GAAP are the guiding principles, rules and regulations that are followed by accountants with an aim of making certain that their practices are ethical and legal (Financial dictionary, 2012). GAAP defines the standard for preparation of the financial statements, managing accounts and accounting techniques and methods. Generally, Accepted Accounting Principles are governed and provided by the (FASB) in addition to (IASB), which offers comparable and equal standards all over the globe (Financial dictionary, 2012).
GAAP rules are enforced on organizations in order to ensure that investors are provided with a minimum degree of reliability in the financial statements they employ, whilst assessing firms for investment intentions. Various things are covered on GAAP, encompassing balance sheet classification, revenue recognition and outstanding share capacity amongst others. Firms are supposed to follow General Accepted Accounting Principles rules, whilst preparing and reporting financial data through financial statements. Nevertheless, GAAP is merely a set of rules and guidelines, and therefore, some dishonest company accountants tend to distort figures, and thus, it is always essential to inspect companies’ financial statements in spite of their use of GAAP.
Accountants make use of Generally Accepted Accounting Principles in order to be guided, whilst reporting or recording financial data. The wide array of principles, contained in the GAAP, has been created by (SEC) and the accounting profession (Generally Accepted Accounting Principles, par 1). SEC obtains its authority of establishing reporting and disclosure obligations from the Securities Exchange Act of 1934 as well as from the Securities Act of 1933 (Generally Accepted Accounting Principles, par.1). Nevertheless, SEC functions on a supervision power, thus, allowing the Financial Accounting Standards Board and the Government Accounting Standards Board (GASB) to create these requirements. This paper will focus on the appropriate GAAP rules that will assist in determining the cases of fraud in various scenarios provided, assess whether such rules are enough in reducing fraudulent actions in companies, and consequences of fraudulent acts in organizations. Besides, the paper will offer recommendations on how these red flags can be corrected and how they can be prevented from reoccurring in the future; also it will describe the persons who are involved in each case.
The five scenarios to be analysed in the paper include:
- Charters on technology assets appear overstated
- Underestimation of electronic-commerce national payment of taxes
- Fabricated staffs, obtaining post-employment reimbursements
- Hiding cash with an aim of assisting in upcoming quarters wherein income do not meet the expectations of analyst’s
- Obscuring inventory decline since it appears low for the organization
Appropriate GAAP rules that will assist in determining if fraud is taking place in each of the scenarios
The present sets of principles that are used by accountants are based on some fundamental assumptions. Most of these principles and assumptions are deemed GAAP, and besides, apply to the majority of financial statements. The appropriate GAAP regulations that will be employed in this scenario to find out if a fraud is occurring in each of the cases presented encompass the following:
The initial supposition is the economic unit postulation. In this, the monetary reports should be independently kept for every economic unit. Economic units comprise of governments, businesses, churches, school districts and added social associations (Generally Accepted Accounting Principles, 2012). Even though accounting reports from various different units might be pooled, intended for financial coverage reasons, every financial occurrence should be linked with and documented by a precise entity. To add to this, business reports should not take in the individual liabilities of the proprietors.
Another assumption is the monetary unit assumption. A financial unit’s accounting proceedings comprise of just quantifiable dealings. Some financial procedures that have an effect on a company, like employing a chief executive officer or bringing in a fresh produce, is not capable of being easily computed in fiscal units and so, do not show in the firm's accounting proceedings. In addition, accounting proceedings ought to be documented with a constant currency (Generally Accepted Accounting Principles, 2012). For example, businesses within the United States generally use the U.S. dollars for this reason. In this case, the principle was not observed, when there was an overstatement in the leases on technology assets.
The full disclosure principle is one of the principles. In this, financial reports usually give reports, concerning a firm's precedent performance. Nevertheless, incomplete dealings, pending proceedings or additional circumstances might contain significant and imminent effects on the firm’s financial position (Generally Accepted Accounting Principles, 2012). This full disclosure principle necessitates that monetary declarations include revelation of this information (Generally Accepted Accounting Principles, 2012). Annotations complement monetary reports to pass on this data and to illustrate the procedures that the firm employs to document and account business dealings. This principle was not observed, when there was concealing of inventory shrinkage since it seemed low for the firm. Those operating did not fully disclose the inventory shrinkage. There was also an understatement of e-Commerce state tax payments and this could also be said that there was no full disclosure, thus, it would interfere in the audit.
The going concern principle was also not observed, when it was discovered that there was some hidden cash that was to help in the future quarters, where earnings would not meet the expectations as per the analysts. In this principle, the monetary reports are organized assuming that the firm would stay in the industry for an indefinite period (Generally Accepted Accounting Principles, 2012). For that reason, properties do not have to be valued at fire-sale costs, and the amount outstanding does not have to be compensated before it matures.
The principle of reliability, relevance and consistency was also not observed since the information, used in the audit, was not reliable (Generally Accepted Accounting Principles, 2012). This was due to the concealing of some information and the money was also not well accounted for. According to this principle, financial reports must be reliable, relevant and consistent. Relevant reports assists those involved in decision making know a firm's performance in the past, present state, and outlook in the future so that decisions, which are informed, are completed in an appropriate way. The information requirements of personal consumers may be different, necessitating that the report will be offered in diverse layouts. Internal consumers frequently require more comprehensive data than outside users, who may possibly require to be acquainted with just the firm's worth or its capability to pay back loans (Generally Accepted Accounting Principles, 2012). Dependable data is provable and purposed. Consistent data is organized with the use of similar techniques in every accounting phase, which permits meaningful evaluations to be made, involving diverse accounting phases and between the statements of finance of different firms that make use of the same techniques.
Are GAAP Rules Sufficient To Minimize Fraudulent Activities In Organizations?
Most firms in the United States and other parts of the world stick on the General Accepted Accounting Principles with an aim of maintaining consistency, whilst recording and reporting financial information in order to minimize the risk of error and fraud. Studies have proven that if GAAP rules did not subsist, firms would not be in a capacity of offering consistent and accurate financial information to various important persons such as stakeholders, creditors and investors of the company (Lang and Ricciardella, 2001). It is true, therefore, to state that the GAAP rules are sufficient to minimize fraudulent activities in organizations.
Although law does not obligate GAAP rules, the majority of firms that stick to these guidelines maintain reliable reporting procedures, and besides, prepares correct financial statements. Enforcing the GAAP rules also helps in setting organizational standards and minimizes various risks, problems and erroneous in reporting in the company departments (Lang and Ricciardella, 2001). Even though the GAAP rules may be deduced and applied in various ways, the main principles act as a basis for reporting, scrutinizing and summarizing financial documents. However, GAAP are merely a set of rules and guidelines, and therefore, some dishonest company accountants tend to distort figures, and thus, it is always essential to inspect companies’ financial statements in spite of their use of GAAP.
Consequences of Fraudulent Activities in an Organization
In a whole market, fraud is a regrettably familiar occurrence. There are various impacts on an organization. It leads to financial loss in this organization in that after discovering these fraudulent activities, an investigation is supposed to take place, this expenditure can vary from five to six-figure cost, and this depends on how complex the fraud is (Association of Certified Fraud Examiners, 2002). Besides, the reputation of the company will be destroyed, since the public may tend to lose faith in it (Association of Certified Fraud Examiners, 2002). People will tend to assume that the firm is running under a poor management and they may, in turn, decide that the organization lacks credibility
These fraudulent activities may also lead to loss of employees; especially if it’s a staff member who is in a senior position commits it (Association of Certified Fraud Examiners, 2002). The employees may possibly start searching for a better place to run for employment. Moreover, the morale of the employees is damaged and this is especially for those who decide to stay in the firm. The employees may feel that the company has unsuccessfully represented them and subsequently failed the mission (Association of Certified Fraud Examiners, 2002).
Internal Controls to Be Used In Preventing These Frauds from Happening Again In The Future
Apparently, most companies have methods and systems of carrying out business, which safeguard their possessions, whilst promoting the effective employment and the assets, so as to attain the acknowledged aims (Lang and Ricciardella, 2001). Such systems and methods, taken on to help in achieving this outcome, are termed as internal controls. Firms should comprehend that internal controls may not offer assurance of total prevention of fraud, but makes certain that, in case a crime occurs, it will be noticed on a well-timed basis and besides, it is possible to identify the person who committed it (Lang and Ricciardella, 2001). An effective internal control system that offers techniques of fraud detection may serve as a strong restriction to unacceptable behaviour, whilst at the same time, encouraging honesty amongst the staff.
Internal controls encompass the administrative controls and internal accounting controls. Efficient administrative controls necessitate commitment by management and top level employees to the principles and guidelines of good control, in addition to direct participation in the oversight procedure (Thompson-PPC, 2004). Active involvement and participation by management in the operations of the company, definition of roles and clear authority serves as a strong restriction to fraud.
Some of the internal controls that may be used to prevent the red flags from reoccurring in future encompass:
The organization should utilize a budget that is often matched up to the actual outcomes with the entire important variances being reviewed. These budgets should be practical and besides, should be based on past experience. The persons who are involved in carrying out the vital role for internal controls are the senior management and the board (Thompson-PPC, 2004). Besides, they are responsible for overseeing the creation of a strong and effective internal control system.
The organization should also have a straightforward structure, whereby authority lines and responsibilities are clearly defined. In addition, the organization should make certain that it has a concise and updated manual of procedures and policies in place to communicate clearly with the staff (Thompson-PPC, 2004). Besides, there should be segregation of roles to ensure that an employee does not have control of the entire processes such as processing, authorizing, safeguarding assets, accounting and recording, which necessitates to be distributed to make sure that there are appropriate controls over fraud and errors. The segregation of these responsibilities means that there is the existence of a system of checks and balances and they minimize the probability of fraud (Lang and Ricciardella, 2001).
In addition to this, board should take the responsibility of reviewing the internal controls of various accounting functions frequently, including fixed assets, payroll, cash receipts and cash disbursements amongst others (Lang and Ricciardella, 2001). The most efficient means of guaranteeing effective internal controls is separating incompatible functions. This implies that a person should not be given the role of custody of assets and takes the role of maintaining the associated records.
Recommendations How the Red Flags Can Be Corrected
Certainly, fraud is an important probable predicament in all organizations. As a result, the syndicate of professional associations has provided Management Antifraud Programs and Controls, Guidance to assist in preventing and detecting fraud (Lang and Ricciardella, 2001). According to the document, various companies have considerable lower degree of asset misappropriation, and thus, less vulnerable to fraudulent reporting compared to others, since they undertake practical steps of avoiding or detecting fraud (Lang and Ricciardella, 2001). It is true that the only companies that succeed in avoiding fraud are those that consider the risks of fraud and besides, take practical steps to mitigate its happening. Nevertheless, in case fraud happens, organizations can still correct the same and prevent future occurrence.
The organization in our case study can correct each red flag that has taken place and this is a major step in controlling and preventing fraudulent activities and their future occurrence. The various red flags that took place in the organization encompass charters on technology assets appear overstated, underestimation of electronic-Commerce national payment of taxes, fabricated staffs, obtaining post-employment reimbursements, hiding cash with an aim of assisting in upcoming quarters, wherein income do not meet the expectations of analyst’s, obscuring inventory decline, since it appears low for the organization. In all these happenings, the organization should make certain that those responsible for the red flags take full responsibility. This will assist in preventing future occurrence of such an event. In addition to this, frequent checking of the various organizational documents such as lease documents, tax payment documents, employee benefits documents, inventory and financial documents will assist greatly as any intention of fraud will be noticed. These are believed to be high susceptible risk areas and their frequent assessment will assist in preventing similar happenings.
Fraud reduction encompass three aspects, which include identification and measurement of fraud risks, using appropriate steps to reduce recognized risks and applying and monitoring suitable detective and preventive internal controls amongst other deterrent measures. Those who are responsible in correcting these red flags are the management, encompassing the officers and directors. These persons should first ensure that they set an example to the other employees on how to behave in an honest and ethical manner and through this they will be able to punish those who break the rules. Besides, the top management will be responsible in checking the organization documents frequently in order to avoid future occurrence of the fraud.
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