Famous Examples of Accounting Frauds

Accounting fraud is the deliberate manipulation of financial records to present a company’s financial health in a deceptively favorable light. It is a calculated effort to mislead investors, creditors, and the public by violating established accounting principles. These manipulations range from subtle distortions to outright fabrications, designed to influence stock prices, secure financing, or enrich executives. The consequences often lead to significant investor losses, company collapses, and an erosion of trust in financial markets.

Fictitious Revenue Schemes

A common form of accounting manipulation is creating fictitious revenue. This approach makes a company appear more profitable by inventing sales or improperly recognizing revenue before it is earned. This deception can be executed by creating fake invoices or manipulating the timing of revenue recognition in violation of accounting standards.

An infamous example is Enron, an American energy company that collapsed in 2001. Enron used off-balance-sheet vehicles known as Special Purpose Entities (SPEs) to hide debt and generate artificial profits. The company would transfer its own assets to these SPEs and then book the transactions as sales, creating the illusion of revenue from internal dealings.

Enron used “mark-to-market” accounting to immediately book projected future profits from these deals, even if no cash had been received. This practice allowed Enron to report massive earnings from ventures that were failing or non-existent. The scheme was enabled by Enron’s own executives running the SPEs, creating a conflict of interest that was not disclosed to investors.

Another major scandal involved WorldCom, a telecommunications giant that filed for bankruptcy in 2002. WorldCom’s fraud primarily involved improperly capitalizing operating expenses. The company took billions in “line costs”—fees paid to other telecom companies for using their networks—and recorded them as capital expenditures, a violation of Generally Accepted Accounting Principles (GAAP).

By capitalizing these expenses, WorldCom spread their cost over many years, which inflated its reported profits. The company also made fraudulent entries to create fictitious revenue streams. An internal audit eventually uncovered manipulations that had inflated the company’s assets by over $11 billion, and a subsequent financial restatement revealed years of concealed losses.

Concealed Liabilities and Expenses

Another method of accounting fraud involves concealing liabilities and expenses to present a healthier financial picture. By hiding debts or failing to record expenses as they are incurred, a company can make its balance sheet appear stronger and its operations more profitable. This misleads investors and creditors into believing the company is less risky.

The collapse of Lehman Brothers in 2008 provides an example of this deception. The investment bank used an accounting maneuver known as “Repo 105” to temporarily remove tens of billions of dollars of liabilities from its balance sheet. A standard repurchase agreement, or repo, is a short-term loan where a company sells assets with an agreement to buy them back.

Lehman exploited a loophole by structuring these as “Repo 105” deals, arguing that over-collateralizing the assets allowed them to be classified as “sales” instead of loans. This interpretation allowed Lehman to treat the cash received as proceeds from a sale, which it then used to pay down other debts right before the end of a reporting period.

This practice artificially reduced Lehman’s reported leverage, making the firm appear less risky. In the first two quarters of 2008, Lehman used these transactions to temporarily remove approximately $50 billion from its balance sheet. After the reporting period ended, the company would borrow funds to buy back the assets, and the liabilities would reappear on its books, a fact not disclosed to the public.

Improper Asset Valuation

Improper asset valuation occurs when a company deliberately overstates the value of its assets or fails to record a decline in their value, a process known as depreciation. This type of fraud can make a company appear more asset-rich and profitable, as it directly impacts both the balance sheet and the income statement.

The case of Waste Management, Inc. in the 1990s is an example of this practice. The company inflated its earnings by manipulating its depreciation expenses. A primary method was to arbitrarily increase the salvage value of its garbage trucks and equipment. Inflating this value reduced the annual depreciation expense, which boosted pre-tax profits.

The company also extended the useful lives of its assets without justification, which also reduced the annual depreciation expense. The Securities and Exchange Commission (SEC) found these practices, along with other manipulations, resulted in a $1.7 billion overstatement of pre-tax earnings over five years. When uncovered, the fraud led to one of the largest financial restatements in history at the time.

Outright Financial Fabrication

This form of accounting fraud involves the outright fabrication of a company’s financial reality. It goes beyond manipulating specific accounts by inventing significant portions of the financial statements, such as revenue, profits, and cash balances. These schemes often involve forged documents and collusion among top executives.

An international example is the case of Satyam Computer Services, once one of India’s largest IT firms. In 2009, its chairman confessed to a long-running fraud where he had falsified the company’s accounts. The most significant aspect was the fabrication of over $1 billion in cash and bank balances that did not exist.

The deception was maintained with thousands of fake invoices and forged bank statements to give the illusion of real business activity. These fictitious records were used to inflate the company’s revenue and profits, which boosted its stock price. When the truth was revealed, it led to the company’s collapse and subsequent acquisition.

A more recent example is Wirecard, a German payment processing company that collapsed in 2020. Wirecard claimed to have €1.9 billion in cash held in trustee accounts in Asia. An audit could not verify the existence of these funds, and it was later revealed that the money had likely never existed, and its auditor had been provided with fake confirmations for years.

The fraud was maintained for a significant period despite questions from journalists. Wirecard attacked its critics and convinced German regulators to investigate those questioning its accounting. The scheme’s unraveling led to the CEO’s arrest and the company’s insolvency, wiping out billions in market value.