Preventing Fraudulent in Financial Reporting by

Maintaining Auditor’s Profesionalism

Eden Zarista
Audit Board of The Republic Indonesia
Province of Bangka Belitung

ABSTRACT
By history there are two types of timeless crimes, prostitution and fraudulence. Those two
crimes occur almost in each country by hitting every sector, both public or private sectors and
academicians . ACFE (Associated of Certified Fraud Examiner) declared that there are three
types of fraudulance, first is corruption, seconds is asset missapropriation and the last is
financial statement fraud. Financial statement fraud, per se, is phenomenon that exist over the
past few decades. This is that happened to Enron scandal in United States by Arthur Andersen,
Satyam India by PwC (PricewaterhouseCoopers) and recently Telecom Scandal by EY (Ernst
and Young) in Indonesia. Third scandal mentioned before shows that companies related has
manipulated their financial report by overstating aset or revenue, and concealing liabilities.
That scandals can not be catched due to audit failured. As impact, the public accounting firms
which are enggaged to those clients are fined million dollars by PCAOB (Public Company
Accounting Oversight Board). The stock price of those companies drop significantly due to
scandal issues. Brokers and investors suffered big loss. Audit failure happened as Auditor
missed lack on audit procedure. This paper aims at elaborating the importance of maintaning
Auditor’s professionalism in assuring the financial report with unqualified opinion so that
Audited financial reporting are usefull for the users (relevant) and its showed the real condition
of the companies (reliable).

Keywords: Financial Statement Fraud, Scandal, Auditor, Commitment, Professional

INTRODUCTION
Worlwide nowadays is developing concern over fraudulence. Year by year fraudulence is
growing rapid in several country and increasing to many symptoms. Fraudulence now play a
more central role in politics that at any other time. Both government as public sector and private
sector are loosing society trust, reputations falling of as people can clearly look for the
information about them through boundless social media. ACFE define fraud as any kind of
crime for gain that uses deception as it principal modus operandus. Black’s law dictionary
explain fraud as a knowing misrepresentation of the truth or concelament of a material fact
induce another to act to his or her detriment1.

ACFE elaborate more about what is causing of fraud into fraud triangle fraud scheme, they are
pressure, opportunity, and rationalization. This three reason is the answer why people commit
fraud. Pressure is one of causes that a man does fraud. Pressure can be formed of anything,

1
Bryan Garner, ed., Black’s Law Dictionary. 8th Ed. (2004), s.v., “fraud.”
mostly the pressure comes from of economic side. Other causes of fraud is opportunity,
whenever there is a chance, a man is able to used his power of his position to do fraud. An
employee usually will not expect that there is an opportunity to do fraud unless there is a low
chance to be caught. The last is rationalization, its happened when fraud is being common
thing, fraud is done for reasonable reason, so that everyone did fraud, then fraud is acceptable.
It seems like a condition where fraud being a culture from previous continued to the next
generation.
Figure 1.1
Fraud Triangle by ACFE

Resources: www.acfe.com

ACFE divided type of fraud into three types. First is corruption, second is asset
missapropriation and the third is financial statement fraud.

A. Corruption
The definition of corruption is illegal or dishonest behavior by people in official positions,
(mostly like misused power), the economists largely view corruption as a sand in the gear
of the economy, political scientists view it as the grease in that gear2. Corruption can be in
the form of conflict of interest, bribery, illegal gratuities and economic extortion.This
greater recognition that corruption can have a serious adverse impact on development has
been a cause for concern among developing countries. In a recent survey of 150 high level
officials from 60 third world countries, the respondents ranked public sector corruption as
the most severe obstacle confronting their development process (Gray and Kaufmann
1998).
There is an interesting story of corruption in the type of bribery. The falling great wall
during Qing Dynasty 1800 to 1910 by monggol is beacuse of bribery. Genghis Khan who
is the leader of mongol was alleged said that the strength of a wall depends on the courage
of those who defend it3 or often called bribing offical and guards of the great wall. Then
soon, the Mongols completed their takeover, becoming the first but not last non-Chinese
group to rule the whole of China.

B. Asset Missapropriation
Asset misappropriation schemes include those frauds in which a perpetrator employs
trickery or deceit to steal or misuse an organization’s resources. Mostly asset

2
Dr Ahmad. M Mashal, International Journal of Economics and Mangement Science. Vol.1 No 4.
(2011), JEMS, “ Corruption and Resource Allocation Distortion for “ESCWA” Countries.”
3
Ala-Ad-Din ‘Ata-Malik Juvaini. Manchester University Press. Unesco Publishing (1997). Genghis
Khan The HistoryOf The World Conqueror
 missapropriation is in the form of cash theft however ACFE describe asset
missapropriation into two group which are cash, and inventory and all other assets. ACFE
elaborate more the cash types into theft of cash on hand, theft of cash receipts (skimming
and lacerny) and fraudulent disbursement. Meanwhile inventory and all other assets are
consist of misuse and lacerny.

C. Financial Statement Fraud.

Financial statement fraud is a fraud which deliberating misstatement, misrepresentation,
or omission of financial statement information for the purpose of misleading the users and
creating a false impression of an organization's financial condition. Public and private
businesses commit financial statement fraud to secure users things such as investor interest
or obtain bank approvals for debt. Another aims is for bonuses or increased salaries or to
meet expectations of shareholders. Gail D Moore in his research about “Fraud, Collusion
and the Financial Statements A Refresher for Practicing Professional” said that upper
management is usually at the center of financial statement fraud because financial
statements are created at the management level.

ACFE divided financial statement fraud into two types. First is asset or revenue
overstatement by window dressing the financial report by manipulating timing difference
of revenue (accruing revenue inprorper year), fictitious revenues, concealed liabilities and
expenses, inproper asset valuation and inproper disclosure. Second is asset or revenue
understatement such as timing differences, understated revenues (usually for taxes
purposes), overstated liabilities and expenses and inproper asset valuation.

The last types of fraud which is Financial statement fraud is considered as an expensive and
common in private sectors as it has many users like investor, shareholder, tax officer, broker
and etc. According to the ACFE, the average loss due to financial statement fraud is over a
million dollars. Due to its nature, financial statement fraud is conducted by one or more persons
in top level management.

FINANCIAL STATEMENT FRAUD - SCANDAL

Financial statement fraud, per se, is phenomenon that exist over the past few decades. This is
that happened to Enron scandal in United States by Arthur Andersen, Satyam India by
PricewaterhouseCoopers and recently Telecom Scandal by Ernst and Young in Indonesia.

Enron and Arthur Enderson Scandal

Enron which is an American corporation is running the business in a power plant and
electricity industry. Firstly this corporation is just only a common corporation but later on
Enron expand its business through diversification in many type of industries such as
commodity trading, future transaction and many others. Then not longer than it expansion,
Enron is becoming a well-known corporation which having a high price of stock in each
par. The increasing value of the firm in Enron’s corporation is so fast that creating a
question how could it be that fast, it’s because of the expansion or there is something which
producing the incremental. By the time go on finally our curiosity is answered by the
bankruptcy and the collapse of Enron in year 2001. That news is totally had make capital
market in America struggled and create an economic shock to worldwide.

Many observers try to seek about what actually happened to Enron. They explore how the
incremental of stock price is quickly increasing. Then they found that there is something
wrong to Enron’s financial report especially to their statement of financial position. The
result shows us that Enron is hiding their receivable through their stock equity. An article
from Intermediate Accounting by Kieso, it is told us that Enron reported the stock in equity
side and the receivable as the factor that increase Enron’s asset. Then of course what Enron
has been done would drive the increasing of Enron’s value right (which causing the stock
price higher than previous).

Equity is a representation of company‘s owner which shown in stock. Equity is the portion
of company’s ownership (the amount capital). While receivable is someone’s debt to our
operating or financing activity such as sales or others, It is categorized as asset to us cause
in the future after the collection the receivable will give us certain amount of cash. Then it
is confusing when our equity is coming from the receivable.

Arthur Endersen is the public accounting firm which is enggaged to Enron. The SEC
(Stock Exchange commission) widens its investigation to include Enron's chief Auditor,
Arthur Andersen, due to reports of document shredding the in comes the ends partnership
with Enron. U.S. Justice Department indicts accounting firm Arthur Andersen for
obstruction of justice in the Enron case. Arthur Andersen found guilty of obstructing
justice. The United Stated Supreme Court overturns Arthur Andersen's obstruction of
justice conviction for Audit Failure.

Satyam and PricewaterhouseCoopers Scandal

Satyam Computer Services Limited was an Indian company that was running the business
in IT (Information and Technology) services company based in Hyderabad India. Satyam
offered a several services, including software development, system maintenance, packaged
software integration and engineering design services. Satyam stocks was listed on the Pink
Sheets, the National Stock Exchange and Bombay Stock Exchange. It showed good
performance since 2005, and it’s still increasing to 2009. Satyam, becomes India's fourth
largest software services provider, serves almost 700 companies, including 185 Fortune
500 companies, and generates more than half its revenues from the United States (CNN
India)

Satyam mergered with Tech Mahindra in 2009. Then suddenly The company had reported
a consolidated net loss of 2.33 billion for the quarter of 2010. Ramalinga Raju as the
chairman confessed that he had inflated profits with fictitious assets and non existing cash.
Raju explained that the balance sheet padding began several years ago to close marginal
gap between actual operating profit and one reflected in the company's accounting books.
PricewaterhouseCoopers who was the accounting public firm was fined 7.5 millions dollar
by the US SEC as the penalty due the Satyam scandal. The SEC said that PwC failed to
independently in verifying cash balances in Satyam bank accounts. Satyam created falsify
 invoices to inflate cash balances that appeared to double the value of the company's assets
from 2005 to 2009, the SEC said. This missleading holders of Satyam's American
Depository Shares, which were trading on the NYSE (New York Stock Exchange), making
Satyam stock seem more profitable. Satyam's common shares are traded primarily on
Indian exchanges. The company did not admit or deny the allegations when settling the
charges. It is pathethic that actually Satyam is one of india language which mean truth

Telecom and Ernst Young Scandal

Telecom is a company which run its business in telecommunication. Telecom has been
audited by EY for the last five years. In 2011, EY as public accounting firm which affliated
to Telecom release it report with unqulified opinion. Then in 2017 PCAOB held quality
review with the report. PCAOB found that the unqualified opinion on Telecom’s report is
based on inproper audit evidence. There is not enough accurate evidence in term assuring
the leasing of 4000 unit of cellular telecommunication tower. EY is missing the audit
procedure, checking the existence and occurance about the transaction. However EY
declared unqualified opinion. Moreover PCAOB found that EY’s documentation for
Telecom which has been archived in prior years can be edited after EY release Telecom’s
report.

The effect of fraudulance - financial statement fraud impact between the companies, public
accounting firm, shareholder and other users. The public accounting firms which are enggaged
to those clients are fined million dollars by PCAOB. The stock price of those companies drop
significantly due to scandal issues. Brokers and investors suffered big loss. The company’s
going concern itself end up to liquidation.

AUDITOR PROFESSIONALISM OVERVIEW

The definition of audit by Boynton is a systematic process objectively obtaining and evaluating
evidence in fullfilling assertion about economic actions and events due to degree of
corespondence, established criteria and communicating the results to interested users4.
Meanwhile Auditor is a job who is working in assurance service business, they had an
obligation to assure the interested users that the report which had been audited is reflect the
real condition so that the users can used it in making decision (ex. shareholder can decide to
invest or not). United Stated has established SOX (Sarbanes Oxley Act) to protect the investor
by increasing the accuracy and the reliablity of the audited company’s report. Its also formed
PCAOB as an organization board that control public accounting firms workdone. PCAOB
control the quality report, public accounting firms opinion, the audit evidence, the accounting
policy, ethic code and etc.

Audit enggagement must be performed with profiency and due the proffesional due care. The
conduct of enggaging auditor is like hiring people to assure users that the audited financial
report is giving the real condition of a companies. That report is able to used for any kind of
decision making. Therefore it is an obligation for Auditor to commit their profesionalism. The
professionalism itself comes from many aspect. Auditors must have the knowledge, skills, and

4
Boynton, William C. Johnson., Raymond N. and Kell, Walter G. “Modern Auditing”
other competencies required to perform their individual responsibilities. Knowledge, skills, and
other competencies is a several term that refers to the professional proficiency required of
auditors to effectively bring their professional responsibilities. Auditors are encouraged to
demonstrate their proficiency by obtaining appropriate professional certifications and
qualifications. Auditors must be alert to the significant risks that might affect objectives,
operations, or resources by following audit procedures. Nevertheless Auditor must fullfill what
accountability is, accountabilitty is a term that represent the fact that proper observance of rules
and regulations.

Auditor also must be independent and objective in auditing its clients to get the real
information. In their audit report, the trustworthiness of the audit evidence is completely a must.
They are allowed to determine whether the evidence of audit is sufficient and verified. However
Auditors had only limitation time to do their audit. They also had an obstacle in combining the
balance between reliable and relevant. Reliable and relevant are both two side important. Kieso
defines relevant as a financial report must be capable of making a difference decisions
whenever it has predictive value, confirmatory value or both. Reliable is related to faithfull
representation which means the numbers and description match what really existed or
happened. It has completeness, neutrality and free from error.

CONCLUSION
As long as people conclude do to commit fraud and rationalize what they’ve done as the
common thing, fraud is going to be difficult to detect without outside reviewer (Auditors). It is
Auditors requirement to find the misstament. Arthur Enderson failed in fullfilling the
fundamental qualities of financial report (account receivables and equity), PwC failed to
independently in verifying cash balances in Satyam bank accounts, and EY is reported wrong
opinion due the lack of data information during audit enggagement. These three scandal
proofed that fraud can not be catched whenever auditors did not fullfill their commitment for
professional occupancy. Auditor did not keep their independency and failed in following audit
procedure.

However public know that Auditor are facing obstacles. Auditors only have limitation time for
auditing the entities, their duties in to find only material mistatement that effecting in decision
making not the whole misstatement. Its not about dishmissing the obstacles by hidding
information then gaining profit, but its about how turning the obstacle into stepping stone by
commiting the professional of Auditor’s profiency.

LIST OF REFERENCE
Association of Certified Fraud Examiner (ACFE). 2012. Report to the Nations on Occupational
Fraud and Abuse
Boynton, William C. Johnson., Raymond N. and Kell, Walter G. “Modern Auditing” Edisi
Ketujuh, Jilid 2, Erlangga, Jakarta. 2001
Bryan Garner, ed., Black’s Law Dictionary. 8th Ed. (2004), s.v., “fraud.”
DiNapoli, T. (2011). Red flags for Fraud, State of New York, Office of the Comptroller,
Division of Local Government and School Accountability Guide, 1-15.
Dr. Ahmad. M Mashal, International Journal of Economics and Mangement Science. Vol.1 No
4. (2011), JEMS, “ Corruption and Resource Allocation Distortion for “ESCWA”
Countries.”
Gray, Cheryl W. and Daniel Kaufmann, 1998. Corruption and development, in IMF/World
Bank, Finance and Development.
Iman Sjahputra Tunggal dan Amin Widjaja Tunggal. 2005, Memahami Sarbanes Oxley Act
(SOX 2002). Harvarindo Jakarta
Kieso, D. E., Weygandt, J. J., & Warfield, T. D (2011). Intermediate Accounting Volume 1
IFRS Edition. United States of America : Wiley.
Moore Gail, At all. The Journal of Global Business Management Volume 12 Number 1, April
2016.” Fraud, Collusion and the Financial Statements A Refresher for Practicing
Professional”
http://www.acfe.com/fraud-101.aspx
http://www.edition.cnn.com/2009/BUSINESS/01/08/india.satyam.stock.exchange
http://www.edition.cnn.com/2009/BUSINESS/01/10/india.satyam
http://www.enron.fast.facts-CNN.com.htm
http://www.sarbanes-oxley.com/search.php?q=section%20404&o=&page=4