using data analytics to detect fraud · the financial statements. types of financial statement...

© 2018 Association of Certified Fraud Examiners, Inc.

Using Data Analytics to

Detect Fraud

Data Analysis Tests for Detecting

Financial Statement Fraud

© 2018 Association of Certified Fraud Examiners, Inc. 2 of 27

Financial Statement Fraud Schemes

▪ The fraudster

intentionally

misstates or omits

financial statement

amounts or

disclosures to

deceive users of the

financial statements.



▪ Typically involve:

• Falsifying, altering, or manipulating financial

records, supporting documents, or business

transactions

• Recording fictitious transactions or transactions

that lack economic substance

• Intentionally omitting or misrepresenting

information about transactions or events

• Intentionally misapplying generally accepted

accounting principles (GAAP)



▪ Overstatement of revenue

▪ Overstatement of assets

▪ Understatement of expenses

▪ Understatement of liabilities

▪ Improper disclosures


Red Flags of Financial

Statement Fraud Schemes

▪ Anomalies in profitability

▪ Anomalies in cash flows

▪ Anomalies in assets

▪ Anomalies in liabilities

▪ Anomalies in equity accounts

▪ Anomalies in relationships between financial

statement items


Red Flags of Financial


▪ Anomalies in significant transactions

▪ Anomalies in journal entries

▪ Anomalies in account balances

▪ Anomalies in business structure or operations

▪ Changes in industry, regulatory environment, or

other external risk factors


Tests for Financial Statement

Fraud Schemes

▪ Financial statement analyses identify

changes, trends, and significant accounts on

the financial statements.

▪ Types of financial statement analysis:

• Horizontal analysis

• Vertical analysis

• Ratio analysis


Horizontal Analysis

▪ Analyzes percentage change in individual

financial statement items from one period to

the next

▪ Can be performed on companywide data or

on segregated data (e.g., by department or

location)

▪ Watch items that should move in tandem:

• Sales and warranty liability

• Sales and cost of goods sold

• Purchases and payables to cash paid to vendors


Horizontal Analysis—Balance Sheet

20X3 20X2 Change 20X1 Change

Assets

Current assets

Cash and cash equivalents $27,491 $3,506 684.10% $1,686 107.95%

Accounts receivables, net $33,054 $16,085 105.50% $8,475 89.79%

Prepaid expenses and other current

assets$2,198 $1,435 53.20% $395 263.29%

Deferred tax assets, net $716 — —

Total current assets $63,459 $21,026 201.80% $10,556 99.19%

Property and equipment, net $13,773 $6,891 99.90% $2,197 213.65%

Long-term accounts receivables $2,700 — —

Deposits and other assets $2,757 $2,148 28.40% $251 755.78%

Total assets $82,689 $30,065 175.00% $13,004 131.20%


Horizontal Analysis—Balance Sheet20X3 20X2 Change 20X1 Change

Liabilities and shareholders’ equity

Current liabilities

Accounts payable and accrued

expenses$11,904 $9,636 23.50% $2,811 242.80%

Accrued compensations and employee

benefits$7,356 $3,633 102.50% $1,748 107.84%

Deferred revenue $10,732 $8,340 28.70% $5,120 62.89%

Line-of-credit — $4,508 -100.00% $2,758 63.45%

Notes payable, current portion — $900 -100.00% $356 152.81%

Dividend notes payable $5,000

Total current liabilities $34,992 $27,017 29.50% $12,793 111.19%

Notes payable, long-term portion — $2,428 $460 427.83%

Deferred revenue $746 $1,047 -28.70% $544 92.46%

Deferred tax liabilities, net $671 — —

Total liabilities $36,409 $30,492 19.40% $13,797 121.00%

Total shareholders’ equity (deficit) $46,280 ($427) -10938.40% ($793) -46.15%

Total liabilities and shareholders’ equity $82,689 $30,065 175.00% $13,004 131.20%


Horizontal Analysis—Income Statement

20X3 20X2 Change 20X1 Change

Total revenues $106,430 $53,557 98.7% $22,603 136.9%

Total cost of goods sold $19,781 $11,116 78.0% $5,257 111.5%

Gross margin $86,649 $42,441 104.2% $17,346 144.7%

Operating expenses

Sales and marketing $53,408 $30,468 75.3% $13,054 133.4%

Research and development $12,106 $5,049 139.8% $2,840 77.8%

General and administrative $11,809 $6,552 80.2% $3,742 75.1%

Total operating expenses $77,323 $42,069 83.8% $19,636 114.2%

Income (loss) from operations $9,326 $372 2407.0% ($2,290) (116.2)%

Provision for income taxes ($3,442) — —

Net income (loss) $6,178 $121 5005.8% ($2,375) (105.1)%


Vertical Analysis

▪ Analyzes the relationships among the items

on an income statement, balance sheet, or

statement of cash flows by expressing

components as percentages

▪ Highlights which accounts are the biggest

drivers of company performance


Vertical Analysis—Balance Sheet

20X3 20X2 20X1

Assets

Current assets

Cash and cash equivalents 33.25% 11.66% 12.97%

Accounts receivables, net 39.97% 53.50% 65.17%

Prepaid expenses and other current

assets2.66% 4.77% 3.04%

Deferred tax assets, net 0.87% — —

Total current assets 76.74% 69.94% 81.18%

Property and equipment, net 16.66% 22.92% 16.89%

Long-term accounts receivables 3.27% — —

Deposits and other assets 3.33% 7.14% 1.93%

Total assets 100.00% 100.00% 100.00%


Vertical Analysis—Balance Sheet20X3 20X2 20X1

Liabilities and shareholders’ equity

Current liabilities

Accounts payable and accrued expenses 14.40% 32.05% 21.62%

Accrued compensations and employee benefits 8.9% 12.08% 13.44%

Deferred revenue 12.98% 27.74% 39.37%

Line-of-credit — 14.99% 21.21%

Notes payable, current portion — 2.99% 2.74%

Dividend notes payable 6.05% — —

Total current liabilities 42.32% 89.86% 98.38%

Notes payable, long-term portion 8.08% 3.54%

Deferred revenue 0.90% 3.48% 4.18%

Deferred tax liabilities, net 0.81% — —

Total liabilities 44.03% 101.42% 106.10%

Total shareholders’ equity (deficit) 55.97% (1.42)% (6.10)%

Total liabilities and shareholders’ equity 100.00% 100.00% 100.00%


Vertical Analysis—Income Statement

20X3 20X2 20X1

Revenues 100.00% 100.00% 100.00%

Total cost of goods sold 18.59% 20.76% 23.26%

Gross margin 81.41% 79.24% 76.74%

Operating expenses

Sales and marketing 50.18% 56.89% 57.75%

Research and development 11.37% 9.43% 12.56%

General and administrative 11.10% 12.23% 16.56%

Total operating expenses 72.65% 78.55% 86.87%

Income (loss) from operations 8.76% 0.69% (10.13)%

Provision for income taxes (3.23)% — —

Net income (loss) 5.80% 0.23% (10.51)%


Ratio Analysis

▪ Means of measuring the relationship

between two different financial statement

amounts:

• Accounts receivable turnover

• Sales to total assets

• Related-party sales to total assets

• Working capital to total assets

• Leverage ratios

• Ratios involving nonfinancial data


Other Tests for Financial


▪ Tests to identify

anomalies in:

• Journal entries

• Account balances


Robert Gunning’s Fog Index

▪ Analyzes notes to financial statements

▪ Measures readability of a sample of writing

▪ Uses index comparisons to identify

significant changes in readability


Gunning’s Fog Index

▪ Compare the Fog Index score of a particular

note in a particular period to that of a similar

note:

• In a different period

• Of a similar company

▪ Compare the Fog Index score of all the notes

combined in a particular period to that of all

of the notes combined:

• In a different period

• Of a similar company

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