Financial Statement Fraud: Understating Expenses

One surefire way to increase a company's profits and enhance the financial statements is by not booking expenses as the company incurs them. The manipulation of expenses can be very simple. Management can hold expenses and wait to book them until future periods.

Another option is improperly capitalizing the expenses instead of immediately booking them to the profit and loss statement. For example, one automobile dealership had high advertising expenses. During a period of depressed sales, the owner of the dealership was worried about presenting the real financial results to the auto maker. Therefore, several months’ worth of advertising expenses was capitalized instead of expensed. Not only did the income statement improve immediately, the balance sheet looked better too because current assets were increased by this manipulation.

A company with a large construction project may also utilize this financial statement fraud method rather easily. As buildings and equipment are quickly being added to the balance sheet, it might not be noticed if management moves some expenses into fixed assets. Again, this creates an instant improvement in the company’s financial picture because the balance sheet looks stronger and profits are inflated. The risk of detection of the inflated fixed assets is low.

Companies can also manipulate expenses by not writing down assets such as accounts receivable, inventory, or buildings and equipment to their correct values under the accounting rules. There are many instances when companies should book an expense and create a reserve for an asset with an impaired (decreased) value. It is tempting to ignore this rule, especially because by ignoring it, expenses are kept artificially low.

Finally, companies can reduce their expenses by failing to report sales discounts, returns, and allowances. Failing to account for such items again reduces the company’s expenses. The additional profits created by such a scheme fall right to the bottom line. This is also an area of the financial statements that's often not heavily scrutinized, minimizing the chance of detection.


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