Financial Fraud examination Memorandum

[Virtual Presenter] The purpose of this comprehensive guide is to introduce the concept of financial fraud examination, delving into the intricacies of financial statement fraud. This presentation aims to thoroughly explore the red flags, analyze the data, and scrutinize the circumstances surrounding the alleged fraud. The ultimate objective is to provide a profound comprehension of the process and its significance in preserving the integrity of financial reporting. We shall initiate our inquiry by examining the background and scope of the investigation..

[Audio] The allegations of fraud were investigated by determining whether there was any basis for them. This was necessary because the claims came from NKR, a layperson unfamiliar with financial matters, and were being made against experienced accountants who had spent decades working in finance..

[Audio] When conducting a financial fraud examination, our initial strategy was to demonstrate that no fraud occurred by examining fraud risk indicators. However, this proved challenging since the allegations were made against highly skilled and experienced accountants. We focused on analyzing the most trustworthy documents – financial statements. Unaudited reports are particularly reliable because they contain management's assertions and have been reviewed by an independent auditor. During the investigation, we analyzed the audited financial statements for the period under review. When performing comparative analysis, we considered opening balances from 2016, which fell outside the scope of our inquiry..

[Audio] The audited accounts for the year 2016 showed several red flags, including two separate sets of accounts, a change in auditors without a board resolution, failure to act on management report queries, and signatures from only two directors who are also practicing accountants. Furthermore, NKR's absence of signature despite being approached multiple times raised additional concerns. These findings collectively suggested that there might be issues with the financial reporting process that required further investigation..

[Audio] The financial statements show that the cost of goods sold in 2016 led to a remarkable profit margin of over 300%, indicating that the company sold its products at a very high price compared to the cost of producing them. However, this profitability did not result in increased revenue, as operating costs and administrative expenses remained relatively high. In 2017, the cost of goods tripled, but revenue only increased slightly, suggesting difficulties in selling products despite rising production costs. Moreover, in 2018, the company reported a gross loss on its manufacturing activities, which is a significant departure from previous years' profits. Additionally, there was a substantial decline in revenues from 2018 onwards. These findings imply that something went awry with the company's operations, necessitating further investigation to determine what occurred..

[Audio] The investigation will focus on several key areas, including analyzing management reports to identify discrepancies or irregularities indicating financial fraud. This involves reviewing financial statements, balance sheets, and income statements to ensure accuracy. The examination of sales orders will determine unusual patterns or anomalies suggesting fraudulent activity, while investigating cost of goods sold identifies potential issues with inventory valuation, pricing, or accounting practices. A review of the accounting software ensures proper implementation and maintenance, and interviews with relevant parties gather information and verify facts..

[Audio] Did financial statement fraud occur? We found evidence suggesting manipulation of financial statements, indicating intentional misrepresentation or omission of material information..

[Audio] The income statement for 2017 reveals a gross profit of 5,142,460.00, which is a significant decline from the 30,429,117.00 recorded in 2016, indicating a notable deterioration in profitability. The operating loss in 2017 amounts to 29,131,615.00, a stark contrast to the 1,602,711.00 recorded in 2016. This suggests that the company's financial performance has undergone a substantial decline over this period. The finance cost increased by 3,825,681.00 in 2017 compared to 4,177,593.00 in 2016, further exacerbating the decline in profitability. Overall, the income statement underscores a substantial decrease in the company's financial well-being between 2016 and 2017..

[Audio] The income statement for 2018 reveals a loss of 24,828,518.00 compared to 2017, where there was a loss of 32,957,296.00. This suggests that the company's financial performance has improved slightly between these two years. The gross profit margin decreased from 5,142,460.00 in 2017 to (176,137.00) in 2018, indicating potential difficulties in maintaining profitability. Operating expenses increased by 8,517,729.00 in 2018 compared to 2017, possibly due to higher staff costs, administrative expenses, and other operational expenditures. The finance cost also rose by 4,492,680.00 in 2018 compared to 2017. Overall, the company's financial performance appears challenging, yet showing signs of improvement..

[Audio] The income statement for 2019 reveals a gross profit of 2,697,908.00 compared to a gross loss of 176,137.00 in 2018, indicating an improvement in profitability. Operating expenses decreased by 1,569,018.00 from 2018 to 2019, whereas administrative expenses increased by 3,991,465.00 over the same period. The company's finance cost also rose by 658,669.00. Consequently, the company reported a loss of 16,118,616.00 in 2019 compared to a loss of 24,828,518.00 in 2018..

[Audio] The income statement for 2020 reveals a gross profit of 2,363,429.00, which is a decline of 334,479.00 or approximately 12.4% compared to the gross profit of 2,697,908.00 recorded in 2019. Furthermore, the operating loss in 2020 amounts to 12,668,704.00, representing a decrease of 317,463.00 or approximately 2.4% from the operating loss of 12,986,167.00 reported in 2019. Additionally, the finance cost in 2020 stands at 1,159,624.00, marking a significant reduction of 1,972,825.00 or approximately 63.1% compared to the finance cost of 3,132,449.00 in 2019. Lastly, the profit/loss after tax in 2020 totals 13,828,328.00, indicating a decline of 2,290,288.00 or approximately 14.2% from the profit/loss after tax of 16,118,616.00 reported in 2019..

[Audio] The income statement for both years reveals a substantial decline in operating profit. In 2020, the company recorded an operating loss of KES 12,668,704, whereas in 2021, this figure was not disclosed. Nonetheless, it is evident that the company's financial performance has worsened over the past year. The gross profit decreased by KES 2,363,429 from 2020 to 2021, signifying a downturn in revenue. Additionally, administrative expenses rose by KES 2,109,637, contributing to the decline in operating profit. Moreover, the finance cost increased by KES 1,159,624, exacerbating the company's financial difficulties. Overall, the income statement implies that the company must address its operational and financial challenges to enhance its profitability..

[Audio] The revenue figures from 2017 to 2021 reveal a significant disparity between sales orders and audited accounts. In 2021, both the audited and sales order figures were identical, indicating no discrepancy in recorded revenue. However, examining earlier years reveals substantial variances. For example, in 2020, the audited figure was 11,011,134.00, whereas the sales order figure was 13,440,251.80, yielding a variance of 2,429,117.80. Similarly, in 2019, the audited figure was 11,942,792.00, but the sales order figure was 12,841,355.67, resulting in a variance of 898,563.67. These disparities imply potential issues with revenue recording in those years, necessitating further investigation to identify the root causes..

[Audio] The management accounts reveal a substantial disparity between the audited accounts from 2015 to 2018. Each year, the audited accounts report higher revenues compared to the management accounts. This inconsistency sparks doubts about the accuracy of the financial records. A thorough examination is necessary to uncover the root cause of these discrepancies and guarantee the reliability of the financial statements..

[Audio] The revenue figures from 2017 to 2021 show a significant variance between the quarterly book records and the audited accounts. In each year, the audited accounts reported lower revenues compared to the quarterly book records, with the largest variance occurring in 2017. The total variance over the five-year period amounts to 36,601,918.01. This suggests that there may have been some discrepancies in the recording of revenues during these periods. Further investigation is needed to determine the cause of these variances..

[Audio] The variance between the audited accounts and the forensic accounting records has increased significantly over the years, with a difference of 36,601,918.01 in total. This discrepancy suggests that there may be inconsistencies in the company's financial reporting. A further investigation is necessary to identify the cause of these discrepancies and determine if they were intentional or accidental..

[Audio] The variance between the actual sales orders and audited accounts has been increasing over the years, from 2017 to 2021. A significant difference of 19 million dollars emerged in 2017, followed by a decrease in 2018, but then increased again in 2019 and 2020. In 2021, the variance reached its highest point, with a total difference of almost 37 million dollars. This trend implies that there might be inconsistencies in the company's financial reporting. Further examination is required to identify the root cause of these disparities..

[Audio] The findings reveal that there were two fraudulent schemes discovered during the investigation. The first scheme pertains to the understatement of sales, where an amount of thirty-six million six hundred one thousand nine hundred eighteen naira was concealed. This is deemed material, implying its significance in affecting the financial statements. The second scheme concerns the understatement of cost of goods sold (COGS), where an amount of seven million three hundred eighty-nine thousand eight hundred seventy-five naira was hidden. Similarly, this is considered material. When aggregating these two amounts, we obtain a total of forty-three million ninety-one thousand seven hundred ninety-three naira that was falsified. These discoveries suggest that there was a deliberate effort to alter the financial statements, which could have severe repercussions for stakeholders..

[Audio] The findings reveal that financial statement manipulation took place with the deliberate intention of hiding unreported sales and cash theft by Mr. Charles Mbaya. This was a meticulously planned fraud scheme, rather than an accidental mistake. The two directors neglected their responsibility, intentionally misrepresenting the financial statements and causing harm to Director NKR. Moreover, the external auditor either actively contributed to the fraud or was careless in their duties, permitting the scheme to proceed without hindrance..

[Audio] The investigation has concluded, but certain limitations must be recognized. Regrettably, we have not had the chance to interview the two directors of the company, whose viewpoints would have been invaluable in grasping the circumstances surrounding the alleged financial statement fraud. Moreover, the independent auditor who examined the company's financial statements has not been interviewed, and their insights could have shed more light on the situation. Furthermore, the accountant responsible for preparing the financial statements has also not been questioned. These omissions might hinder our capacity to comprehensively grasp the events that unfolded. Nonetheless, we will proceed to analyze the evidence collected during the investigation to draw conclusions regarding the allegations of financial statement fraud..