Financial Statement Fraud Detection and Investigation in Digital Environment

Financial Statement Fraud Detection and Investigation in Digital Environment

Radiah Othman (Massey University, New Zealand)
Copyright: © 2020 |Pages: 28
DOI: 10.4018/978-1-7998-1558-7.ch011


This chapter discusses some of the stages involved in detecting and investigating financial statement fraud in the digital environment. It emphasizes the human element aspects – the fraudster and the forensic investigator, their skills and capability. The explanation focuses specifically on the context of financial statement fraud detection and investigation which requires the accounting knowledge of the investigator. It also highlights the importance of the investigator to be a skeptic and have an inquiring mind of who had the opportunity to perpetuate the fraud, how the fraud could have been perpetrated, and the motive(s) to do so.
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The emergence of the Internet as a tool for global information exchange, accounting information systems, and the information they store and the process will increasingly fall victim to computer crime and fraud (Hurt, 2016, p. 197). Fraud is a deception that includes a representation about a material point that is false and intentionally or recklessly so, which is believed and acted upon by the victims to the victim's detriment (Albrecht, Albrecht, Albrecht, & Zimbelman, 2019). The essential characteristics of financial statement fraud are: 1) the misstatement is material and intentional, and 2) users of the financial statements have been misled. Often, the victims do not have access to information possessed by the perpetrators.

Financial statement fraud can be perpetrated by the management (e.g. earnings manipulation) or by the employees (e.g. billing fraud). The misstatement and misrepresentation can result from manipulating, falsifying, or altering accounting records in the accounting information systems. It is the most expensive type of fraud (Albrecht et al., 2019). Like any other fraud, this fraud involves intentional deceits and attempted concealment, so it is difficult to detect or takes a long time to investigate (Albrecht et al., 2019).

In investigating a fraud case, the investigators should incorporate qualities of skepticism, curiosity, and humility, and mix them with a deep understanding of human behavior and principles of fair play and forensic mindset (Schilit, Perler, & Engelhart, 2018, p. 287). Schilit et al., (2018) advise keeping the focus on key issues in investigating financial statement fraud. Figure 1 outlines some of the critical aspects that a forensic investigator needs to be aware of in investigating a fraud case.

Figure 1.

Applying the forensic approach here


Information technology (IT) is a double-edged sword in that it can be used to commit financial statement fraud, though IT can also be used to detect it by using computer forensics applications.

Computer forensics is the application of computer investigation and analysis techniques to determine perpetrated schemes and potential evidence (Taylor, Haggerty, Gresty & Lamb, 2011). In investigating financial statement fraud, forensic investigator’s knowledge in accounting and information systems would be valuable (Huang, Lin, Chiu & Yen, 2016). In a digital environment, the investigator would emphasize electronic evidence in the absence of physical evidence (Solieri & Hodowanitz, 2016). However, interaction with the affected people such as interviews with witnesses, conspirators, and the suspects requires the investigator to have both computer and human-related skills. Financial statement fraud using a computer is people fraud as no computer system can perpetrate fraud without at least some human intervention (Hurt, 2016, p. 198).

According to (Kranacher, Riley, and Wells, 2019), investigations centered on the elements of fraud (act, concealment, and conversion) that include an indication of the fraud triangle have the greatest chances of being successful if grounded in the evidence. The well-known fraud triangle theory states that individual or group conducting fraud is motivated by pressure, opportunity, and rationalization. (Wolfe and Hermanson, 2004) introduce the fraud diamond theory, in which they includedthe capability element of the fraudster which is a trait that drives individuals to seek an opportunity and exploit such opportunities. Nonetheless, the need to understand the motives for the perpetration is paramount to any fraud investigation. The motives explain the reasons and if the investigator would be able to predict the motives and be supplemented with the evidence from the fraud detection process, he or she would be able to anticipate which accounts would be manipulated and what type of fraudhadpossibly beencommitted.

Key Terms in this Chapter

Digital Environment: An environment in which computer and other technological apparatus and systems are used to prepare and produce financial statements.

Control: Mechanism established to prevent or minimize error or fraud.

Conceal: Way in which the alleged fraudsters hide their fraudulent action.

Investigation: A systematic process of investigating an alleged fraud.

Fraud Diamond Theory: An extension of the fraud triangle theory to include the capability element of the fraudster.

Fraud: An action perpetrated with intent to the detriment of the victim(s).

Fraud Triangle Theory: A theory that explains the elements of fraud perpetration, that is, pressure (motive), opportunity, and rationalization.

Financial Statements: The statements required to be produced at the end of the accounting period which includes balance sheet, income statement, and cash flow statement.

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