Forensic Accounting - Finding Red Flags in Financial Statements

Section One - Background

• This forensic accounting course begins by differentiating between fraud, aggressive accounting and incompetent accounting

• What is the purpose of the fraud or aggressive accounting?

• Forensic accounting analysis by external analysts versus fraud detection by auditors

• Management incentives and earnings smoothing

• Auditor relationships and restatement history

• MD&A language and footnote analysis

• Key Audit Matters & going concern statements

• Management background checks

• Corporate governance warning signs

• Management actions that may signal underlying problems

• Information sources – financial statements, presentations, earnings calls

• The importance of sector and macro-economic data

• The use of short-seller reports (MuddyWaters, Iceberg, etc)

• Can AI help accountants, management, and auditors detect fraud?

• Can AI help external analysts detect and prevent fraud?

• The importance of sector-wide comparisons and analysis

Section Two - Red Flags in Financial Statements: The Income Statement

• Revenue recognition issues

• Repurchase agreements

• Deferred revenues

• Analysing reported EBITDA and quality of earnings assessments

• Moving EBITDA losses off the balance sheet

• Expense manipulation

• Accounting choices and estimates (depreciation, reserves, provisions)

• Capitalisation of operating and interest expenses

• “Other operating income”

• Trends in interest expense

• Financial expense of certain hybrid instruments

• Related party transactions to enhance earnings

• The statement of other comprehensive income

Section Three - Red Flags in Financial Statements: The Balance Sheet

• Overstated tangible and intangible assets and impairment avoidance

• Forensic accounting training explores management valuations

• Developments in net working capital

• Analysis of receivables – impairments and collections

• Service contracts versus IFRS 16 leases

• Off-balance sheet leases and other off-balance sheet liabilities

• Hybrid securities

• “Other creditors”

• How much cash is really available to the firm? Assessing restricted cash and advance payments

• Working out the true levels of gross and net debt

• How less than 100% ownership of subsidiaries can distort debt metrics

• Full consolidation versus investment accounting versus equity accounting

• Provision liabilities

• Related-party transactions

• Cash balances versus capital raisings

• Overview of ROIC versus WACC

• Offering the same security to multiple lenders

• Covenant breaches and liquidity problems

Section Four - Red Flags in Financial Statements: The Cash Flow Statement and Scoring Models

• Manipulation of operating cash flow

• Manipulation of net working capital changes

• Understatement of capital spending

• Exaggeration of capital spending

• Related-party transactions

• Dividend leakage to NCIs

• M-score (Beneish model), Altman Z-score, and other screening tools

Section Five - Conclusions

• Discussion of what was missed by analysts versus what flagged suspicions

• Post-mortem of activist and short-seller reports

Methodology

The teaching method used in this forensic audit and accounting course combines formal theoretical instruction with frequent reference to financial statements, reports and case studies. The case studies, based on real situations, help delegates install new analytical techniques and learn from empirical experience.

Delegates should be familiar with basic Excel usage and should bring their own personal computer.

The course is practical and interactive, with delegates encouraged to ask questions. The techniques taught to delegates are intended to be of immediate practical use in the workplace.

Training Objectives

Redcliffe's Forensic accounting training in the UK consists of:

• Standard practices for overstating revenues, earnings, operating cash flow, assets and net assets. Whilst also understating costs and actual and potential liabilities.

• How to amend reported figures to derive key underlying metrics. This includes: Revenues

• Earnings

• Operating cash flow

• Net debt and available cash balances to show a more realistic and conservative perspective

The importance of reading the notes and picking up signals from presentations and earnings calls.

How management actions may indicate there are underlying problems.

The importance of benchmarking financial ratios, management commentary, strategies and key trends to the peer group and to sector/macro-economic data.

Training Course Summary

This forensic accounting course will help a wide range of analysts and investors:

• Those who are looking to sell short securities that may be overvalued.

• Those concerned that a firm’s true credit quality is worse than perceived, such that rating downgrades and spread widening may occur in future.

• And those who are looking to avoid investing in firms whose valuation and credit profiles are based on an over-optimistic assessment of the firm’s current performance and financial situation.

Under the IFRS framework and accounting standards, firms must present their financial statements in a manner that is clear, relevant, reliable, comparable, transparent and conservative. Nonetheless, the financial statements will also be based on a wide range of management assumptions as well as differing interpretations and applications of the standards.

Most firms do present their accounts in a transparent and conservative manner. However, some firms pursue aggressive accounting policies and practices. This includes distorting consolidation techniques, which may lead to the overstatement of revenues, earnings and assets and the understatement of costs and actual or potential liabilities.

The most likely candidates for aggressive accounting include firms that are deteriorating, distressed, trying to avoid covenant breaches, adverse credit rating moves and/or trying to reach earnings targets expected by equity investors and analysts. In a worst-case scenario, the aggressive accounting practices may be borderline or definitely fraudulent.

Whilst it can be very difficult to spot outright fraud, there are techniques analysts can use while gathering evidence of red flags. You must look for overstated revenues, earnings and assets and understatement of actual or potential liabilities. It may also be possible to spot other signs of deterioration.

Throughout forensic accounting training, we will review a wide range of financial statements from different sectors. We will undertake a detailed data analysis of the notes and a benchmark peer group ratio analysis to gain a better understanding of the firm’s operations and financial situation.