Category Archives: General

RSM’s Global Leader for Quality and Risk, Bob Dohrer, draws parallels between horse meat and financial fraud

The current scandal taking place in Europe involving the substitution of horse meat in food products purportedly made of beef has prompted a massive recall and spurred a significant social debate. Would you consider this scandal to be a fraud committed against consumers? Is there a parallel between this scandal and our profession?

The ‘fraud triangle’ is a concept that is premised on three different criteria being present when the risk of fraud is elevated:

- there needs to be an incentive for the perpetrator to commit the fraud

- there needs to be an opportunity presented for the perpetrator to execute the fraud

- there must be ability on the part of the perpetrator to rationalise or justify his or her actions.

It is fairly evident that in the case of the horse meat scandal there was an opportunity to obtain higher profit margins on the products in question by using cheaper horse meat instead of beef. With financial frauds, the same types of incentives are often in play; repairs and maintenance costs to equipment might be inappropriately capitalised to avoid recording expenses on the income statement, or fictitious inventories might be recorded to inflate the balance sheet for example. In both cases, the incentive is often to make profit appear better than it really should be and often the individuals involved in the fraud benefit personally in some way from the inappropriately inflated profits.

With either the horse meat scandal or financial fraud, an opportunity presents itself for the fraud to be perpetrated because of a weakness or breakdown in quality control. With the horse meat scandal, testing is designed to be carried out to verify that the components listed on food packaging are actually the components in the food product. With financial fraud, basic internal controls over financial reporting such as segregation of duties for example, are designed to help prevent intentionally misleading financial information from being provided to users of the financial information. When financial fraud has occurred, a weakness or deficiency in the design or operation of internal controls is generally present.

And lastly, how might one rationalise or justify committing fraud? With respect to the horse meat scandal, the excuse frequently heard is that horse meat is perfectly acceptable for human consumption and thus, no one is hurt by unknowingly eating horse meat. The excuses for financial fraud are often the same and fraud such as premature revenue recognition or capitalisation of expenses is often passed off as just a timing issue; that over a period time, no one is disadvantaged.

Wouldn’t it have been ideal if someone would have identified the risk that a producer would substitute horse meat for real beef and thus would have been able to put testing and other preventative measures in place to keep the horse meat from arriving on supermarket shelves in the first place?

The fact is that using the fraud triangle after a fraud has been revealed is easy; hindsight is almost always perfect! But as auditors, our responsibility to the public interest is to use the fraud triangle to identify financial fraud risk before it happens or at least detect that it occurred and prevent financial statement users from being misled. Of course, this means that we must never just believe management’s statements given to us without the evidence to corroborate the details and that we always insist on performing tests of financial information to obtain persuasive audit evidence supporting or refuting management’s assertions. As auditors, if we discharge our responsibilities to the public with respect to fraud as required by our professional standards, perhaps other sectors such as the food industry, can look to us as exhibiting behaviour to model themselves after.