1. FINANCIAL STATEMENT FRAUD
16 November 2013

2. About me
• 17+ years in project appraisal, audit, financial due diligence,
financial feasibility, valuation and real estate finance
• 15 years in the Middle east- Oman, Bahrain and now Dubai
• KPMG, Ernst & Young, Nakheel, Gulf Finance House
• Teaching advanced finance and accounting courses since 1996
• Chartered Accountant and a CFA charterholder
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3. Genesis
• Market leader in CFA preparatory courses in the GCC
• Largest prep provider for all levels of CFA in the Lower Gulf
• Diverse product portfolio of Bespoke Training and Executive
Education
• Trained 2,000+ finance professionals till date
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4. THE FRAUD TRIANGLE

5. The “Fraud Triangle”
Incentives or Pressures
Three conditions that
are present when
accounting fraud
occurs
Opportunities
Rationalization
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6. THE HALL OF SHAME

7. Hall of Shame
COMPANY
YEAR
1998
ISSUES
IMPACT (USD)
Inflated revenue
550 Million over
3 years
Treated lease as sales
between 1997-2000
2000
1.5 Billion
1999-2001
Channel stuffing
Restatement of
P&L by 1.5
billion
1998-1999
Inflated revenue by double
counting license fees from
unrecognised portion of
existing contracts& full on
new contracts
500 million

8. Hall of Shame
COMPANY
YEAR
ISSUES
IMPACT(USD)
20002001
Inflated advertising revenue by
booking banner deals & ads it
sold on behalf of others as its
own
NA
2002
Improperly booked construction
cost overruns as revenue before
clients agreed to pay them
NA
2002
Executed round trip deals by
trading subsidiaries to artificially
boost energy trading volume and
revenue
5.2 billion
19992002
Inflated revenues with bogus
accounting entries from
corporate unallocated revenue
accounts
3.3 billion

9. Hall of Shame
COMPANY
YEAR
ISSUES
IMPACT
(USD)
2002
Engaged in network capacity swaps
with other carriers to inflate revenue.
Also, recorded revenue from long term
IRU contracts immediately rather than
over the term of the IRUs.
NA
20012002
Booked higher promotional payments
(provided by suppliers to promote their
goods) than actually received at US
subsidiary FoodService.
1.0 billion
19992002
Recognised revenue from services to
patients by billing Medicare for
reimbursements where patients were
not pre-certified & payment was never
got
2.64 billion

10. 10

11. AN OLYMPIC SCANDAL

12. Olympus
• Major Japanese manufacturer of optical equipment
• FYE 31 March 2011, sales of US$10.589 billion, and total equity of
US$3.281 billion
• Assets of US$13.295 billion
• Employs 40,000 people globally
CEO Michael Woodford suddenly removed from office on 14
Oct 2011, just 2 weeks after promotion
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13. The Firing
“Michael C. Woodford has largely diverted from the rest of the management
team in regard to the management direction and method, and it is now
causing problems for decision making by the management team. Hence,
judging that realisation of the 2010 Corporate Strategic Plan with its slogan of
"Advancing to the Next Stage of Globalisation" would be difficult to achieve
by the management team led by Woodford, all the board directors attending
today, except for Woodford himself who could not participate in the voting
due to special interest, unanimously resolved the dismissal from his office of
the representative director"
— Olympus press release
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14. Mr Woodford
•
•
British born Woodford became COO and President in April 2011
On 1 Oct 2011 he was made CEO. This appointment was very unusual:
 Non Japanese CEO, the first for Olynpus
 Unlikely choice
 25 other potential candidates were ignored
So why was he elevated AND removed suddenly??
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15. History
• In the 1980s, many Jap corporations relied on Investments to boost
profits, as exports fell due to a strong yen
• In 1991 Olympus had to take losses of ¥2.1 billion
• In June 1998, Olympus was subject of rumours of sizeable trading losses
on derivatives
• In Oct 1999, Olympus disclosed that it had lost nearly ¥17 billion from
interest rate and currency swaps
• Olympus lost ¥2.9 billion in the Princeton Economics International Ponzi
scheme
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16. Why the promotion?
• He asked questions on the $ 2.2 billion acquisition of Gyrus
• AXAM (Advisors) were paid $ 687 million, 31% of the value! How?:
 $ 67 million in cash
 Olympus bought back preference shares for $ 620 million
• Olympus paid $965 million when it acquired three "small venture firms“
• It wrote down $ 600 million in 2010 related to acquisitions
• Woodford wrote to the Chairman, copying the Auditors (E & Y)
• Woodford was promoted to CEO to shut him up!
• He was a puppet COO and CEO. The real power was Tsuyoshi Kikukawa,
Chairman
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17. Timeline
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18. Why did this happen?
"Japan's corporate culture of denial, of ignoring problems and letting them
fester, keeps running up against a globalized world that values agility,
innovation and transparency. Olympus demonstrates all too painfully how
much Old Japan tolerates a lack of accountability among senior executives;
inadequate disclosure; a disinclination to challenge authority and absolute
deference to corporate boards regardless of share performance”
- Bloomberg View columnist William Pesek
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19. TRUTH… AND UNTRUTH

20. Satyam Computers : The Rise
•
•
•
•
•
•
•
Annual revenue rose from $ 467 million to USD 2.1 bln
Average Operating Earnings was 21%, a CAGR of 35%
Earnings Per Share rose from $ 0.12 to $ 0.62, a CAGR of 40%
Share price rose from INR 138 to INR 526, a 300% increase
SCL was the first Indian company to publish IFRS financials
SCL won the Golden Peacock award from the World Council for Corporate
Governance for Best Governed Company (2007 and 2008)
Ramalinga Raju was awarded Entrepreneur of the Year by Ernst & Young
(2008)
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21. Satyam Computers: The Fall
•
•
•
•
•
16 Dec 2008: Shareholders oppose takeover of Maytas Properties by SCL.
Stock falls 53% on NYSE
23 Dec 2008: World Bank bars SCL from doing any business due to bribery.
Stock falls 14%
28 Dec 2008: Three Directors quit
7 Jan 2009: Ramalinga Raju resigns and admits fraud
11 Jan 2009: Govt of India steps in and forms a new board
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22. Satyam Computers: The Fraud
Cash
$ 1.04 bln in cash that SCL claimed to own was non existent
Liabilities
Liabilities underreported on the balance sheet
Revenue
Revenue overstated in almost every quarter. Fake customer identities were
created and fake invoices were raised by the SLC Head of Internal Audit to
create revenue
Profit
Profit overstated by showing interest income from fake bank
accounts
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23. Satyam Computers: Red Flags
Financial Red Flags
• $ 1.04 billion in non interest bearing deposits
• Large amount of accrued interest in deposits
• 35% EPS growth over five years
• With $1.2 billion of cash, Satyam closed 2007-08 with $56 million of debt
• Insiders lowered ownership from 17.4% in 2004 to 8.7% in 2008
Non financial Red Flags
• Ramalinga Raju was the Chairman. His brother, Rama Raju, was the CEO
• No audit experts on the Audit Committee
• The Rajus had a history of trying to siphon out funds from SCL companies
• PwC was paid twice what other firms would charge for audit
• Independent directors? Krishna Palepu was Director and
Consultant, earring nearly $ 200K in 2007
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24. The Dirty Dozen
1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
11.
12.
Revenue recognition
Non recurring gain as operating
Understating expenses
Understating depreciation
Deferring expenses
Operating expenses as non operating
Big bath provisions
Cookie jar accounting
Off balance sheet liabilities
Investments- equity accounting
Investments- reclassifications
Fair value accounting
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25. Red Flags!
1.
2.
3.
4.
5.
6.
Increasing Days Sales Outstanding
Increasing sales as % of cash collected
Receivables growing faster than revenues
Revenue growing faster than industry average
Falling ratio of CFO to Net Income
Higher 4th quarter revenue not explained by seasonality
7.
Decrease in provision for bad debts as % of receivables
8.
9.
Decrease in provision for obsolete inventory as % of inventory
Increasing Days Of stock in Hand
10. Sudden increase in Gross Profit or EBIT as % of Sales
11. Depreciation out of line with peers
12. “Mark to model” approach to fair value accounting
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26. Z score model
-
4.840
+ SGI ( Sales Growth Index) X 0.892
+ GMI (Gross Margin Index) X 0.528
+ AQI (Asset Quality Index) X 0.404
+ DSRI ( Days Sales in Receivables Index) X 0.920
+ TATA ( Total Accruals to Total Assets) X 4.679
The red flag is a Z score greater than – 1.99. Enron had a Z score of 0.045 in
its last year
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27. “The truth may be puzzling. It may take some work to
grapple with. It may be counterintuitive. It may
contradict deeply held prejudices. It may not be
consonant with what we desperately want to be true.
But our preferences do not determine what's true.”
― Carl Sagan
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28. Binod Shankar, CFA
+971 50 558 2498
bshankar@genesisreview.com
www.genesisreview.com
Genesis Institute
Dubai | Abu Dhabi
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