Finance and Accounting

Financial statement fraud - reconciliation to the rescue

Amid a rapidly evolving business landscape, one thing that remains constant is the element of fraud. Financial fraud in the business world has many forms; the most difficult to detect, and expensive one being financial statement fraud.

Simply put, financial statement fraud is when businesses attempt to appear more profitable than they are by forging their financial statements. Such fraudulent activities can lead to disastrous implications for potential investors. Fortunately, innovative use of technology can come to the rescue in this scenario to nip emerging financial scams in the bud by implementing thorough fraud detection techniques.

Balance Sheet Account Reconciliation (BSAR) is one of the ways that companies have deployed to guard themselves against the ever-present concern of fraud. With the advent of digital transformation in financial practices, even the reconciliation process can be automated, thereby reducing human intervention and providing the guarantee of impeccable book-keeping.

The Threat of Misreporting

According to a global survey by The Association of Certified Fraud Examiners (ACFE) in 2020, financial statement fraud is the rarest form of fraud, detected in only 10% of cases. When detected, however, fraudulent reporting is the most impactful fraud, with a median loss of $954,000. By contrast, the most prevalent type of fraud, asset misappropriation, accounted for 85% of all cases with a median loss of a mere $100,000.

Inflating revenue, overstating an asset’s net worth, hiding/undermining liabilities or pertinent transactions in official company statements amounts to fraudulent financial reporting. Some potential red flags while detecting such fraud could be anomalies in the account statements, a defined upward trend in profits while competitors struggle to break even, improper accounting practices not in adherence to GAAP (Generally Accepted Accounting Principles), such as not maintaining consistent standards of reporting every financial period, a significant spike in sales in one fiscal year, and poor internal governance. 

Last Line of Defense

Financial fraud is not an everyday occurrence, a company needs to be vigilant in tracking any suspicious activity as soon as it appears in their books of accounts. Organizations need to be proactive in their approach towards detecting any untoward activity and alerting authorities if the need arises. This can be accomplished by structured auditing activities such as BSAR.

BSAR is the last line of defense for companies to ensure the validity of the figures quoted in the financial statements. It plays a crucial role in reducing risks to the company by verifying the accuracy of the balance sheet, comparing documents to corroborate the numbers, and explaining internal or external discrepancies, if any. Accurate tax reporting, ruling out identity fraud, and safety against embezzlement are the other benefits of undertaking BSAR at regular intervals for any organization. Increased reliability due to such reconciliation, in turn, contributes to better business decisions and regulatory compliance. Strict adherence to best practices of business management policies and governance enables organizations to eliminate the risk of fraud. Companies must have defined policies for maintaining books of accounts, categorization of accounts, periodic overview of high-risk accounts and cashflows and undertake book-keeping as per the GAAP to warrant quality and compliance.

While companies strive to implement internal audits to detect reporting red flags, most of these methods remain manual to this day. Bigger the size of the company, the more mammoth the task of manual internal control and auditing becomes. This is where digital transformation steps in to help ensure the sanctity and compliance of a company’s financial statements in a faster and error-free manner.

Automated Reconciliation is the Answer

In today's information-driven business environment, with complex and dynamic business processes and systems, detecting false financial reporting is extremely difficult. Additionally, manual reconciliations may result in erroneous data-keeping, the inefficiency of operations, and duplication of efforts and costs.

The end-to-end automation of BSAR through RPA, AI, and ML has the potential to change the face of reconciliation for organizations. Integration of such a solution with any business ERP system can clear the path for a live transfer of data and autonomous functioning.  Such a tool also has the potential to house the company data on the cloud, making the information accessible to all relevant parties and ensuring transparency. Incorporation of an automated reconciliation solution can thus facilitate identification and resolution of bottlenecks, simplification of operations, optimization of efforts and cost in the long run, and unification of data across systems, complete accuracy and provide a single source of truth to all stakeholders. It allows for standardization of processes as well as supervision and prioritization of key accounts, leading to the delivery of real-time information and analysis, thereby benefiting strategic business decision-making.

Automated BSAR is here to stay and empower enterprises to combat fraudulent reporting and financial manipulation. It holds the future of compliant accounting practices and can bring about a shift from risk-prone to risk-free auditing for businesses.

This article was first published by CFO Dive.

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