DETECT AND IDENTIFY THE FRAUD ON THE FINANCIAL STATEMENT IN MALAYSIA

COMPANIES:

1.1 BACKGROUND OF THE STUDY

These researches are mainly focus on to determine and identify the Financial Statement Fraud (FFS),
fraud on the financial statement is a significant threat to corporate worldwide, The fraud are manipulation
based on Statement of financial position, Statement of comprehensive income, statement of cash flow and
Statement of changes in equity and make the companies look better and to the people who read them and
to invest. The global fraud survey (Ernst &Young, 2011) revealed that fraud on the financial statement
are remained one of the most problematic and critical issues for businesses worldwide.

The most of companies reporting the fraud cases increased 22% since 2003 (PwC, 2007). Financial
statement fraud (FFS) particular is a major problematic and risk to businesses and can completely drain
the long-term success of the business. However the reliability of financial statement information seems to
be questioned by both investors and the public. As a matter of fact, the reliability of information provided
by financial statements remains one of the most problematic issues for businesses worldwide (PWC
2007).

According to a UK Studies of fraud on financial statement have two thirds of businesses perceived
fraud to be a risk and problematic in their industry; however, less than one third of businesses had a fraud
awareness programmed or any educational programmer relating to the threat of fraud. The fraud may be
out for personal gain, or is trying to keep the business afloat, Nevertheless due to a number of the
reported financial statement fraud cases, the public confidence in accounting and auditing profession has
been eroded and also gives a huge impact to the fraud companies.

The reports by Association of Certificated Fraud Examiners (ACFE, 2004) suggest that the
occurrence of fraud on financial statement has increased considerably over the recent years and is likely
to continue to increase in the future (AFCE, 2014), Financial statement fraud (FFS) control and manage
has attracted considerable attention and associated response in recent years due to the incalculable
collateral damage that could drain the long term success of companies.

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 The fraud sections listed as false by representation, fraud by failing to disclose information and fraud
by abuse of position respect to financial statement fraud allegations, false numbers or representation,
inaccurate information that may relate to fraud by failing to disclose the correct information and also
involvement of company’s directors or top management. Therefore, it could be charged as fraud due to an
abuse of position.

The above sections are entirely relevant to financial statement fraud allegations as they involve the
falsification of accounts and records, which, ultimately, misleads the financial statement users. In this
case, the false financial reporting can be associated with market manipulation through which the
manipulation of financial figures is achieved to mislead the company’s investors. However the financial
statement should be seemed as the reliable tool for investors to make investment decision and company’s
shareholders to appraise the company’s financial performance.

1.2 CURRENT SITUATION OF THE STUDY

This section will present current situation of fraud on the financial statement (FFS) in Malaysia, The
Frauds on the financial statement are one of the many varieties of accounting fraud and they can involve
multiple crimes, including securities fraud and perjury. The reports and the reported cases of fraud
involving Enron, WorldCom and Satyam resulted in losses estimated to be more than US$20 billion.
According to ACFE, there are three types of fraud comprising financial reporting fraud, misappropriation
of assets, and corruption. Amongst different types of fraud, it is reported that financial statement fraud
contributes the highest loss compared to other reported corruption and asset misappropriation fraud cases
(ACFE 2014).

Malaysia is not spared as cases involving Megan Media, Transmile Berhad, United U-Li and Repco
Holdings Bhd proved that fraud is prevalent here too. Organizations are reported to lose an estimated
average of 6 percent of their annual revenues due to fraud. Due to increasing the number of fraud cases
and its detrimental negative impacts, it is vital to spend a significant amount of time to find an effective
model to detect fraud.

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1.3 PROBLEM STATEMENT

This segment will express along with what is the major problem and issue of fraud on the financial
statement, this learning is aggravated as a result of the following cause. Primary is the growing concern
greater than the increase in fraud cases in Malaysia. The PricewaterhouseCoopers and KPMG economic
offense or fraud investigation commencing 2000 on the way to 2009, on top of the reported cases in the
Malaysian Securities Commission Enforcement discharge, have point out the seriousness of this issue
statistically.

This trend turns out to be more challenging as the losses suffered threaten the capability of fraudulent
business to carry on their business activities as well as be moneymaking. As a result, it distresses the
shareholders along with stakeholder’s wealth on top of the strength of the public as a whole. The
investigation of PwC (2007) offense beginning the period 2003 until 2007 illustrate that fraud remains a
serious predicament in each one country around the world. The analysis indicate there is common frauds
dedicated be asset misappropriation, accounting fraud, corruption, currency laundering.

Based on the study by the group of sponsoring association of the Tread way Commission (COSO),
the use of fictitious revenues is the majority trendy method of committing financial statement fraud and
Securities and Exchange Commission (SEC) Commissioner, Isaax C. Hunt, Jr, in his speech, the present
of SEC financial fraud developments, said more than partially of financial report cases are in a straight
line connected to revenue recognitions (Hunt, 2000).

The present business atmosphere with still more economic downturn, contain in current period hard-
pressed the top management of several business into paying concentration to how to compose financial
statements of their companies give the impression of being improved in organize to create a center of
attention to shareholder by manipulating information and transaction in their financial statement
moreover as a result of rising or declining the statistics depending on what they wanted to accomplish at
the split second using destructive or creative accounting or else recognized as financial statement fraud
(Anumak, 2007).

In the present period, the fraud has been exposed to a large hazard on business. It is a large business
risk, which is able to acquire an extremely large cost leading to a bunch of problems of which one of the
issues is loss of assurance of shareholders and the public on the company. This investigates work tries to
explanation to financial statement fraud.

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1.4 OBJECTIVE OF THIS STUDY
This section will present the objective of this research, the purpose of these studies will use to examine,
inspection and identifying the fraud on the financial statement and how the auditors is going to detect and
identifying the fraud on the financial statement.
- To investigate why the companies are overstatement of revenue.
- To examine why the companies are understatement of expenses.
- To identifying on the misrepresentation of accounting rules and misrepresentation of information.
- To identifying method to prevent the fraud on the financial statement
- To determine and investigate the responsibilities of auditor to detect and identifying the fraud on
the financial statement.

1.5 RESEARCH QUESTIONS

This segment is reaction to the objectives of the study, the following research question prepare to meet
the need of the study, which is fraud on the financial statement and the auditors responsibilities.

1. Who commit financial statement fraud?

2. Why do people commit fraud?
3. How do people commit fraud on the financial statement?
4. To determine why do companies commit fraud on the financial statement?
5. To investigate what’s made the business to carry out fraud on the financial statement?
6. To inspect what are the fraud technique and method, which the companies used to further the
business process?
7. To investigate what is different type of financial statement fraud taking place in organization?
8. To recognize how do auditors obtainable to detect and prevent the fraud on the financial
statement?
9. To find out what are appropriate fraud method to detect the fraud on the financial statement?
10. To recognize auditors responsibilities for the audit of the financial statement?

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Literature Review

The financial statement fraud may be recognizes as a intentional misstatement the financial statement and
its arise with two type fraud is misstatement and miss -presentation in the financial report, fraud on the
financial statement reporting is being one of the serious threat for gaining shareholder confident in
financial statement information. (Hussain et al., 2010)

Fraud is a worldwide problem which has become increasingly prominent in the eyes of
the public and world's regulators and Malaysia’s corporate sector is no exceptional.
Indeed, it represents a corporate threat for Malaysian businesses as number of fraud
cases documented has increased considerably over the recent years. There have been
few recent studies on fraudulent financial reporting in Malaysia, Omar and Bakar (2012),
Nelson (2010, 2011), Arshad and Othman (2011) and Yap et al. (2011), to name a few.

The growth in fraud cases may indicate a strong need for research that aims to find
alternatives to mitigate fraud. Thus, in Malaysia various studies performed had included
many aspects of fraud’s background such as Yap et al. (2011) examined the association
between corporate governance mechanisms, ownership structures, Internet visibility and
fraud activities via Internet financial reporting. The result shows high transparency level
by corporations is required to use the Internet to communicate information in order to
reduce fraud occurrences. An empirical study by Nelson (2010) had proxied fraud as a
measure for financial reporting quality when examining the audit committee expertise
effectiveness and documented certain aspects of audit committee that are significant to
fraud. While Arshad and Othman (2011) examined the propensity of financial reporting
fraud as a proxy of regulatory efforts in enhancing the quality of financial reporting which
include the influence of ownership structure and capital structure on the likelihood of
financial reporting fraud.

On the other hand, Ahmad et al. (2008) examined fraudulent financial reporting quality
from tax evidences. They examined the relationship between companies’ characteristics
with the types and amount of fraudulent reporting that were submitted to Inland Revenue
Board (IRB) for tax purposes, and utilised real tax cases. These tax cases where the
non-compliance with the Malaysian statutes and tax laws are used as a measure for
fraudulent financial reporting. In addition, studies have also expanded into utilising
qualitative method.

Studies in relation to behavioural factors had also gained interest in the Asian region,
such as China. Zhu and Gao (2011) from China also adopt qualitative study by
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investigating the nature, types, and methods of fraudulent financial reporting committed
by Chinese listed companies with a view to understanding corporate behaviour relating
to management fraud in China.

The corporate governance of an organisation, indirectly reflects the process of how the
organisation is being managed, no doubt that the failure in governance itself will result in
reporting failure as well. Thus, corporate governance mechanisms play significant
function in the financial reporting quality (Beasley, 1996; Carcello and Nagy, 2004;
Sharma et al., 2009). Given the association between fraudulent financial reporting and
corporate governance, an important contribution of this study is to understand the
factors that could improve fraud firms after the said fraud had occurred. Furthermore, a
well defined governance responsibilities and structure in the firms are likely to reduce
the probability of financial fraud when sufficient red flags or warnings exist (Vlad et al.,
2011; Grove and Basilico, 2011).

The current study expands existing fraud literature by

investigating corporate governance in association to financial reporting quality proxy by

fraudulent financial reporting. At the same time, contributes to the current literature by
examining the boards’ and firms’ characteristics during post fraud years. More
importantly provide an avenue to understand how fraud firms cope after fraud.

Theory

Agency theory provides a powerful theoretical framework for analysing the behaviour of
managers in different organisations. In this study, board’s characteristics that represent
the board of directors are designed to mitigate problems and acts as monitoring
mechanism on the preparers of financial statement and shareholder (Shapiro, 2005).
Given the problems in mitigating agency problems through the use of contracts, scholars
have suggested various governance mechanisms to address the agency problems.
Agency theory thus provides a basis for firm governance through the use of internal and
external mechanisms (Weir et al., 2002; Roberts et al., 2005). The governance
mechanisms are designed to “protect shareholder interests, minimize agency costs and
ensure agent-principal interest alignment” (Davis et al., 1997: 23).

Hence, the study expects that with good governance such as, larger board’s size, larger
audit committee size, higher number of independent audit committees, and higher
number of independent directors will result to lesser fraud occurrence.

RESEARCH METHOD

Sample selection and data collection

The sample is limited to publicly traded firms because listed companies represent wider
stakeholders such as public at large, other institutional holders, and regulators. The
study had identified 32 fraud firms similar to prior studies (Nelson, 2010, 2011),
consistent with prior literature (Erickson et al., 2006; Owens-Jackson et al., 2009). The
small fraud companies are consistent with Peyrefitte et al. (2002) with a final sample of
66 and Mustafa and Youssef (2010) at 28 cases of misappropriation of assets. Data was
hand collected from publicly available data. Data was hand collected via annual reports.

For each firms, information regarding board’s and firm’s characteristics were identified
for three consecutive years following the fraud’s year. Hence, the study arrives to 256
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firms’ observations, including their control group. Subsequently, based on a match pair
sampling and a dichotomous dependent variable, a logistic regression is most
appropriate for further investigation.

Hussain MM, Kennedy P, Kierstead (2010). Can Audit Prevent Fraudulent Fianncial
Reporting Practices? Study of Some Motivational Factors in Two Atlantic Canadian
Entities. Issues in Social and Environmental Account., 4(1): 65-73.