M&A Due Diligence: Consideration of Fraudulent Financial Statements

• DOI: http://doi.org/10.1002/jcaf.22117
• Author: J. Ralph Byington,Jo Ann McGee
• Date: 01 January 2016
• Published date: 01 January 2016

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© 2016 Wiley Periodicals, Inc.

Published online in Wiley Online Library (wileyonlinelibrary.com).

DOI 10.1002/jcaf.22117

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M&A Due Diligence: Consideration

ofFraudulent Financial Statements

Jo Ann McGee and J. Ralph Byington

INTRODUCTION

Merger and

acquisition (M&A)

deals are considered

to be one of the

traditional avenues

for management to

pursue to increase

shareholder wealth

(Mahn,2011). The

motivations for

this activity include

the ability to (1)

strengthen market

position, (2) improve

economies of scale,

and (3) expand into new mar-

kets as ways to achieve rapid

growth and return. Thepro-

cess will also enable them to

gain new expertise, synergism,

knowledge, and technologies

that will make the acquiring

business become in general

more efficient and more effec-

tive (Oil Voice, 2011). While

M&A activity is anticipated

to increase shareholder wealth

and satisfaction, it does not

come without risks. Compa-

nies engaging in this activity

have long been familiar with

the legal and financial due dili-

gence that is necessary before

entering into a merger. How-

ever, corporate management

should be aware of the need to

conduct an in depth analysis

for financial misstatements.

Should their company acquire

a company that has fraudulent

financial statements (FFSs),

the consequences can be severe,

including devastating results for

their employees, shareholders,

lenders, board of directors, and

anyone else who relies on the

falsified statements. Possible

results include com-

panies being sold for

unrealistic prices,

the extending of

credit to undeserving

entities, and share-

holders investing in

overvalued securities

(Gravitt & Johnston,

2008). The purpose

of this article is to

familiarize corporate

management with

the common fraud

schemes employed to

create FFS and the

red flags that signal

the potential existence of these

schemes.

OVERVIEW OF FRAUDULENT

FINANCIAL STATEMENTS

Kelley (1976) defined

white-collar crime (WCC) as

illegal acts involving deceit,

violation of trust, and conceal-

ment that are not dependent

on physical force or violence.

More recently, the Association

of Certified Fraud Examiners

(ACFE, 2014) referred to this

type of crime as occupational

Merger and acquisition (M&A) deals help com-

panies grow quickly (Whitchelo, 2015). However,

these types of deals do not come without risks.

Corporate management should be aware that

when they are conducting M&A due diligence,

they should exercise caution in regards to the

existence of fraudulent financial statements (FFSs)

because of the severe consequences related to

FFS. Thepurpose of this article is to familiarize

corporate management with the common fraud

schemes employed to create FFS and the red

flags that signal the potential existence of these

schemes. © 2016 Wiley Periodicals, Inc.

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