Accounting Fraud Example

When investigating possible accounting fraud of public corporations, the SEC filings is the starting place. Look on EDGAR, the searchable database of filings on SEC’s website. I will use a 6-K filing from China Finance Online Co. Limited, a financial markets information service in Beijing, Shanghai and Shenzhen. I want to note here that I’m using this company as an example and in no way am I claiming that there is accounting fraud taking place here. There is no proof of fraud in this article.

cfocCFOC claims to provide “vertically integrated financial information and services including news, data, analytics, securities investment advisory and brokerage-related services.” This may or may not be relevant to our findings, but one should always start with the business the company is in.

I’m going to start with the Balance Sheet. Current Assets shrink by about $3M while Total Assets shrank about $20.5M. Total Liabilities shrank about $5M. Which mean Shareholders’ Equity shrank about $15.5M.

Onto the Income Statement. Revenue increased by about $31M. This brings up the first question: Why did the value of equity shrink when revenue increased? First answer comes at the Operating Profit, which decreased about $6M. Part of this comes from an accounting-only transaction where the company marked down the goodwill of something they bought by about $8.1M. But that still means Operating Profits would have been -$10M. An increase in revenue of $30M increases Operating Profits by just $2M? This does not sound like a good business to be in. Because even after Operating Expenses, there are other expenses, like interest expense from loans or fixed expenses from office rent and the like. Net Income decreased by $2M to -$10M. The second question arises: How did fixed expenses eat up the $2M operating profit gain from the previous year and then some. The answer comes below the corporate Net Income line where it splits the Net Income for the business they are operating and the businesses they are invested in. Nearly all of the additional losses comes from their invested companies. The business they are operating lost an additional $10K from previous year. So, one can conclude two things: more revenue means less income and they have made some very poor investment decisions.

As Cash Flows Statement is not required, so, it was not included. There are some big questions about whether this company can be a going concern. While the businesses it operates is not doing well, there doesn’t seem to be major questions about how everything was accounted for, at least not at a high level. But the companies CFOC decided to invest into lost a lot of money and required the company to write down the value of those purchases. Since it is difficult to find any connections to other causes of loss, further inquiry is necessary.

About the Author: Marcus Maltempo is a compliance professional with more than a decade of experience helping banks, law firms and clients manage investigations and regulatory responses.


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