Forensic Focus on COVID-19 Financial Statement Fraud

Forensic Focus on COVID-19 Financial statement fraud This is the first in a Deloitte Forensic series around COVID-19 business impacts and steps you can proactively take to help respond to and recover from the outbreak and mitigate potential fraud and financial crime risks.

The coronavirus disease (COVID-19) outbreak sensitive to the pressures that could result in • Understatement of allowances and has quickly advanced on a global scale and financial statement manipulations at the reserves—Companies have numerous responses to it continue to rapidly evolve. The corporate or operating subsidiary level. valuation accounts, allowances, and reserves financial impact of Further, management should recognize that including—but not limited to— those for COVID-19 will likely put enormous pressure on the environment created by adverse events inventory, accounts receivable, insurance corporations’ financial results and present such as COVID-19 could lead to increased claims incurred but not recorded, income taxes, potential challenges for individual employees. fraud by employees (e.g., asset and contingent liabilities. Management may be This pressure may increase the temptation for misappropriation or bonus maximization motivated to intentionally manage these individuals to engage schemes). reserves in improper acts in order to address their to avoid additional charges to the bottom immediate financial needs or resort to financial In particular, organizations should consider the line. statement manipulation to meet stakeholder following risks: expectations. • Manipulation of valuations and • Overstatement of revenue—To make impairments—Organizations use forecasts up for decreased consumer spending, as a key element in the valuation of assets such For some, as these financial pressures mount, companies may endeavor to deliberately the line separating acceptable from as inventory, goodwill, financial instruments, fabricate revenue to boost bottom lines and investments (such as portfolio companies and unacceptable behavior can become blurred. show how management was able At the same time, controls debt/equity securities issued by entities), and to persevere in a challenging customer/ certain long-term contracts. Disruptions to such as segregation of duties may be weakened business environment. due to work force displacement or distraction. supply chains and the volatility in financial Organizations need to be Forensic Focus on COVID-19: Financial statement fraud Should allegations surface regarding markets may result in organizational challenges • Margin manipulation—Many companies are accounting/financial reporting misconduct to record such assets at their net realizable or already experiencing significant decline in and/or regulatory inquiries, it is important fair values. Given the inherent uncertainty in revenues, closures of plants, facilities, and to seek assistance from an experienced valuing such assets in turbulent times, some storefronts, reduced transaction fees, and team of forensic companies may take advantage and consider declines in assets under management, all while professionals dedicated to and well-versed in intentionally delaying the recording of such paying their employees and supporting current- conducting extensive fact-finding financial losses or may attempt to overvalue certain state cost structures. Each of these actions statement fraud and corruption assets in order to generate insurance recoveries. increases the risk that an organization’s profit investigations using advanced analytics, margins could be manipulated. There are many digital forensics, and control remediation.

• Restructurings and “big bath” ways in which this can be done, but organizations —Given the strong probability of charges should consider these risks and be aware of how outbreak-related financial losses, affected it could happen at their company. We’re here to help companies may seek to write-off underperforming assets and/or record charges • Pressures arising from “stock-drop” Deirdre Carwood as part of larger organizational restructurings, litigation—Plaintiffs’ securities firms may seek Partner, Forensic sale, or closure of parts of their business that to capitalize on stock price drops resulting from [email protected] are either marginally the crisis, leading to a slew of new case filings. +353 1 4907051 associated with the impact from COVID-19 or Efforts to avoid costly litigation may lead to not associated at all. financial manipulation resulting in the Eoin O’Reilly misrepresentation of not only a company’s —It may be Director, Forensic • Capitalization of expenses financial statements and disclosures, but also of tempting for companies to capitalize [email protected] key performance indicators in an effort to create expenses and deduct them over several +353 1 4172839 “better than expected” operating reports. accounting periods rather than expense them immediately. Outbreak-related costs may • Internal Controls over Financial be substantial, and executives may be inclined to Reporting (ICFR)—The current economic spread the costs out over a environment may result in increased fraud risks few years, rather than expensing them when related to internal controls. As many incurred. organizations move to a virtual work environment, there is a significant risk that —Companies may be • Disclosure fraud fraudsters may find new ways to override motivated to avoid fully disclosing the existing internal controls, especially those impact of COVID-19 on its overall critical to ICFR. Such controls may include, business results, particularly with respect to but are not limited to: segregation of duties, risks, uncertainties, contingencies, delegation of authority, and information systems and representations contained in their public access. With a potential decrease in workforce, statements, and regulatory filings. For the rapidly changing nature of working example, particular concerns may arise environments, and the possibility of changes in regarding companies’ or individual responsibilities, modifications to their counterparties’ ability to satisfy existing controls may contractual obligations. The disclosure not happen with the same speed, or new should also include an assessment controls may be implemented without of whether reliance on force majeure provisions sufficient testing of their design and/or or common law principles of nonperformance effectiveness. Accordingly, the nature, timing, may apply. The adequacy and sufficiency of and extent of diligence performed in a such disclosures may lead to claims of securities changing control environment create fraud by regulators and investors. increased opportunity for fraud.

This publication contains general information only and Deloitte is not, by means of this publication, rendering accounting, business, financial, investment, legal, tax, or other professional advice or services. This publication is not a substitute for such professional advice or services, nor should it be used as a basis for any decision or action that may affect your business. Before making any decision or taking any action that may affect your business, you should consult a qualified professional advisor.

Deloitte shall not be responsible for any loss sustained by any person who relies on this publication.

As used in this document, “Deloitte” means Deloitte Financial Advisory Services LLP, which provides forensic, dispute, and other consulting services, and its affiliate, Deloitte Transactions and Business Analytics LLP, which provides a wide range of advisory and analytics services. Deloitte Transactions and Business Analytics LLP is not a certified public accounting firm. Please see www.deloitte.com/us/about for a detailed description of our legal structure. Certain services may not be available to attest clients under the rules and regulations of public accounting.