Academic journal article Journal of Accountancy

Balance Sheet Becomes Breeding Ground for Fraud

Academic journal article Journal of Accountancy

Balance Sheet Becomes Breeding Ground for Fraud

Article excerpt

The balance sheet used to be the backwater of financial statement fraud. Now, though, balance sheet frauds have become more complex and the potential rewards much greater as the balance sheet has grown in importance and as the fraudsters have devised more sophisticated ways to implement their schemes.

A balance sheet represents a firm's financial position as of a certain date. Under GAAP, most assets on a balance sheet are recorded at their original historical cost and, absent an impairment, are not adjusted as their market values change. Through the urging of the SEC, though, accounting standards-setters over the last decade have moved closer to reflecting values for assets and liabilities at current prices, especially if the values of those assets and liabilities are volatile and subject to significant change over short periods of time.

For example, securities held in trading accounts and financial derivatives are now marked to their market values. Even presumably less volatile assets such as plant and equipment, under certain circumstances, can be written down (though not up) to fair value under FAS 121 and its recent successor, FAS 144. Thus the balance sheet, with some justification, has gained more importance as it has become a more accurate reflection of current values of assets and liabilities. Lenders and investors, then, have come to place more reliance on the balance sheet. Indeed, numerous academic studies have tracked the relationship between a firm's book value (i.e., its shareholders' equity as reflected on its balance sheet) and its market value and found that book value contains meaningful information for investors looking for undervalued stocks. …

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