Question

How are financial statements relevant to capital markets? How do these frauds occur and remain concealed? How should you assess financial statement fraud risk?

Answer 1

As the time passes the size of operations and volume of business entities is growing very fast. But the basic requirement for doing business is investment, Investors and financiers are the main sources of funds. It is natural that the proposed investors and existing investors including other stakeholders are interested in knowing the profitability of the company and its financial position to assess the paying back ability of the company. Financial statements helps the investors to assess the financial position, financial performance and cash flow generating ability of the company in a broader perspective. It is the formal mode of communicating the financial results of the company to various stakeholders.

It is the responsibility of the management to show the correct financial position and performance of the company through the financial statements. The importance of financial statements in capital markets the concept of audit also came into existence so as to deliver the true and fair view of the financial statements by an independent third party called auditor.

Though the financial statements are audited by an independent auditor, still there are some instances where frauds are happening and material frauds are concealed. these are happening as mentioned below (not an exclusive list):

1. Dishonest management with an intention make money out of unprofessional ways.

2. Dishonest employees who wants to gain personal benefits out of company.

3. Competition in the industry compelling the management to overstate the performance.

4. collusion of auditor with management.

5. Undue pressure on the management to conceal the facts. etc.,

There should be proper controls and procedures to identify the frauds. The financial statement fraud risk should be assessed from the unnatural growth in the performance as compared to the previous periods, Key personnel leaving the company, Litigation against the company, huge gap between the industry performance and the company's performance, Non compliance with laws and regulations etc.,