Sometimes, a financial reporting fraud can be utilized as a method of

concealing an asset misappropriation. A fair value accounting fraud might

just be the perfect choice for such concealment.

Let’s look at an example to illustrate how this might work. Assume the

chief financial officer (CFO) of a company has been misappropriating funds

from the company through the use of a fictitious vendor. The CFO made

up this fictitious vendor and has been submitting phony invoices on behalf

of the nonexistent vendor. The vendor has supposedly been providing a

service that only the CFO has full knowledge of, so the CFO approves the

vendor invoices with little to no scrutiny from others.

The problem is that the CFO has drained the company’s cash over time.

And the payments have all been posted to a handful of expense accounts,

whose balances are now beginning to get substantially larger than what

others in management or the external auditor might expect.

One method of further concealing this fraud would be through a fair

value accounting scheme. The CFO might inflate the fair value of the company’s

investment portfolio. Since many investments are grouped with cash

and cash equivalents for purposes of calculating many financial ratios, such

as the current ratio, the deteriorated financial condition caused by the fraudulent

disbursements might be concealed, at least for a while, by engaging

in the fair value fraud with the investments.

The CFO might even go one step further to conceal the fictitious vendor

scheme. There is still the business of the larger-than-expected balances in

certain expense accounts into which the fraudulent payments have been

posted. Through a series of journal entries, the CFO might reclassify some
or all of the fraudulent recognized unrealized gains on the investments into

the expense accounts, or vice versa, so that the final balances in the expense

accounts are more in line with expectations. Part of the logic the CFO uses

in carrying out this reclassification part of the scheme is that many (perhaps

most) members of management, the board, investors, and even auditors

might be looking only at final balances in various line items of the financial

statements. The details of the underlying transactions are often not looked

at very closely.

Whether the CFO would succeed with this scheme depends on many

factors, including the strategy employed by the internal and external auditors

in performing their work. But the fact remains—perpetrators of frauds

will do whatever is necessary to conceal their frauds. And sometimes, that

involves perpetrating a second type of fraud to conceal the first.