Are financial misstatements always fraudulent?

There are also situations where there is legitimate reason to update or amend financial documents, such as a change in salary payments, revisions to a dividend policy or a change in the business structure.  

In these circumstances, key is whether changes have been carried out in response to a genuine business need or for the purposes of maximising benefits under an income-protection claim – but this can often be difficult to prove.

Lastly, there is deliberate financial manipulation, carried out for the purpose of submitting a fraudulent claim. This type of financial misstatement, while clearly fraudulent, is more difficult to detect, and all resources and documents available must be utilised if fraud is to be proved.  

There is no hard and fast rule or checklist to follow to identify fraudulent claims, but there are indicators, commonly referred to as red flags, which can assist in the detection of financial misstatement. In conjunction with a review of all available information, these can help identify deliberate financial misstatements.

Indicators for identifying financial misstatement

There are numerous ways of manipulating financial statements, but the end result will always be the same – either overstating pre-incapacity earnings or understating post-incapacity earnings. The focus of any financial review should therefore be the assessment of these two areas, and detailed below are examples of some of the indicators to look for.

• False tax and pay records: Tax return forms are readily available online at HMRC so when reviewing a tax return it is important to check that you have a copy of the return that was actually submitted to HMRC – this can be verified by contacting HMRC directly.

Similarly, there are numerous online payroll packages available for use by small businesses that can easily be used to create false payslips. Therefore it is prudent to check payslip details such as tax codes, PAYE references and dates and to reconcile payslips to tax records.

• Extracting money from the business: For owner-managed businesses, there are many legitimate ways to extract earnings from a business, including salary, dividends, drawings or directors’ loans, or a combination of these.

In reviewing salaries and dividends paid from owner-managed businesses, it is important to review whether the business can afford to make these payments or whether they are being funded from retained profits.

Other methods of extracting income from a company can include director’s loans, backdated dividends and payments to friends and family, and in these circumstances careful consideration is also required to establish whether they are legitimate payments and not financial manipulation for the purposes of the claim.

• Multiple businesses: It is not unusual for a policyholder to generate earnings from more than one business, or for related businesses to have inter-business transactions. However, this situation can complicate the assessment of earnings due to the potential for duplication, and you need to ensure inter-business transactions are accounted for appropriately.

Where multiple earnings sources are involved, it is important to understand the businesses, including how and where earnings are generated and how they are recorded in the business’s policyholder’s tax records – for example, one business paying for the policyholder’s services via another business entity.

Financial misstatement of expenses: Unlike limited companies, sole traders are not required to produce formal accounts, and it is important to remember that sole trader records are not required to be independently reviewed. Therefore expenses may not always be accurately recorded and mistakes may go undetected.

Expenses incurred by businesses typically vary year-on-year, but it is necessary to compare them to prior years and identify why any differences have occurred. It is also important to be aware of unusual entries, such as round-sum figures or large one-off items. Anomalous entries may be genuine business transactions, but they could also indicate financial misstatement.

Closing comment

The review of financials is often a complex situation, as there are many different circumstances and legitimate courses of action in business. The underlying focus in any financial review should be to consider all of the documents and information available together, in the context of each claim, with attention to the presence of any red flags or anomalies that may indicate a deliberate misstatement.

Amanda Fyffe is a director and Helen Walters a manager at forensic accounting and consulting firm RGL Forensics