Corporate Finance For Dummies
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Fraud, embezzlement, and illegal practices occur in large corporations and in one-owner/ manager-controlled small businesses — and in every size business in between. The purchasing managers in any size business can be tempted to accept kickbacks and under-the-table payoffs from vendors and suppliers.

Some types of fraud are more common in small businesses, including sales skimming (not recording all sales revenue, to deflate the taxable income of the business and its owner) and the recording of personal expenses through the business (to make these expenses deductible for income tax).

Some kinds of fraud are committed mainly by large businesses, including paying bribes to public officials and entering into illegal conspiracies to fix prices or divide the market.

Fraud and illegal practices happen in the business world and require manipulation of a business’s accounts. For example, if a business pays a bribe it does not record the amount in a bald-faced account called “bribery expense.” Rather the business disguises the payment by recording it in a legitimate expense account (such as repairs and maintenance expense, or legal expense).

If a business records sales revenue before sales have taken place (a not uncommon type of financial reporting fraud), it does not record the false revenue in a separate account called “fictional sales revenue.” The bogus sales are recorded in the regular sales revenue account.

Here’s another example of an illegal practice. Money laundering involves taking money from illegal sources and passing it through a business to make it look legitimate — to give the money a false identity. This money can hardly be recorded as “revenue from drug sales” in the accounts of the business.

If an employee embezzles money from the business, he has to cover his tracks by making false entries in the accounts or by not making entries that should be recorded.

Manipulating accounts to conceal fraud, illegal activities, and embezzlement is generally called juggling the accounts. Another term you probably have heard is cooking the books.

Although this term is sometimes used in the same sense of juggling the accounts, the term cooking the books more often refers to deliberate accounting fraud in which the main purpose is to produce financial statements that tell a better story than are supported by the facts.

Now here’s an irony: When crooks commit accounting fraud they also need to know the real story, so they keep two sets of books – one for the fraud numbers and one for the real numbers.

When the accounts have been juggled or the books have been cooked, the financial statements of the business are distorted, incorrect, and misleading. Lenders, other creditors, and the owners who have capital invested in the business rely on the company’s financial statements.

Also, a business’s managers and board of directors (the group of people who oversee a business corporation) may be misled — assuming that they’re not a party to the fraud, of course — and may also have liability to third-party creditors and investors for their failure to catch the fraud.

Creditors and investors who end up suffering losses have legal grounds to sue the managers and directors (and perhaps the independent auditors who did not catch the fraud) for damages suffered.

The IRS is on constant alert for fraud in federal income tax returns, both business and personal returns. The IRS has the authority to come in and audit the books of the business and also the personal income tax returns of its managers and investors. Conviction for income tax evasion is a felony.

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