Financial statement analysis is a process that enables readers of a company’s financial reports to develop and answer questions regarding the data presented. Financial statements express the economic condition of a company in three ways: (1) the balance sheet reports assets, liabilities, and owners’ equity; (2) the income statement accounts for the income or loss of the company; (3) and the cash flow statement displays the sources and uses of cash.
Financial analysis techniques can help investigators discover and examine unexpected relationships in financial information. These analytical procedures are based on the premise that relatively stable relationships exist among economic events in the absence of conditions to the contrary. Known contrary conditions which cause unstable relationships to exist might include unusual or nonrecurring transactions or events, and accounting, environmental, or technological changes. Public companies experiencing these events must disclose and explain the facts in their financial statements. Increasingly, private and not-for-profit companies follow best practices and do the same.
Unexpected deviations in relationships most likely indicate errors, but also might indicate illegal acts or fraud. Therefore, deviations in expected relationships warrant further investigation to determine the exact cause. Several methods of analysis assist the reader of financial reports in highlighting the areas that most likely represent fraudulent accounting methods.
Analytical procedures are used to detect and examine relationships of financial information that do not appear reasonable. They are useful in identifying:
• Differences that are not expected;
• The absence of differences that are expected;
• Potential errors;
• Potential fraud and illegal acts; and
• Other unusual or non-recurring transactions or events 8
8 HOW TO DETECT AND PREVENT FINANCIAL STATEMENT FRAUD (SECOND EDITION) (NO. 99-5401)
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