Column: The trouble in catching fraud

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KRISHNAMURTHY V SUBRAMANIAN : Jan 07 2010, 20:46 IST

Exactly a year ago, we witnessed the spectacular fall of one of the signposts of the success of Corporate India—Satyam. This day a year back, Raju confessed the accounting fraud that he had been perpetrating at Satyam. Accounting frauds constitute a common theme that connects the Satyam scandal with other international corporate scandals such as Enron, Tyco, WorldCom. As we look back at the year that has passed since the startling revelations by Satyam and attempt to develop appropriate policy responses, it is critical to understand the common mechanisms firms use to commit accounting frauds.

Using a sample consisting of firms prosecuted by the US SEC for accounting frauds, Merle Erickson of the Chicago Booth School of Business and his co-authors have examined the mechanisms used by firms to inflate their earnings. They find that reporting fictitious sales is the most common source of income inflation for sample firms. For example, one firm in the sample created a fictitious customer and shipped empty boxes to this customer at the address of a firm employee. Subsequently, the firm sent invoices to this fictitious customer, which made it appear that a sale had taken place, even though nothing had actually been sold. Ultimately, this transaction increases the firm’s financial statement net income, but not its economic income. Firms also understate their costs or overstate their inventory.

Who executes the financial statement fraud? For the majority of the sample firms, the CEO was accused of assisting in the alleged accounting fraud. In about 50% of

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Is a fraud worth it?

Neelam Khubnani | 12-Jan-2010Reply | Forward

The key difference between a fraud and a visionary is that a fraud eyes investors%u2019 confidence for short term while a visionary shall be able to see the outcome of misrepresentation and hence better avoid it for sustainable profits and wins the confidence ultimately. These result oriented management executives/CEO%u2019s who commit fraud, report inflated earnings to avoid the suspicion of investors don%u2019t seem to care about the long term survival of their company. When the fraud is unveiled, investors can%u2019t even dare to rely even on their true (un-manipulated) results for years to come. After a year of fraud revelation, Satyam no longer exists, what we buy is a new entity altogether, Mahindra Satyam. So was the fraud, that cost the CEO his entire company worth it?