Balance sheet manipulations have made quite an impact in the media in recent years with cases like Enron and WorldCom. But, beyond that, there has been a series of inconsistencies in the more recent past that have affected almost every industry. Recent cases include the Serie A in Italy, where two clubs are currently threatened with forced relegation to the second division. In addition to this, the trials of the ex-Monte-Paschi chief Fabrizio Viola and the Bawag trial, in which 9 people already stand accused, are eagerly awaited. We have taken these latest cases as an opportunity to provide an insight into possible balance sheet manipulations and will present further cases as examples next week.
In contrast to balance sheet cosmetics, balance sheet manipulation is a deliberate and fully intentional misrepresentation of the annual financial statements and/or management report and is thus a criminal offence. Although balance sheet manipulation only accounts for a relatively small proportion of all types of white-collar crime, the average amount of damage caused by the falsification of annual financial statements standing at a figure of over € 200 million is more than considerable![1]
What is also striking is the correlation between the financial damage to the company and the hierarchical level of the perpetrator. Damage caused by corporate governance offences is up to 13 times higher than that caused by employees in non-executive positions. [2]
The following are typical features found in previous cases of incorrect accounting
When assets are capitalized
- Overvaluation of assets due to failure to carry out legally-required depreciation and amortization
- Capitalization of internally-generated intangible assets without meeting the criteria for capitalization
- Capitalization of repairs as production costs instead of recognition as maintenance costs
- Capitalization of leased assets
- Disclosure of non-existent machines or inventories
- Double entry of inventories
- Disclosure of non-existent finished products
- Failure to adjust non-valuable receivables
- Disclosure of fictitious bank balances
In provisions and liabilities:
- Failure to establish a provision despite statutory obligation
- Non-recognition of impending losses from pending transactions as a provision in the German Commercial Code
- Non-recording of existing liabilities and bank loans
- Violation of the ban on netting
- Misuse of sale-and-leaseback contracts through sale of fictitious assets
Fictitious sales revenues, e.g.:
- Disclosure of fictitious transactions with fictitious business partners
- Bringing forward of future sales revenues and thus a violation of the completed contract method
- Recognition of capital contributions by shareholders as sales revenue
- Triangular transactions through reciprocal rental agreements, in which both sales revenues and additional rental expenses are posted
- Recognition of transitory amounts as own sales revenue
In expenses:
- Salaries paid to notional or former employees
- Pension payments in the name of deceased former employees
- Netting of expenses and income despite what is referred to as the ban on netting
- Cancellation of fictitious sales with fictitious business partners by reporting other operating expenses instead of a reduction in sales revenue
- Write-off of a receivable and receipt of payment on a private bank account
- According to the balance sheets, more products are sold than the market demands.
German Sources:
[1] See KPMG, Wirtschaftskriminalität in Deutschland – Fokus Mittelstand, Cologne 2010, pp. 8-9, available at: http://www.kpmg.de/docs/20091220_Economic_crime.pdf (as at 8/4/2010).
[2] See ACFE, Report to the Nation On Occupational Fraud and Abuse, Austin 2006, p. 5, available at: www.acfe.com/documents/2006-rttn.pdf (as at 20/5/2011).
