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hOW tO DEtECt AND PREvENt
fINANCIAL StAtEmENt fRAuD
General Techniques for Financial Statement Analysis
How to Detect and Prevent Financial Statement Fraud 119
VI. GENERAL TECHNIQUES FOR FINANCIAL STATEMENT ANALYSIS
Financial Statement Analysis
Financial statement analysis is a process that enables readers of a company’s financial reports to develop
and answer questions regarding the data presented. Financial statements express a company’s economic
condition in three ways: (1) the balance sheet reports assets, liabilities, and owners’ equity; (2) the
income statement accounts for the profit or loss of the company; (3) and the cash flow statement
displays the sources and uses of cash. At the end of these statements, there is a section for footnotes—a
more detailed description of several items on the financial statements including a discussion of changes
in accounting methods, related-party transactions, contingencies, and so on. Annual and quarterly
reports also typically include a section titled Management’s Discussion and Analysis (MD&A), which gives
management’s perspective on the financial results of the period in the report.
Reading the MD&A section of the financial report can give the fraud examiner a great deal of
information about management’s tone. Management frequently includes information about the financial
results compared with its expectations, as well as further details and insights into the values on the
financial statements. The footnotes to the financials can also give valuable tidbits about the changes that
have occurred in the organization. For example, if an organization has changed an accounting policy, a
fraud examiner might be interested in understanding the reason to determine whether the change was
legitimate or intended to benefit the organization or management.
Financial analysis techniques can help investigators discover and examine unexpected relationships in
financial information. These analytical procedures are based on the premise that relatively stable
relationships exist among economic events in the absence of conditions to the contrary. Known
contrary conditions that cause unstable relationships to exist might include unusual or nonrecurring
transactions or events, and accounting, environmental, or technological changes. Public companies
experiencing these events must disclose and explain the facts in their financial statements. Increasingly,
private and nonprofit companies follow best practices and do the same.
Unexpected deviations in relationships most likely indicate errors, but also might indicate illegal acts or
fraud. Therefore, deviations in expected relationships warrant further investigation to determine the
exact cause. Several methods of analysis assist the reader of financial reports in highlighting the areas
that most likely represent fraudulent accounting methods.
Analytical procedures are used to detect...