Economic Crime Journal

Economic Crime Journal

Dr. David Murphy is a Certified Fraud Specialist and Certified Public Accountant and is a member of the Board of Regents of the Association of Certified Fraud Specialists. In addition, he has served as the Senior Anti-corruption Advisor to the Controller General of Peru and the government of Bulgaria. He was also the director of a two-year USAID anti-corruption graduate education project in Bolivia and consulted to the Central Bank of the Philippines in the wake of a major bank fraud in Manila.

Other Posts:

ASIS Economic Crime Council Highlights LC's Program (11/06/2009)
Fraud on Steroids (10/19/2009)
U.S. Banking Fraud Interview (04/27/2009)
Financial Statement Fraud (04/17/2009)
Internet Fraud on the Rise (04/06/2009)
Fraud Close to Home (03/27/2009)
Can Economic Crime Be Eliminated? (03/20/2009)
Madoff and Ponzi (03/26/2009)
New Credit Card Scam (05/01/2008)

Richard Scrushy, CEO of the former HealthSouth, was asked by federal prosecutors why he wasn't concerned that his company's sales were increasing while its number of facilities were decreasing.  He responded that the auditors missed it too.  The fact is that accounting numbers should be related to underlying business and economic realities.  For example, we know that if sales increase then cost of goods sold should increase by about the same percentage.  Most fraud investigators and auditors are use to looking for logical relationships between related accounts. 

What is often overlooked is the relationship between financial statements and non-financial measures.  Research has shown that when a company's non-financial measures like number of employees, amount of warehouse space, number of sales outlets or the number of manufacturing facilities differ significantly from financial measures, the financial statements may have been fraudulently misstated.

While many different non-financial measures may be used the one that appears to be most telling is surprising and simple; the number of employees.  Measures like customer satisfaction, production capacity, retail outlets, number of distributors, number of dealers, or floor space are significant.  However changes in most of them will cause a change in the number of employees.  For example, if production capacity decreases then the number of production workers should also decrease.  If the number of retail outlets or retail floor space increases, the number of retail employees should also increase. 

The bottom line, if revenue and net income are increasing and the number of full-time equivalent employees is decreasing then be suspicious.  Ask questions.