related off-balance sheete activities such as operating leases.

Do you have a mental checklist you follow to spot fraud?

About the Author
Linda Keith CPA is an expert in credit risk readiness and credit analysis. She trains banks and credit unions throughout the United States, both in-house and in open-enrollment sessions, on Tax Return and Financial Statement Analysis. She is in the trenches with lenders, analysts and underwriters helping them say "yes" to good loans. Creator of the Tax Return Analysis Virtual Classroom at www.LendersOnlineTraining.com, she speaks at banking associations on risk management, lending and director finance topics.