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Risk Alert: Are bribes lurking on the balance sheet?

When choosing transactions to test as part of anti-bribery assessments, the usual suspects include expense accounts like consulting, marketing, promotions, commissions, or miscellaneous. Other expense accounts are selected based on the nature of the company’s business, risk factors or descriptions of the account.

But don’t overlook the balance sheet. While it is true that corrupt payments may eventually flow through the income statement, the accounting for related activities sometimes starts on the balance sheet; and it can take years before the corrupt payment ends up in an income statement account.

Consider as an example a large international corporation employing a scheme in which employees received large cash advances for travel that were instead used to pay bribes. The company repeated these advances over time and recorded the payments as a reduction in cash and an employee receivable on the balance sheet. The receivables were routinely carried for long periods and then written off (expensed), sometimes years after the advance, upon claims of lost receipts and insufficient documentation.

These advances may not be reconciled. The write-off increases travel expense on the P&L, but not until years after the bribes were made. This simple scheme can be employed anywhere by any company, and an assessment that focuses solely on expense accounts will not detect it until it is too late. Other relevant balance sheet categories include accounts receivable, goodwill, and fixed assets:
Accounts Receivable. In another example stemming from an FCPA enforcement action, a large corporation paid an agent several million dollars, ostensibly for customs clearance in a foreign country. In fact, the payment was made to the re-election campaign of that country’s president. The company recorded the expense as A/R for Reimbursable Operating Expenses -- an accounts receivable account on the balance sheet. Later, the company decided to exit the country and settle its accounts receivable balances. It wrote off the uncollected balances to bad-debt expense, including the campaign contributions sitting in the Reimbursable Operating Expenses account.
Building on a previous post, other examples of balance sheet bribes can be much more complex.
Goodwill. When bribes are paid as part of asset acquisitions -- i.e. the purchaser overpays the seller and the seller shares the overpayment with various parties to the scheme -- how and where are the corrupt payments recorded? In this example, the corrupt payments are recorded in the purchase price, since they were a hidden component of that price. The overpayment portion of the purchase price may then be allocated as goodwill, which will sit on the balance sheet unless and until the purchaser later conducts a new valuation and finds that the asset is impaired. The company would then write-down the value carried on the balance sheet and expense the impairment, including the cost of the bribe, in the period in which the impairment was determined.
Fixed Assets. What happens to the accounting for any corrupt payments associated with an asset sale – i.e. the seller secretly agrees to sell for a price less than market value in return for the purchaser agreeing to share the hidden discount with various parties to the scheme? This is a more subtle variation, and may be more difficult to test. If the net asset value (net of depreciation) recorded in the balance sheet is above the agreed-upon sales price, then a loss on the sale of the asset (an expense) will be recorded. A bribe could be inherently a part of this expense, because without the corruption the sales price would have been higher, reducing the loss. If the net asset value is below the sales price, then a gain is recognized as income, but the gain is reduced by the bribe amount. Discovering the missing gain can be very difficult.
Other balance sheet liability accounts that have featured prominently in some of the biggest FCPA enforcement actions include accumulated profit reserves and internal commission accounts; these were used to create pools of funds from which corrupt payments were made as needed.
So what can be done to include or consider the balance sheet in anti-bribery assessments? 

Some of the questions you can ask regarding asset acquisitions and sales were listed in a previous post. But data analytics can help highlight risks on the balance sheet, including analytics to detect:

  • Asset impairment shortly after acquisition
  • Aged employee receivable accounts
  • Miscellaneous or rounded credits to employee receivables
  • Losses recorded on sales of shortly held assets
  • Growth in write-offs reflecting increased bad debt

The possibilities for “hiding” corrupt payments on the balance sheet long before they are expensed are likely endless. Your next anti-corruption assessment might want to consider including the balance sheet.

Note that none of the information in this post relates to the author’s employer or its affiliates.


Cody Worthington, a Contributing Editor of the FCPA Blog, is a Senior Manager in the Forensic Investigations group at Johnson Controls International plc, based in Glendale, Wisconsin. He's a Certified Fraud Examiner, Certified Internal Auditor, and a Certified Public Accountant. He can be contacted here.

Reader Comments (3)

Terrific examples of how bribes can and have been hidden on balance sheet. I have seen some of these schemes used for fraud as well. You just challenged many compliance officers to employ audit and hopefully continuous monitoring of their company's balance sheets. Begs the question of how external auditors in these real life situations failed to question or pursue these balance sheet provisions and then monitor account change. Could one possibility be that many fell below thresholds of materiality for large multinationals?
March 6, 2018 | Unregistered CommenterMark Speck
Very few professionals are inclined to look into Balance Sheet items for Bribery, Corruption. In my years of working for overseas subsidiaries / branches of US and European conglomerates, Bribery and Corrupt payments were well camouflaged as prepaid expenses (capitalized) under categories of legal, Inspection and consultancy charges etc. On the opposite, provisions were made for these aforesaid items pending approvals from Health, Environment Ministries. When questioned the purpose and need to create these liabilities, vague answers without any substantiations were given. Most of the times, these kinds of payments do not get scrutinized and get into washing machines at the time of consolidation. These methods were quite common in basic industries like Oil & Gas, Big Pharma, Motor Vehicle SKD and Consumer industries etc.
March 6, 2018 | Unregistered CommenterSubash Murray
Cody, Excellent piece. @Mark, I think you make an important point about materiality impacting the effectiveness of detection controls. We accountants in the compliance profession need to remember to coach our Finance/Controlling/Internal Audit colleagues upon whom we may rely during risk assessments or substantive testing that the relevant laws do not have materiality thresholds. As a result, our sampling and testing techniques will have to be appropriately nuanced.
March 6, 2018 | Unregistered CommenterGerard Leeman
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