Financial Statement Fraud

Published: 2019-10-28 10:30:00
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Businesses and companies avail financial statements for some reasons. First, it is to show the value of the firm. Second, experts use financial reports to measure the performance of a company. It is the dream of every company to make profits and attract investors, lenders and other stakeholders to the business. However, in the course of striving to remain attractive to stakeholders, businesses today engage in certain illegal practices. One of the illegal functions that companies engage in is financial statement fraud. Actually, this fraud is a significant challenge in the world of business today. Financial statement fraud involves hiding data or maneuvering the accounts of the company to reveal the false financial strength of the firm (Isa, 2011). Additionally, financial statement fraud can mean underplaying or the act of deliberately hiding losses of a business to ensure it remains attractive to investors and creditors. The deliberate misrepresentation or omission has devastating effects on both the business and the economy at large.

Financial statement fraud does undermine the quality, reliability, transparency, and integrity of the financial statement process not forgetting the jeopardy it causes to the integrity and objectivity of the auditing profession. Moreover, it can lead to loss of employment to the individuals involved in the deception, high costs of litigation as well as bankruptcy or substantial loss to the company that participates in the fraud. The discovery of the deceit causes loss of confidence by the public in the company as well as in accounting and auditing professions. Employees can also suffer emotional trauma when they have to lose their jobs because of embezzlement committed by other people in the company that eventually suffers losses and closure (Isa, 2011). There have been significant financial statement frauds in various entities around the world. This paper seeks to focus on the major financial statement frauds of two companies, namely, Cendant and Volkswagen.

The Cendant 1998 Fraud

Cendant Corporation, whose formation dates back to 1997 after Hospitality Franchise Systems (HFS) and Comp-U-Card International Inc (CUC) merged, is one of the companies that have suffered greatly because of financial statement fraud. The company had its base in New York and provided business and consumer services. It specially dealt with real estate and travel industries. A few months after merging with CUC in 1998, Cendant managed to uncover one of its largest accounting scandals in the 1990s. It discovered massive accounting improprieties that had been happening in CUC before the merger. The vice chairman of CUC, who at that time was E. Kirk Shelton, had inflated the revenues of the company by 500 million dollars for three years. Indeed, Shelton reported a net income of 55.4 million dollars in 1997 while in reality; the company made a net loss of 217.2 million dollars that year (Markham, 2015). With the discovery of these irregularities evident in the books of Cendant Corporation in 1998, the Board of Directors set up an audit committee to investigate the situation. This investigation brought to their attention the fraudulent acts of the top executives of the CUC Company. The CUC management team including their top executives Walter Forbes and Kirk Shelton had prepared false financial statements for several years before the merger. Consequently, it resulted in the largest case of financial statement fraud in the history of the country though the Enron and WorldCom accounting scandals later eclipsed it.

The report of the fraudulent acts did get to the public, which led to considerable damage to the market value of the company. According to Markham (2015), the market worth of the company suffered damage of approximately 14 billion dollars, and the stock dropped from 41 dollars to nearly 12 dollars. It is after the discovery of this scandal that the Board of Directors of Cendant forced Forbes to resign, and Silverman took over as the new CEO of the company. In 2001, the Securities and Exchange Commission (SEC) sued Forbes and Shelton for the accounting fraud that resulted in huge costs for the company and losses of billions of dollars owned by the enterprises investors. In 2007, Walter Forbes received a sentence of 12 years in prison while Shelton had got his conviction of 10 years in 2005. Additionally, each of them was required to pay 3.275 billion dollars in restitution. The new CEO of the company had to work hard to regain the confidence of investors and creditors. Moreover, Cendant put in place measures to help it recover from the scandal, and it finally bounced back.

The Volkswagen Scandal

Volkswagen is a German carmaker, which started operations in 1937. Currently, the company is the largest automaker in the world. Despite the company enjoying much success, it has had its share of problems over the years. Volkswagen has also suffered a major scandal during its operations. The major scandal was the Volkswagen emissions impropriety, referred to as the Emmissionsgate or Dieselgate of September 2015 (Fracarolli & Lee, 2016). In 2014, the International Council on Clean Transportation (ICCT) conducted a study on emissions and discrepancies between European and US models of vehicles. Following this research, the United States Environmental Protection Agency (EPA) unearthed that Volkswagen Group intentionally programmed turbocharged direct injection (TDI) diesel engines and as a result activated certain emissions controls only during laboratory emissions testing.

Seemingly, this programming ensured that the vehicles met the US standards required of the nitrogen oxide output during the test but in real sense emitted 40 times more of the nitrogen oxide emission allowed in the United States when driving. The company fitted the cars with a defeat device that detected when the vehicle was under testing. Accordingly, this device or software changed the performance, which resulted in improved outcomes. Apparently, the Volkswagen cars received green car subsidies and tax exemptions in the United States of America because of their low emissions. Moreover, about 11 million Volkswagen cars worldwide including about 500,000 vehicles in the United States of America since 2009 to 2015 had this programming (Ewing, 2015). Therefore, the EPA issued the company with a notice of violating the Clean Air Act.

The fraud led to Volkswagen becoming a target in many countries in relation to regulatory investigations. Moreover, the company lost trust and confidence of the public. Consequently, the value of the stock price of the company fell by a third after the release of the news. Additionally, Martin Winterkorn, the CEO of Volkswagen Group, resigned with the discovery of the scandal while the enterprise suspended other employees. Matthias Mueller who was the former boss of Porsche took over as CEO of Volkswagen Group. Accordingly, Volkswagen planned to spend 18.32 billion dollars to rectify the emissions (Ewing, 2015). As part of their recall campaign, the company also took up the responsibility of refitting the affected vehicles. It is confident that the business's financial status suffered when trying to rectify the mess not forgetting that they had to incur the legal cost from possible illegal actions by the car owners and shareholders. The scandal drew of the regulators' attention to the other carmakers and the possibility of the real-driving pollution that they could be causing.

Conclusion

The accounting information released by companies plays an essential role in its users making the right decisions. However, these experts do not always get the correct data. Companies want to make a profit at all times, and when this does not happen, they seek to find ways to conceal their losses to ensure that the entity remains attractive to stakeholders. While this has helped many businesses to survive for a while, most of these companies never get away with the fraud and they end up suffering enormous losses as the case for Cendant and Volkswagen. Financial statement fraud has seen many businesses lose confidence of the public while some of the companies end up closing down. It is never easy to win back the lost trust.

Therefore, companies should avoid engaging in financial statement fraud if they want to protect their good image. However, financial statement fraud is quite complex. It continues to raise concerns despite receiving considerable attention. Therefore, financial professionals should have the necessary skills to detect manipulations on financial statements. By the same token, auditors have the responsibility of ensuring that users of financial information receive the right information. They must question the numbers when they appear suspicious without fear or intimidation.

References

Ewing, J. (2015). Volkswagen Says 11 Million Cars Worldwide Are Affected in Diesel Deception. The New York Times, 22.Fracarolli Nunes, M., & Lee Park, C. (2016). Caught red-handed: The cost of the Volkswagen Dieselgate. Journal of Global Responsibility, 7(2).Isa, T. (2011). Impacts and losses caused by the fraudulent and manipulated financial information on economic decisions. Review of International Comparative Management, 12(5), 929-939.

Markham, J. W. (2015). A Financial History of the United States: From Enron-Era Scandals to the Subprime Crisis (2004-2006); From the Subprime Crisis to the Great Recession (2006-2009). Routledge.

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