Financial Statement Fraud: Strategies for Detection and Investigation

CHAPTER SIXTEEN

Financial Statement Analysis

USE OF ANALYTICAL TECHNIQUES TO DETECT FRAUD

Financial statement fraud normally leaves a trail that an alert reader can use to detect the fraud. Unfortunately, that trail is often very muddled with immense amounts of information, most of which simply represents legitimate changes in a company's operations. As noted in Chapter 15, for every fraud risk indicator, there is a possible non-fraud explanation.

The challenge for us, then, is to create a reliable set of procedures for detecting fraud in its earliest stages, starting with the use of fraud risk factors but also incorporating other techniques.

One of the most useful techniques for detecting fraudulent financial reporting is financial statement analysis, the subject of this chapter as well as Chapters 17 and 18. While financial statement analysis is also useful in detecting asset misappropriations, the focus here is on its application to detecting financial statement fraud.

HORIZONTAL ANALYSIS

Horizontal analysis involves the comparison of data across multiple time periods. In its most basic application, current results and account balances are compared to those of the prior reporting period. Comparing actual results with budgeted amounts for the same period is another form of horizontal analysis. This analysis should be performed not only for revenues and expenses, but also for asset and liability accounts.

Generally, material variances in current year balances from either prior ...