False Accounting

False accounting fraud refers to the illegal activities, manipulation, or misappropriation performed in the accounting records of the organization. It is typically observed in companies where the assets, liabilities, income, and expenses are overrated or underrated. The sole purpose of this fraud is to represent a business much stronger than it actually is. 

In most cases, employees or management commit to showcasing a more favorable image of the company. Moreover, reporting such fraud is illegal in many countries. It is a statutory offense in the United Kingdom, the United States, Australia, Northern Ireland, and the Republic of Ireland. 

False accounting is a common type of fraud occurring in organizations where the financial statements are wrongly stated. It aims to deceive the company's stakeholders and prevent capital from leaving reserves. This fraud creates a fake or false representation of the company's accounts. As a result, the market valuation also turns out to be manipulated. 

The popular laws that govern reporting false accounting fraud include the Theft Act of 1968. Section 17 of this act creates liability against such individuals and seizes the organization’s assets. Also, it leads to penalties and charges for such offenses. Likewise, in the United States, laws such as the Sarbanes Act, 26 U.S. Code Section 7204, 7206, 18 U.S. Code Section 3301, and others address such fraudulent accounting practices. However, such reporting can occur due to various reasons. 

Various instances can cause such practices to occur in an organization. Some major factors include gaining financial assistance from banks and investors or inflating the share price of the company stock. Unless the company does not have a profitable business, gaining capital is not feasible. In that case, employees or organizations try to manipulate the existing financial records for better good. However, in the long run, it runs the company’s reputation and goodwill. Additionally, it causes an uneven rise in the stock price, which is unjustifiable to the company's valuation. Other notable reasons for this fraud include hiding losses from stakeholders, attracting new customers, or covering theft.

There are specific false accounting sentencing guidelines outlined in the legislature. It explains the conditions and terms where such fraud can occur. Let us look at the basic elements of the False Accounting Theft Act: 

• The account or accounting record may be concealed, destroyed, falsified, or even defaced.
• These individuals may knowingly produce, record, or make use of any account in a way that may be false in its original nature. It may be false, deceptive, and misleading in a particular way to others.
• Furthermore, omitting material from any document or account is also treated as falsifying the accounts or other documents.

Let us look at some examples for a better understanding of this concept: 

Example #1 

Suppose John is a sales associate working in Polin Ltd for more than three years. Until now, the business has prospered from small to large market capitalization. They also hold a substantial number of investors with substantial shareholding in the company. 

However, suspicions arose as John noticed discrepancies within the company's operations. Despite presenting positive results to the press over three years, the company was running into losses, and the management was well aware of this situation. 

At the same time, they were also gaining capital for the company. Yet, the financial records did not record any losses. As a result, John decided to reveal the wrongdoings in the company. John took on the role of a whistleblower, and the chief sales officer and directors were penalized for it. Also, the company's assets were seized as a result of this fraud.

Example #2

According to a news update as of April 2024, Aurelio de Laurentiis, the CEO of Napoli (the Italian professional football club), heard from the prosecutor in the false accounting case. This fraud started with the entry of striker Victor Osimhen to Napoli from Lille. Osimhen is also regarded as a significant suspect in the case. Additionally, Partenopei had offered cash plus four players in this deal. Along with him, Serie A giants had attempted to inflate the players' value until it reached the asked price. 

Certain penalties are imposed on those found guilty in such cases. Let us look at them:

• The United States: In the U.S., the New York State Society of CPAs has explained the legal implications and charges to persons found guilty in this case. As per the Sarbanes-Oxley Act, the CEO has an imprisonment of 10 years, along with a fine of $1,00,000,000. Likewise, in the 26 U.S. Code § 7206, individuals may face imprisonment of up to 3 years and fines ranging from $100,000 to $500,000 (in the case of a corporation). 
• The United Kingdom: As per the Theft Act, the guilty person may face imprisonment of a minimum of six months to a maximum of two years. It includes an unlimited fine depending on the severity of the offense.
• Australia: In Australia, the charge goes up to $945,000, or three times the value of benefits obtained from this fraud. Also, they may face an imprisonment of 10 years. 

Organizations can employ certain measures through which the frequency of these frauds can be reduced to a major extent. Some of the preventive measures are discussed below:

• Firms can develop a strong, robust internal control system that monitors internal activities. It helps them supervise each department, especially within the accounting team, to determine the financial data is not hampered at any cost.
• Limited access to financial records also reduces the chances of false accounting fraud. It restricts unknown parties from managing and altering the firm's confidential data. Further, it helps in preventing occupational fraud in the later stages.
• A reporting system and a team of well-equipped auditors can contribute to creating healthy financial records. Conducting quarterly or frequent audits can reduce the occurrence of tampered data in the company's financial statements.
• Organizations can deploy a whistleblower policy to report any wrongdoings in the firm.