Accounting fraud is also called accounting fraud, financial fraud, accounting fraud, or subjective illegality distortion of accounting information. It refers to the illegal behavior that the accounting subject deliberately forms false accounting information or deliberately discloses false accounting information in accounting work.

companies often use various means to falsely report profits for the purpose of completing financial plans, maintaining or raising stock prices, increasing capital and issuing shares, obtaining loans, and maintaining listing qualifications. Common profit manipulation methods include improper accounting of special transactions (such as creditor's rights, debt restructuring, non-monetary transactions, related transactions, etc.), abuse of accounting policies and changes in accounting estimates, incorrect recognition of expenses and liabilities, and asset fraud.

among all kinds of profit manipulation methods, asset fraud occupies a major position. In recent years, most of the financial statement fraud cases that have great influence in China are related to the fraud of asset projects, among which listed companies Qiong Minyuan, Lantian, Dongfang Boiler and Chengdu Hongguang are typical. Fake companies generally use five means to illegally increase the value of assets and inflated profits, namely, fictitious income, false time difference, concealment of liabilities and expenses, false disclosure and fraud in asset pricing. Among them, asset valuation fraud is the usual method of asset fraud. However, due to its wide variety, strong liquidity and diverse pricing methods, inventory overvaluation constitutes the main part of asset pricing fraud. The analysis of it is the focus of this paper.

among Chinese and foreign listed companies, there are many cases involving inventory fraud, among which mckesson & Robbins Company, Swindon Salad Oil Company, Equity Fund, ZZZZ Best Company, Fallmo Company, Hongguang Industrial Company in China and Tianjin Guangxia (Group) Co., Ltd. are famous. The fraudulent schemes planned by these companies have brought great audit risks to certified public accountants. Here, the typical case of Fallmo Company in the United States will be introduced.

Second, the case of Fallmo Company

Since childhood, Mickey Monas likes almost all sports, especially basketball. However, due to the limitation of talent and height, he didn't have the opportunity to play in a professional team. However, Monas does have a characteristic that all top players have, that is, he has an irresistible desire to win.

Monas shifted his endless energy from the court to his chairman's office. He first managed to acquire a pharmacy in Yangtu Town, Ohio, and in the following ten years, he acquired another 299 pharmacies, thus forming a national chain Fallmo Company. Unfortunately, all these glories are based on asset fraud-unchecked inventory overvaluation and false profits, which eventually led to the bankruptcy of Monas and his company. At the same time, it also caused the "Big Five" firms providing audit services to lose millions of dollars. The following is the story of this case:

Since he got the first drugstore, Monas dreamed of developing his small shop into a huge drug empire. The strategy he implemented is what he called "strong buying", that is, selling goods by offering large discounts. The first thing Monas did was to bring the unaudited pharmacy statements that were actually unprofitable and add non-existent inventory and profits to them with his own pen. Then, with his talent for empty talk and a set of exaggerated statements, he defrauded enough investment to buy eight pharmacies within one year, laying the foundation for his small drug empire. The empire later developed to the scale of having 3 chain stores. For a time, Monas became a man of the hour in the financial field, and his company won an admirable position in Yangtu Town.

Monas and his company have been fabricating false profits for ten years when an accidental opportunity led to the surface of this well-designed financial fraud that caused at least 5 million dollars in losses. This is really not an easy task. At that time, the financial director of Fallmo Company thought that the company had incurred serious losses by selling goods at a lower cost, but Monas thought that through "strong purchase", the company could develop sufficiently so that it could successfully adhere to its sales methods. Finally, under the strong pressure of Monas, the CFO was involved in this fraud case. In the following years, he and several of his subordinates kept two sets of account books, one to cope with the audit of certified public accountants and the other to reflect the bad reality.

They first put all the losses into a so-called "bucket account", and then redistributed the amount of this account to hundreds of member pharmacies of the company by inflating inventory. They imitate purchase invoices, make false accounting vouchers to increase inventory and reduce sales costs, confirm purchases without recognizing liabilities at the same time, and count or double the inventory. The reason why the financial department can conceal the shortage of inventory is that the certified public accountants only supervise the inventory of four of the 3 pharmacies, and they will inform Fallmo Company which pharmacies they will inspect several months in advance. Managers then filled the four pharmacies with physical inventory, and distributed those inflated parts to the remaining 296 pharmacies. If accounting fraud is not considered, Fallmo Company is actually on the verge of bankruptcy. In the latest audit, its cash was so short that the supplier threatened to cancel its supply because it failed to pay the purchase price in time.

Certified public accountants have been unable to discover this fraud, and they have paid a high price for it. The audit failure cost the accounting firm $3 million in civil litigation. The CFO was sentenced to 33 months' imprisonment, while Monas himself was sentenced to 5 years' imprisonment.

Third, case analysis: How to identify inventory fraud

Why have certified public accountants failed to find signs of fraud in Fallmo companies? Perhaps, they may trust their customers too much. They read articles about it in the newspaper and saw reports about Monas's hard work on TV, thus paying the price for this deceptive propaganda; They may also perform the audit under the wrong assumption that their clients have no motivation to cheat in accounting statements because they are making a lot of money. Looking back on the whole incident, as long as anyone asks such a basic question, that is, "how can a company that sells goods below cost make money?" Certified public accountants may be able to discover this fraud.

This case has sounded the alarm for us. Inventory audit is so important and complicated that inventory fraud can be detected not only by simple supervision. However, if certified public accountants can find out how these deceptive manipulations are carried out, it will be of great help to discover these frauds, which means that certified public accountants must master the technology of identifying inventory fraud.

(1) Manipulation of inventory value

The determination of inventory value involves two elements: quantity and price. It is often difficult to determine the quantity of existing inventory, because goods are always being bought and sold; Constantly transferred between different storage locations and put into the production process. There may also be problems in the calculation of inventory unit price, because there will inevitably be great differences in the inventory value calculated by FIFO, LIFO, average cost method and other valuation methods. Because of this, the complex inventory account system often becomes an attractive target of fraud.

dishonest enterprises often use the combination of the following methods to falsify inventory: fictitious non-existent inventory, inventory counting manipulation and incorrect inventory capitalization. All these well-designed schemes have the same purpose, that is, inflating the value of inventory.

1. Fictitious inventory

As Monas did, an easy-to-think method to increase the value of inventory assets is to fabricate all kinds of false materials for items that don't actually exist, such as accounting vouchers without original vouchers, exaggerating the quantity of inventory on the inventory list, forging shipment and acceptance reports and false purchase orders, thus inflating the value of inventory. Because it is difficult to identify these forged materials effectively, certified public accountants often need to prove the existence and valuation of inventory through other channels.

2. Inventory control

Certified public accountants rely heavily on the supervision of customers' inventory to obtain audit evidence about inventory. Therefore, it is very important for certified public accountants to carry out and record the inventory test. Unfortunately, in some inventory fraud cases, the audit clients changed the working papers of certified public accountants within a few hours. Therefore, certified public accountants must take adequate measures to ensure the credibility of audit evidence.

for example, suppose that an audit client receives a large quantity of goods five days before the end of the accounting period, and then draws out all relevant acceptance reports and invoices and their copies, and hides them during the audit. Then, during the physical inventory, employees will count these goods and count them into the batch of goods tested by certified public accountants.

obviously, in the above example, the physical inventory will be overvalued, and at the same time, the liabilities of the same amount will be underestimated. For customers, the advantage of this method is that the overvalued amount of inventory will be mixed into the calculation of the whole cost of sales. In this case, certified public accountants need to analyze the proportion or trend to find possible fraud. In addition, you can also check the payment expenditure within a period of time after the end of the accounting period. If the certified public accountant finds that there is any direct payment to the supplier that is not recorded in the purchase journal, he should conduct further investigation.

3. incorrect capitalization of inventory

although there may be improper capitalization in any deposit and loan project, this problem is particularly prominent in finished goods projects. The capitalized parts of finished products are usually sales expenses and management expenses. In order to find these problems, certified public accountants should interview relevant personnel in the production process to obtain information on whether the process of collecting and distributing expenses classified as inventory costs is appropriate. Audit clients can often list many seemingly sufficient reasons to support the process of increasing profits by capitalizing inventory items. This kind of fraud is often carried out by the chief financial officer at the instigation of the president. Therefore, in the formal interview with key people, if they are suspected of being instructed to exaggerate the information about inventory, certified public accountants should adopt a straightforward way to force them to tell the truth with a reproachful attitude.

(II) Limitations of inventory

The most effective way to confirm the inventory quantity is to make an overall inventory. Certified public accountants must arrange the inventory procedures reasonably and carefully and implement them carefully. The inventory time should be as close as possible to the year-end closing date. Measures should be taken as far as possible to improve the effectiveness of inventory, such as simultaneous inventory at all storage points, stopping inventory flow and reaching a reasonable proportion of inventory. However, even if certified public accountants carefully implement this procedure, there is no guarantee that all major frauds will be discovered. This is because there are the following limitations in the inventory counting test:

(1) The management authorities often send representatives to follow the certified public accountants, on the one hand, they record the test results, and at the same time, they can grasp the location and progress of the test. In this way, audit customers have the opportunity to add fictitious inventory to untested projects, thus wrongly increasing the overall value of inventory.

(2) When carrying out the inventory test procedure, the certified public accountant will generally inform the customer of the time and place of the test in advance so that they can make preparations before the inventory. However, for companies with multiple storage locations, this kind of advance notice gives the management an opportunity to hide the shortage of inventory in those storage locations that the CPA has not checked.

(3) Sometimes CPAs do not perform additional audit procedures to further check the sealed packing boxes. In this way, in order to overstate the inventory, the management will fill the warehouse with empty boxes.

(III) Identifying possible inventory fraud through analysis procedures

Since all major fraud can't be found by supervision, certified public accountants must implement analysis procedures.

a dishonest customer can manipulate inventory information in many ways. Certified public accountants must look at those data from a variety of thinking angles in order to find the relevant fraud as much as possible. It is necessary to speculate not only on how fraud is conducted, but also on why customers cheat and why customers take this illegal practice as their first choice. That is to say, certified public accountants should evaluate the motives and opportunities of major inventory fraud by management authorities in order to find asset fraud.

1. Motivation of the management for fraud

There are various motivations of customers for fraud, and it will be helpful to find possible fraud by analyzing them and considering them during the audit. The following are some common reasons that lead to the fraudulent impulse of management:

(1) The client company is facing financial difficulties.

(2) The customer management authorities are under pressure to complete the financial plan.

(3) Inventory is an important item in the balance sheet.

(4) There is pressure on supply as defined in the contract.

(5) The client company attempts to obtain financing secured by deposit and loan.

(6) The management authorities are faced with pressure from the capital market, such as falling stock price and the risk of delisting or acquisition of the company.

2. Opportunities for fraud by the management

Not all companies can inflate their profits by falsifying their inventories and hide from the accounting procedures of certified public accountants. In fact, for some companies, such as those with small scale and simple business, it is very difficult to cheat the certified public accountants and cheat on the inventory. However, the possibility of inventory fraud by management authorities will increase under the following circumstances:

(1) The customer company is a manufacturing enterprise, or it has a complex system to determine the inventory value.

(2) The client company is involved in high-tech or other rapidly changing industries.

(3) The customer company has many storage locations for inventory.

3. Signs of management fraud

Fictitious assets will make the company's accounts out of balance. Compared with the previous period, the cost of sales will be too low, while the inventory and profit will be too high. Of course, there may be other signs. When evaluating the risk of overvaluation of deposits and issuance, certified public accountants should answer the following questions. The more "yes" answers, the higher the risk of inventory fraud.

(1) Is the growth of inventory faster than the growth of sales revenue?

(2) Is the percentage of inventory in total assets increasing year by year?

(3) Does the inventory turnover rate decrease year by year?

(4) Has the proportion of transportation cost in inventory cost decreased?

(5) Is the growth of inventory faster than that of total assets?

(6) Is the percentage of sales cost in sales revenue decreasing year by year?

(7) Does the account book record of sales cost conflict with the tax report?

(8) Are there any major adjustment entries to increase the inventory balance?

(9) after the end of an accounting period, have you found any important reversal entries that have been posted into the inventory account?

IV. Enlightenment and lessons for CPA industry

Inventory items have long been an ideal object for fraudsters because of their own complexity, and have also attracted special attention of CPA. Since the audit case of the famous American Macpherson Robbins medicinal materials company occurred in 1938, the American Institute of Certified Public Accountants has listed inventory counting as one of the important procedures that must be carried out in the company audit. However, due to the limited existence of the audit bureau, registration