"Financial reporting fraud is considered to be something that happens in the US and elsewhere, not Australia – but in KPMG's experience it's increasingly prevalent here," Gill said.
In KPMG's 2004 Fraud Survey, financial reporting fraud was identified as the most costly form of fraud. Of the reported incidents, three were nominated by the respondents as being the largest single case of fraud that occurred within their organisation in the survey period. Although the largest reported misstatement was A$10 million, it is likely there were significantly higher misstatements that were not reported.
"This sense of complacency means that many companies here are not as proactive as they should be in putting in place mechanisms to detect financial reporting fraud," Gill said.
"Unless Australian companies pick up their game, we may see more financial statement fraud scandals."
Financial reporting fraud usually occurs as the result of three factors: incentives and pressures; opportunity; and where it's possible for the perpetrator to rationalise their actions, according to KPMG.
In many cases corporate criminals, particularly senior management, had aggressive compensation schemes based on unrealistic profit targets. Other motivations included the desire to retain employment, to cover up poor performance or to meet shareholder and market expectations.
Opportunity for fraud was created when boards and audit committees were not sufficiently aware of the risks and were not as vigilant as they should have been scrutinising changes in accounting treatments and policies, thereby creating opportunities for deception.
Fraudsters find it easier to rationalise their actions in companies with a cavalier corporate culture, another factor that management must assess.
The most prevalent type of financial reporting fraud involves some type of overstatement of revenues by recording revenues prematurely or by creating fictitious revenue transactions.
The next most common kind of corporate fraud is the overstatement of assets by recording fictitious assets or assets not owned, capitalising items that should be expensed, inflating existing asset values through the use of higher market values, and understating receivable allowances.
Financial reporting fraud doesn't only involve the most senior management of an organisation, according to Gill.
"In many cases I have investigated, middle managers manipulated reported earnings of their divisions or business units, often to influence their remuneration," he said.
The top 10 warning signs of risk of potential financial reporting fraud
1. Senior management's remuneration is heavily performance-based and linked to unrealistic performance hurdles.
2. The CEO is alternately a bully or charming.
3. The CEO takes a keen interest in basic accounting entries.
4. The company's operation represents only one person's vision.
5. The corporate organisation structure is unnecessarily complex.
6. The board does not understand all aspects of the business.
7. Senior people have a flamboyant lifestyle.
8. The balance sheet includes deferred expenses.
9. Non-core business activities generate high revenues.
10. Large round-number journal entries at year's end.
