The Gaap are a set of regulations which set standards that properly lead the professional accountants. They place standards on the manner in which records of financial transactions should be made and also the correct financial statements.
The rules are dynamic and ever changing as the political and economic environment changes. The diversity of the GAAP is proportional to the diversity of different countries in the world. However, there are a group of GAAP that are applicable all over the world. A general set of rules which can be compared to the traffic rules. They may be seen as the universal standards for accounting.
The origin of GAAP
The rules cannot be said to have come from one specific origin. There are various sources of these regulations. The first (in no particular order of importance) is from the official pronouncements. This is a document that has authority and is formal in nature. The document is prepared by a body called the (FASB) Financial Accounting Standards Board. The body is the most authoritative standard setting organization. It is independent and obtains its mandate from the Federal Securities and Exchange Commission and also accounting boards accept the FASB as the most influential accounting authority. Those rules made by the body are called SFAS (Statements of Financial Accounting Standards). They specify the manner in which transactions should be recorded (Jones 2011).
Other sources include the FASB technical guides. These guides handle intricate and particular subject matter in the field of accounting. Accounting literature and Industrial practices also serve as a source for the GAAP. They have led to conflicting ideas in the accounting practices since they differ from one group to another. However, they are a source for the GAAP.
There are four main GAAP rules. These are the general rules that govern the GAAPs and include the cost principle, matching principle, reliability principle and revenue recognition principle. The revenue recognition principle makes sure that the accountant makes a record of revenue only once it is earned. The revenue is noted as earned when the seller delivers the required product, the buyer is likely to pay and the expected revenue is measurable. This prevents the wrong practice where businesses report revenues prematurely so as to reflect a high net income. The reliability principle ensures that the information that is input into the accounts is objective, can be supported and has got evidence. These examples of evidence include bank statements, receipts or invoices. In the situations where estimates are required, the accountant should be careful to make a very objective and unbiased conclusion. The cost principle ensures that all the transactions performed are done and records kept reflect the historical cost of the transaction. The matching principle ensures that a business places the expenses incurred side by side with the revenue that the expense generated.
The GAAP operate with the assumption that before their application, the prevailing conditions were basic. There are some modifying limitations in the application of the GAAP. The GAAP do not apply in situations where the items being reported do not influence the decision maker at the strategic and operational level (materiality). In case an accountant is faced with a choice between two methods that satisfy the GAAP, he or she must choose the one that is not favorable. The last is that the cost of coming up with information should not be more than the benefits that users obtain.
THE RED FLAGS
Inflated Lease On Technology Asset
The technology assets which are of various types such as computers, servers, printers, projectors, software programs and copiers, can be leased. However, there are some asset categories that do not fall under the GAAP during their lease. A capital lease does not operate according to the rules that are set by the GAAP concerning the reporting of technology assets. The rate fixed term financing is a financial instrument that is organized in a manner that it has a fixed rate that is organized as a note and security arrangement (Epstein and Saafir 2010). The operating leases are the ones recognized by GAAP in the manner in which they are recognized in the financial documents.
The international financial reporting standards (IFRS) cover the first time adoption of leases under IFRS 1. The principle of full retrospect must be considered. Leases should be reviewed to establish the charges to be put into the financial reports. The management ought to refer to the inception of the lease. According to the IAS 17, a lessee who is under a finance lease should recognize liabilities and assets at the fair value of that leased property. However, if this is lower than the lease, it should be recognized according to the present value of the last lease payments. An operating lease is defined by the IAS 17 paragraph 4. The lease transfers all the risks and rewards that are associated with the ownership of the asset. The lease amounts should recognize risks such as the possible losses emanating from idle capacity or the costs associated with technology becoming obsolete (Epstein and Saafir 2010). The expected rewards include the anticipation of the profitable operation during the economic life of the asset and any gains associated with the appreciation in the value including the presence of a residual value.
The IAAS 17 covers any mandatory disclosures that must be made in the case of a financial lease. These include:
The future sublease payments that happen to be expected on the balance sheet date.
A description of the leasing arrangements.
Any contingent rent considered as an expense for that time.
The IAS 17 requires that the lessees avail all the information concerning operating lease commitments. I t also stipulates that all the disclosures required by IFRS 7 and all other relevant interpretations must be done.
Disclosures under operating leases are guided by the IFRS 17. The payments are considered as expenses incurred during the term of the lease. The SIC 15 lays out the proper procedure that should be followed when recognizing the lease incentives given to the lessee by the leaser to encourage him into entering into the lease. IAS 39 handles the cases of the embedded derivatives which present themselves in a host contract. It stipulates that the embedded derivatives are accounted separately from the host contract.
Understatement Of E-Commerce State Tax Payments
The topic of e-commerce covers a very broad category of accounting practices. There seem not to be very clear GAAP on the matter. In the USA there is selective application of the taxation on e-commerce. The federal internet tax moratorium imposed a 3 year suspension of any internet related taxation (Epstein and Saafir 2010). The suspension bore application to the discriminatory or multiple taxes leveled on the e-commerce. This was supported by a legislation called the internet freedom act moratorium.
Payment Of Post Employment Benefits To False Employees
The FASB statements number five and forty three provide a set of standards that govern the provision of benefits to former employees and employees who are no longer working but are not in retirement. In the statement number forty three, employers must recognize post employees benefits. The estimated amount of payment that the company should record is given by the FASB statement five, accounting for contingencies.
The fraud associated with the presence of ghost employees is well known and in many cases hard to detect due to the big volumes of payroll information which is often processed. The GAAP require the information that is reported in accounting is reliable and truthful. Reporting the post-employment benefits to ghost employees in accounting practice is wrong both ethically and professionally (Jones 2011). The method of reporting used by the accountant in this case goes against the principle of sincerity. The action of recognizing the ghost employees was not in good faith and does not reflect the reality of the financial status of the organization.
Hiding Money To Help Future Earnings
The IFRS 7 emphasizes that disclosures are made in the financial statements. The failure to do so defeats the principle of conformity which demands that the financial reporting must conform to the law. Furthermore, the principle of prudence is violated by this kind of activity because of the fact that the accounts do not show the state of the organization as it is. The reports show a different picture and when the hidden amounts are used in the future accounts they make a false impression of the state of the organization (Epstein and Saafir 2010). They make the accounts more attractive and canvas the losses or reduced profits. The action also goes against the principle of full disclosure which ensures that all the information concerning the business finances should be disclosed.
Hiding Inventory Shrinkage
This is the act of hiding the information concerning the loss of inventory between the purchase and the sale of the finished goods (Jones 2011). Often, this results in the manufacturer incurring more costs out of the manufacture of the products. This goes against the full disclosure principle of accounting. The financial reports should make a clear picture of the company’s situation up to the time in question. The failure to show the shrinking inventory either as a part of the financial statement or as a foot note (depending on the way the company presents its financial information), works against the principle. In case this was done intentionally then fraud takes place.
The regulations and rules are sufficient towards reducing fraudulent activity in organizations. However, the rules do not have the strong backing of proper legislative bodies and policies which can enforce these rules. The rules cover all the possible accounting principles that form the basis for good and truthful accounting. These rules also place a set of standards for the accountants to base their reporting on. However, due to the diversity of business activities rigid rules concerning the manner in which transactions should be reported present a challenge (Jones 2011). The basic transactions have rules as shown in the IAS and IFRS, but the complexity of the business environment often gives lea way for different organizations to make financial accounts in their own way. The accounting principles are clear and the set out the accepted principles which should govern the actions taken by accountants while presenting their reports. Based on these principles proper legislation can be set up depending on the rules governing the different countries which have embraced the GAAP.
CONSEQUENCES OF THE FRAUDULENT ACTIVITIES
The main financial consequence of fraud is the loss of equipment and funds. Often the share prices become affected badly if the extent is great. This often occurs if there are weak internal controls. The reputation of an organization and its management also become negatively affected by fraud. The ability of the organization to deliver services according to the contracts is put under question and the result is loss of the clients and customers in future (Madura 2004). The trust between the employees and management becomes severely damaged and this affects the output of the company. This becomes worse if there have been cases of fraud in the past that have not been followed up. The hiring and keeping of employees then becomes an issue that affects the functions of the organization.
CORRECTION OF THE RED FLAGS
Once the red flags are identified, the first action is to carry out an audit of the firm’s financial statements (Jones 2011). The audit must be followed up with an investigation of who the responsible parties are. The most preferred parties to carry out the audit and investigations are external parties, preferably unbiased and hold no conflicting interests in the organization.
The inflation on the technology lease can be corrected by carrying out the relevant account adjustments or reverse entries. The subsequent adjustments for the false entries should then be accompanied by relevant footnotes relating to the changes made. The adjustments for these entries are best done by the accountants in conjunction with the auditors (Madura 2004). The adjustments made concerning the correction of inflated leases vary depending on the region or country that is applying the GAAP.
The e-commerce state tax correction is still not very clear. The best solution would be to recognize the correct state tax and overstate it for the subsequent accounting periods until the amount understated is covered. The appropriate disclosures in form of footnotes should be made. These adjustments involve the relevant tax company working in conjunction with the accountants of the organization.
The payment of post employment benefits can only be corrected when the collected amounts are recovered. In case this does not happen the amount should be recognized as an expense or a debt gone bad. The proper disclosures must be made (often in the form of footnotes). The corrections for these entries should be made by the accountants in conjunction with the relevant retirement benefits authority and auditors.
The hidden cash should be disclosed and placed in the rightful place in the financial statements. The cash must not be allowed to affect the financial report of the subsequent quarters and analysts should be made aware of such activity in the business through the footnotes. The correction can be made by the accountants in conjunction with the auditors.
The concealed shrinkage inventory should be clearly accounted for in the subsequent reports inclusive of the accrued shrinkage at that time (if any) and the appropriate footnotes recorded. The shrinkage can be expensed as a part of cost of sales depending on the region or country and its accounting practices. The correction can be done by the accountant and the auditors.
INTERNAL CONTROLS TO PREVENT FRAUD
The organization’s strategic management should develop an anti-fraud strategy. It must provide guidance on how to differentiate unacceptable and acceptable practice. It must show when pilfering turns into fraud and when hospitality turns to corruption. The next thing the organization must do is to establish an audit committee (Madura 2004). The functions of this committee will be to establish fraud prevention precautions, launch investigations into reports of fraud and offer the suggested course of action once fraud is discovered.
The organization should also build a culture of fraud prevention and detection. The organization should support the growth of an environment where the detection of fraud is supported and communicated. The clear lack of support for fraud should come from the top management and be followed through with action. In the situation where fraud has taken place there should be clear communication with the concerned authorities in the organization. The offence must be investigated when the report comes through. This also shows the importance of a whistle blowing structure. The employee should have a clear channel to follow when raising the concerns. The employees should not investigate the suspected of fraud themselves. There are acts such as the Public Interest Disclosure Act which protect the employee from sanctions as a result of whistle blowing.
The most important aspect of the internal controls is to have an organized investigation team in place. They should collect any supporting evidence before making a decision to open investigations (Madura 2004). The committee should have a leader (lead officer of investigations), proper records of alleged fraud (times, places, people and dates), come up with course of disciplinary action and carry out analysis of past cases to anticipate future occurrences.
Due to the severity of the consequences of fraud, it is better that every functioning organization has a working anti-fraud policy in place (Madura 2004). The value of having a working structure to combat fraud in an organization ensures long-term success and sustainability of the organization.