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Background to the Study and Overall Research Aim:
Fraudulent accounting cases have always been critical and prevalentissues in listed Chinese companies. In recent years, some Chinese companies have been embroiled in accounting scandals in Hong Kong stock market. According to a Hong Kong Exchange report on 30 November 2013, there were 42 companies ’shares that had been suspended for more than three months. 17 out of 42 are under investigated formally for potential irregularities. Listed Chinese companies have the potential to be embroiled with fraudulent accounting.
Financial statements reflect a company’s performance and it requires a series of fundamental and appropriate financial analysis. Due to its high importance, the validity and accuracy of financial statements must be stressed. Additionally company managers have to report to the owners of organization and other related users such as banks and other lenders about the financial aspects of their activities. Those relying on external financial reports want to receive the information that is qualified or has been audited in the reports to assure reliability.
The use of financial statements and its high significance drive forces of creative actions. Nowadays, more and more companies use fraudulent accounting to make company’s performance more attractive to investors. On the other hand, it provides more difficulties for auditing and results in affecting audit quality.
Companies deliberately use fraudulent accounting to mislead stakeholders and shareholders. It is easily found out that some companies own good economic performance on the financial positions but they go bankrupt suddenly. If a company goes into bankruptcy, the stock can drop dramatically and often results in stop trading on the stock market. Generally, investors have to suffer investment loss.
The objective of this research is built up to review the literature of accounting fraud in the financial statements, to study methods of accounting fraud. The most important task for this dissertation is to find out whether any indicatorsor patterns of fraudin the financial statements of the listing companies. Theories will be compared to the truth in the case study of several companies in order to explain those theories are good enough to explain the same evidences in the company.
Initial Review of Relevant Literature:
The literature review focuses on following parts:
- Definition of accounting fraud
- Causes of accounting fraud
- Overview of fraud techniques
- Consequences of accounting fraud
Definition of accounting fraud
Fraudulent accounting is an intentional cheat, various manipulations of a company’s assets or its financial statement to benefit vested interest holder. It often includes complex techniques for misappropriate of assets, fail to report liabilities, misusing funds, overstating revenues and understating expenses. In related to fraudulent financial reporting, which is sometimes called creative accounting, window dressing and income smoothing, etc.
However, some corporate fraudulent accounting scandals have been argued that it is a series of reasonable actions in view of earnings management rather than an intentional cheat, various misappropriations and manipulations. The distinction between fraudulent accounting and earnings management is the managerial intent.
If managers make changes on financial statement to mislead shareholders or stakeholders that rely on the statement about economic performance of the company to influence outcomes, it can be judged as fraudulent accounting.
Causes of accounting fraud
The complexity of accounting standards is one of reasons why various fraudulent scandals happen. Companies seek opportunities to take advantage of loopholes in existing accounting standards although it is more detailed. For example, Enron used complex contracts to blur the truth of company transactions for such a long time. Fraud is committed by misusing the accounting standards that are expected to protect public interests.
Furthermore, reward of senior managers provides a breeding ground to accounting fraud. It is closely related to short-term performance of a company such as bonuses, stock options and perverse incentives. These rewards create incentives to managers to further manipulate financial statements under the pressures although it is fraud.
Overview of fraud techniques
The fraud techniques are implemented on financial statements. Some major applications of fraud techniques are the followings.
- Overstatement of Revenue
- Understatement of Expenses
- Tamper with Taxation
Consequences of accounting fraud
Research Methods: Justification and Description:
This dissertation primarily collects secondary information which will be conducted to collect and analyse through an examination of a series of books, journals, articles, annual reports and professional bodies. It is easier to obtain.
Since there are many well-known cases about corporate fraudulent accounting scandals, there are lots of information and discussion available on articles and websites that can be analysed from different views. Moreover, annual reports of listing companies are easier to be obtained.
In addition to secondary data, primary data is harder to be found due to the nature of fabrication truth by using it.
Information to be collected:
How information will be collected:
This dissertation is going to adopt sampling as research method. Sampling method is the study of selected samples from a population. The subjects are easily controlled and more accurate than studying the whole population. Interestingcorrelationsmay be found from few subjects.
Judgment samplingwhich is a nonprobability method and is often extension of convenience sampling will be adopted in this dissertation. With nonprobability sampling strategies, sample is selected based on judgment. The sampling strategy should be chosen to select research companies which are best able to accurately and meaningfully provide information to the survey instrument. Therefore, the samples have to be chosen carefully and they are truly representative of the whole population when using this method.
A list of characteristics of the elements in the sample needs to be determined. These sampling criteria are essential to form of the sample in order to look at the fraudulent problem. These criteria include:
- Companies are listed
- Companies have annual report which can provide financial statements for analysis
- Companies have evidences of reported fraud, such as published cases by SFC, HKICPA, HKEx, etc.
Correlation refers to the strength of a relationship between two variables. A weak correlation means that the variables have a weak relationship with each other while a strong correlation means that the variables are closely related. This correlation analysis technique assumes that the variables are analyzed and measured by correlation coefficient which is the Pearson’s r which measures as linear relationship. The correlation coefficient can be calculated by taking the covariance of the two variables. The range of Correlation coefficients can be represented from -1 to +1. For example, +1 represents an extreme positive correlation while -1represents an extreme negative correlation. 0 represents that there is no relationship between the variables being tested.