Ye Qinhua Ye Fan Huang Shizhong: Identification and Response to Income Fraud - Based on the case study of Oriental Jinyu trading fraud
Original Ye Qinhua et al. Finance and Accounting
The largest proportion of financial fraud types is income fraud, which is even more so in the transaction fraud category (Huang Shizhong et al., 2020), in more and more financial fraud cases, enterprises in the manipulation of income at the same time, often also on the monetary funds, inventory and other asset items to cover up the financial abnormalities caused by income fraud, so when identifying income fraud, you can start from these related asset categories. However, in transaction fraud income cases such as Oriental Jinyu (600086) and Selen Technology (002341), due to the cooperation of the closed loop of capital flow, it is sometimes difficult to find clues from asset-type accounts, which brings new challenges to certified public accountants to identify fraud risks. Based on the case of financial fraud of Oriental Jinyu, this paper analyzes the new characteristics, new means and new identification signs of transaction fraud income fraud.
Oriental Jinyu's financial fraud was listed by the CSRC as one of the 20 typical illegal cases in 2020, and the total inflated profits in the 2016 annual report, 2017 annual report and 2018 semi-annual report were 0.95 billion yuan, 184 million yuan and 0.79 billion yuan respectively, and the proportion of the inflated profits in the total consolidated income statement profits of the corresponding reporting period was 29.60%, 59.70% and 211.48% respectively. Fictitious trading is the most eye-catching problem of Oriental Jinyu's income fraud. An in-depth analysis of this case shows that the company's fictitious and complex "hidden" related party relationships and the "one-stop fraud" chain of in vitro funds in vitro can be observed. This also poses new challenges and inspirations for anti-fraud procedures and verification ideas.
I. The "Death" of the Emerald Empire
Oriental Jinyu is a backdoor listed company in the jadeite industry. In 2003, Zhao Xinglong, the "King of Gambling Stones", established Yunnan Xinglong Industrial Co., Ltd., which is mainly engaged in the sales of handicrafts and jewelry. In 2005, Zhao Xinglong spent about 57.47 million yuan on two occasions to become the largest shareholder of Duojia shares of the listed company, and injected the jade assets of Yunnan Xinglong Jewelry Company to achieve backdoor listing. In August 2006, Duojia shares changed its name to Oriental Jinyu. After 2011, Oriental Jinyu was involved in frequent capital operations, and the private placement in May 2014 caused regulators to pay attention to the actual controller Zhao Xinglong, and in 2015, the subsidiary Shenzhen Oriental Jinyu Company invested 2.2 billion yuan to establish Oriental Jinyu Microfinance Co., Ltd. (hereinafter referred to as Jinyu Small Loan). In April 2016, Zhao Xinglong resigned as chairman of the board due to health reasons, and his son Zhao Ning took over.
Since 2018, the problem of Oriental Jinyu has emerged. Since January 2018, the company's major shareholders have been repeatedly hindered in their attempt to "shell out the shell of the golden cicada" through major asset restructuring; in July 2018, the "17 jinyu bonds" issued by the company could not pay interest on time, and some bank accounts and assets were judicially frozen; the Hubei Securities Regulatory Bureau and the Shanxi Securities Regulatory Bureau punished The Oriental Jinyu repeatedly violated the law. Since 2019, the problem of financial fraud has begun to appear: in January 2019, due to external factors such as debt default litigation and media doubts, Oriental Jinyu was investigated for information disclosure violations; in April 2020, it received an administrative penalty advance notice; finally, in 2021, Oriental Jinyu was identified as a financial fraud in the category of transaction fraud, and was terminated in January 2021.
The financial fraud of Oriental Jinyu identified by the CSRC was mainly in the 2016 annual report, 2017 annual report and 2018 semi-annual report, fictitious jadeite rough sales and procurement transactions between its controlled sister Andi Hongning Company and six nominal customers of natural persons, including Pu Rila, and six nominal suppliers such as Li Ganhui, thereby inflating operating income, operating costs, total profits and accounts receivable. The CSRC's penalty letter also pointed out the abnormal characteristics and evidence of fictitious behavior, mainly including: the customer's handwriting on the sales contract was not his real handwriting; the customer declared that no jadeite rough transaction had occurred with the company; there was no record of the subject matter of the delivery contract, such as the name record of the pick-up, the pick-up document, the logistics document, etc., and the relevant staff did not know the whereabouts of the subject matter; the customer lacked the relevant experience, financial strength and channels of the jadeite rough transaction, and did not have the ability to perform the contract; and the sister told Hongning Company to control 19 bank accounts to forge cash flow. It covers 6 fictitious customers, 7 transit natural persons and 6 fictitious suppliers.
Daxin Certified Public Accountants and UOB issued unqualified audit reports on Oriental Jinyu's 2016 and 2017 financial reports respectively, and it was not until Oriental Jinyu was investigated that UOB issued a qualified opinion on the company's 2018 financial report. In July 2020, the Shanghai Stock Exchange's inquiry letter "Sword Finger" accounting firm asked it to answer the reasons and reasonableness of the company's financial fraud that had not been discovered despite repeated media and regulatory questions.
II. "Analysis" of Fictitious Transactions
This paper attempts to engage in pre-analysis and multi-dimensional data perspectives, discuss how to find anomalies in financial indicators, analyze the degree of matching of financial logic and business logic, and provide inspiration for more timely identification of transaction fraud revenue fraud. This article will use the framework of the five-dimensional financial fraud identification model for analysis (Ye Qinhua et al., 2021), and the analysis period is mainly the 2016-2018 annual report and semi-annual report of Oriental Jinyu that have cheated. Among them, before the disclosure of the 2018 annual report, Oriental Jinyu has been investigated, the annual report should not involve fraud, and the final penalty does not involve the 2018 annual report. Therefore, the 2018 annual report is used as a comparison of the late stage of fraud. Oriental Jinyu has been adjusted in its annual report for many years, and this article selects pre-adjustment data that does not involve fraud adjustment.
(1) Financial and tax dimension: the linkage between the revenue growth rate and related indicators is abnormal
Table 1 shows the revenue, cost, profit and other financial data of Oriental Jinyu from 2016 to 2018. The first anomaly that can be found is that after a revenue decline of more than 20% in 2016, it suddenly achieved a revenue growth "performance" of 40.74% in 2017. Theoretically, such a continuous large change may only indicate that the company's performance has fluctuated abnormally, how to further discuss whether there is fraud in financial anomalies? An effective method is to select the same industry data as the reasonable expectation value of the indicator analysis and analyze the rationality of its abnormal fluctuations. Oriental Jinyu is the main business of the relatively single jewelry manufacturing industry, this article refers to the industry classification data of the financial fraud identification system of Tianjian Caiju, and selects six listed companies such as Gangtai Group, Jinyi Culture, Qiulin Group, Chao Hongji, Gangtai Holdings, and Jinzhou Cihang as the same industry comparison company (the six companies are selected here as a comparison, on the one hand, to solve the problem that the industry classification of the CSRC is not meticulous enough. On the other hand, it also gives a relatively efficient and easy-to-define way of contrasting. Theoretically, to make the most matching comparison, a variety of factors need to be considered), and through the analysis, it was found that there were two fraud warning signals in Oriental Jinyu:
First, the revenue growth rate in 2017 (40.74%) was much higher than the average revenue growth rate of comparable companies in the same industry (14.63%), and the revenue structure of the year did not change significantly, and its revenue growth performance was questionable.
Second, the per capita output value of Oriental Jinyu (operating income/total number of employees) reached 19.7375 million yuan, which is also much higher than the industry average, but the per capita salary of Oriental Jinyu sales staff is 69,000 yuan, far lower than the industry average of 103,100 yuan. While the growth rate of income is much higher than the growth rate of listed companies in the same industry, the per capita salary is far lower than the level of the same industry, and "one high and one low" is puzzling.
(2) Financial and tax dimension: the linkage between gross profit margin and inventory is abnormal
When enterprises implement revenue fraud, they often need to pay taxes, internal and external collusion, upstream and downstream cooperation and other related "counterfeiting costs". In order to save "counterfeiting costs", companies sometimes artificially adjust gross margins, especially in special industries where product pricing or cost carry-over is difficult to verify, such as the jadeite jewelry industry. Therefore, the analysis of gross margin anomalies is also another important breakthrough in identifying revenue fraud.
As shown in Table 1, the change in the operating cost of Oriental Jinyu is similar to the operating income and fluctuates. However, inventory continued to rise, basically higher than the growth rate of operating costs, and the year-on-year growth rates of the 2017 semi-annual report and annual report reached 43.91% and 39.60%. Moreover, the proportion of inventory in total assets is extremely high, from 72.38% in the 2016 semi-annual report to 79.53% in the 2018 semi-annual report. Through industry comparison, it can be seen that its inventory turnover rate is also much lower than the average level of the same industry.
Table 2 shows the cash flow of Oriental Jinyu, and it can be found that the monetary funds continue to decrease significantly, mainly because the absolute amount and growth rate of cash for the purchase of goods and the payment of services are basically higher than the cash received from the sale of goods and the provision of services. This shows that the revenue, gross profit and cash realized by Oriental Jinyu may be "absorbed" by inventory to a large extent. To this end, it is necessary to pay attention to the existence of the product, whether the unit cost of the finished product balance at the end of the period is high, and whether the completeness of the cost carry-forward is reasonable.
Table 3 further analyzes the types of inventory and the income they bring, oriental jinyu products mainly have three categories: gold bars and jewelry, jadeite finished products, jadeite raw materials, the latter two are listed in the inventory of goods. From 2016 to 2018, the proportion of finished jadeite products and jadeite raw materials in revenue and inventory has increased significantly. It can be expected that the verification of jadeite inventory should be more difficult than the verification of gold inventory. It can be seen that judging whether The large amount of "jadeite" inventory hoarded by Oriental Jinyu is a normal strategic procurement reserve, or whether it is used as a "reservoir" for gross profit margin adjustment by using the more difficult to verify characteristics, is also the top priority of fraud verification.
(3) Internal control dimension/digital feature dimension: abnormal customer and supplier characteristics
Studies have shown that behind the financial fraud of transaction fraud is often accompanied by collusion and collusion between upstream and downstream transaction objects (Huang Shizhong et al., 2020). In the early days, on the grounds that customer and supplier information was a trade secret, Oriental Jinyu did not disclose the specific information of the top five customers and suppliers, but only disclosed the total amount of purchase and sale and the proportion of related parties therein. Until the Shanghai Stock Exchange's 2017 annual report inquiry letter put forward a clear request to disclose the relevant information, and replied that the company has no relationship with customers and suppliers, Table 4 is the customer and supplier situation of Oriental Jinyu Jadeite Rough, there are still many doubts:
First, there is an implicit correlation between important customers and suppliers. In 2017, the second largest supplier, Shanghai Master Jade Carving Co., Ltd., only transferred control from Shanghai Zhang Tiejun Jewelry Group Co., Ltd. to Zhou Wenqing and Zhao Wei in March 2014, and then jointly controlled a financing guarantee company with the customer Shanghai Zhang Tiejun Jade Co., Ltd., corresponding to a sales amount of about 199 million yuan and a purchase amount of about 214 million yuan. Another example is that among the top ten customer suppliers disclosed in the inquiry in 2018, Dongguan Jiayan Jinpin Jewelry Technology Co., Ltd., Shenzhen Jiayan Jinpin Jewelry Sales Co., Ltd. and Shenzhen Yuetong International Jewelry Co., Ltd. have the same directors, supervisors and senior management.
Second, the registration information of listed companies and important customers and suppliers is implicitly related. For example, ruili Shangyi Jewelry Co., Ltd., the fifth largest supplier in 2017, was dissolved in January 2019, and its address is adjacent to the subsidiary of Oriental Jinyu. For example, Oriental Jinyu has the same contact information as important customers Ruili Laisheng Jewelry Store, Haobin Jewelry Store, yuanhao Jewelry Store, and the three customers were established on November 8, 2017, is it a coincidence or artificial manipulation? Human manipulation tends to present some "unnatural" phenomena, which can be analyzed from the dimension of digital characteristics, such as the significant anomaly of registration information that appears here. In 2019, Oriental Jinyu also had the situation of "purchasing jadeite rough, because of the inability to pay for the goods, and then using gold to pay for the goods", of which the object of procurement of rough stones is these three jewelry stores. This may constitute a path to transfer assets and funds.
Finally, the new customers and suppliers themselves have abnormal characteristics. For example, there are more natural person customers among the new customers and suppliers in 2018, and the media has visited and investigated the natural person customers and suppliers among them, but they have "no such person". Another example is that the fourth largest supplier in 2017, Tengchong Die cui Danxia Jewelry Co., Ltd., was cancelled in December 2018, and the number of historical social security contributions was zero; at the same time, the fifth largest supplier in 2017, Ruili Shangyi Jewelry Co., Ltd., was still a loan user of Jinyu Small Loan, and the 2018 semi-annual report showed that its 25 million yuan loan had all been overdue, which may constitute a path of capital outflow. These are issues that require further verification of the existence of potential related parties.
(4) Industry business dimension: The loan of small loan companies is abnormally overdue
Jinyu Small Loan, a subsidiary of Oriental Jinyu, was established in February 2017 to specialize in small loan business, but its revenue and profit contributions account for a very small proportion, and the gross profit margin is extremely low. It was later proved that a large amount of overdue and impairment had occurred in the loans issued: as of the end of 2019, all 871 million yuan of loans were overdue; only one year after the establishment of Jinyu Small Loans, large amounts of impairment began to occur in the issuance of loans, which was also the largest part of the impairment losses of all assets of Oriental Jinyu. At the same time, Oriental Jinyu only issued a collection letter and did not actively carry out litigation and other collection methods. The regulator has also repeatedly raised inquiries on relevant matters, asking Oriental Jinyu to explain the names of the top 50 customers who issued loans, whether the company and the controlling shareholder have related relationships and other agreements and interest arrangements that should be explained. Oriental Jinyu repeatedly delayed the reply before disclosing the relevant content, which showed that the loan object was mostly natural persons, and the proportion of letters could be written. Although it was discovered afterwards that there was a problem with Jinyu Small Loan, it also suggested that it was necessary to pay attention to the company's new special business during the verification, which may involve both fraud tactics, such as capital manipulation, or fraud motives. For example, in this loan business, it is necessary to verify the company's process of approving the relevant business, the destination of the loan funds, whether the loan object has related party problems, whether it involves the externalization of internal funds and fraud, and strengthen the authenticity and integrity of the letter results.
(5) Corporate governance dimension: The controlling shareholder and the actual controller behave abnormally
During the period of financial fraud of Oriental Jinyu, abnormal behavior of controlling shareholders closely related to the motive or fraud method of fraud can be found: one is the problem of high equity pledge, and the other is the abnormal reduction of controlling shareholders. Behind these two abnormal behaviors, one may be that the controlling shareholder holds a large amount of cash outside the body, which is the source of "ammunition" for fraudulent transaction fraud; the other may be the fraud motive caused by the controlling shareholder's lack of money, especially with the sign of equity freezing, because this may indicate that the major shareholder is worried about the liquidation pressure caused by the decline in the performance of the listed company.
Since the listing of Oriental Jinyu, the equity pledge ratio of its actual controller has been very high: when It was listed in a backdoor listing in 2006, the pledge or freezing ratio of Oriental Jinyu shares held by Zhao Xinglong through Xinglong Industry and Minkang Enterprises was 78.07% and 100% respectively. In February 2015, after Zhao Xinglong's control of Ruijin Jinze became the second largest shareholder of Oriental Jinyu through a fixed increase, 100% of the equity was pledged in May of that year; in recent years, the equity pledge or freezing ratio of Xinglong Industry controlled by Zhao Xinglong and Zhao Ning and Ruili Kanazawa Company has basically reached 100%. It can be seen that there is a greater incentive for fraud behind the continuous high pledge of the equity of the actual controller.
In addition, in June 2017, Chairman Zhao Ning also put forward the "Proposal on Issuing a Proposal to All Employees of the Company to Increase the Company's Shares", and promised that the Company's employees would buy Oriental Jinyu shares through the secondary market from June 7 to 9, 2017 and hold them for more than 12 consecutive months, and if the final loss was made, Zhao Ning would be fully compensated by Zhao Ning. However, its controlling shareholder, Xinglong Industrial, reduced its shareholding during this period: 26.99 million shares through block trading in September 2017 and no more than 108 million shares from December 8, 2017 to June 8, 2018. The call for employees to increase their holdings while the majority shareholders do so is disgraceful.
(VI) Corporate governance dimension: Regulatory inquiry letters are frequently questioned
In the case of Oriental Jinyu, whether during the financial fraud or after the penalty, the inquiry letter already mentioned the possibility of fictitious transactions. The regulator has noted the relevant problems and asked the auditors to explain the relevant problems in a special manner, but the certified public accountants still have not discovered and confirmed the fraud problem in time. In 2018, although the certified public accountant issued a qualified opinion, oriental jinyu had already been investigated by the time the annual report was issued. Therefore, a question that needs to be discussed and remains to be answered is whether the CPA has a situation where the scope of the audit is limited and cannot be confirmed. If verified, are there still other issues that prevent the CPA from obtaining sufficient evidence?
In summary, from the analysis results of the five-dimensional model, oriental jinyu presents abnormal signals of fictitious transactions: revenue growth rate is far more than the average level of the same industry; per capita output value and per capita compensation "one high and one low" divergence; gross profit margin and inventory linkage abnormality; important customers and suppliers suspected of implicit correlation; new important customers and suppliers the scale characteristics are abnormal; new loan issuance is abnormal; controlling shareholders are abnormally reduced. This cross-verifies the abnormal characteristics of income fraud from multiple dimensions, constituting a "vague portrait" from fictitious transaction objects, fictitious gross profits to asset destinations, fictitious capital closed loops, etc., pointing to the possibility that the company may have transaction fraud income fraud.
3. Inspirations and Recommendations
After the "Liangkang" and Luckin Coffee incidents, the CSRC adhered to the working principle of "building a system, non-intervention, and zero tolerance", and strictly and quickly investigated and dealt with nearly 60 cases of financial fraud in accordance with the law, pointing out that fraud presents the four characteristics of the whole chain of the fraud model, the concealment of methods, the diversification of motives, and the seriousness of harm. In January 2020, the Chinese Institute of Certified Public Accountants revised the answers to five auditing standards, including the Answers to Questions on the Auditing Standards of Chinese Certified Public Accountants No. 1 - Professional Doubts, clarifying that the risk of fraud should become one of the most important audit objectives of CERTIFIed public accountants, and making the pre-assumption that there is a risk of fraud in revenue recognition, which is of great significance for CPAs to prevent the risk of income fraud.
In February 2021, the China Securities Regulatory Commission (CSRC) announced the inspection and handling of audit and evaluation institutions in 2020, clearly stating that the certified public accountant has not found that the company is suspected of financial fraud through fictitious business in the audit practice. Combined with the case analysis in this article, it can be seen that when dealing with listed companies with fraudulent income from transaction fraud, under the "satisfactory" control test results prompted by the "business flow", "capital flow" and "information flow" three-stream matching of the internal control norms on the surface, it is often difficult for certified public accountants to identify signs of fraud simply through conventional risk assessment procedures such as financial statement analysis. Therefore, this paper believes that special verification procedures for transaction fraud revenue fraud should also be formulated from the perspective of data mining and the use of multi-dimensional data, and the specific recommendations are as follows:
(1) Make full use of industrial and commercial, judicial, and other such data to identify hidden related parties
Undisclosed hidden related parties are often highly correlated with transaction fraud. Social psychology research suggests that social relationships can lead to bias between individuals, leading to blind obedience and even collusive behavior (Cai Ning, 2018). In practice, the transaction object who is willing or dares to cooperate with the company's fraud often needs to have a "mutual trust" relationship with the actual controller of the company or the company itself, and in order to improve the concealment of fraud, this relationship cannot be a legal related party relationship. Undisclosed implicit associations are more hidden, but there are also some common "clues". Investigation of the implicit correlation relationship of the transaction object is an important method to identify the signs of fraudulent income fraud in the form of transaction fraud.
In the case of Oriental Jinyu, the issue that requires special attention is how to find problematic customers and suppliers, and even possible related parties, because they have formed a closed loop of transactions and funds through external customers and suppliers. The above analysis mentions some feasible verification methods, such as using industrial and commercial information, geographical location, contact information and other data to observe the potential relationship between the company, customers, suppliers, and the establishment time of customers and suppliers themselves. In the final penalty letter, you can also see the verification from the handwriting of the sales contract, the detailed records of the import and export of goods, the qualification of customers, the flow of bank accounts, etc. Therefore, making full use of non-financial data such as industry and commerce and judicial, and verifying the top five customers and suppliers of listed companies is an important way to identify transaction fraud and income fraud.
(2) Pay attention to the analysis of industry characteristics and expected value data
According to the requirements of auditing standards, identifying anomalies by comparing expected values through financial data trend analysis, ratio analysis and other methods is one of the most common risk assessment analysis procedures. Then, how to set accurate and comparable expected values is crucial, of which the selection of industry classification and industry characteristic indicators is the key. Improper industry classification criteria and granularity settings will result in incorrect selection of expected values, resulting in "technical anomalies" rather than "substantial anomalies" in financial indicators. Therefore, a more detailed industry classification should be selected, comparable listed companies should be more accurately positioned, and the expected value of industry data should be determined.
(3) Attach importance to early warning signals of correlated incidents of fraud stakeholders
The chain of collusion and fraud required to complete a transaction fraud type of income fraud covers a wider range of aspects from finance to business, from management to governance, from internal to external. However, "one hundred dense and one sparse": the longer the counterfeiting chain and the more dimensions, the greater the opportunity for fraud identification, and the data sources and research perspectives required for fraud identification need to be expanded accordingly. The above analysis not only considers financial data, transaction objects and other issues, but also starts from information such as the reduction of shares and equity pledges of controlling shareholders, and the inquiry letter of the regulator, and finds early warning signals related to fictitious transaction fraud. For example, the actual controller's own capital manipulation behavior may be the key motivation to promote its fraud. For example, financial fraud often requires large amounts of cash flow as a support, and at this time, the attention to the large current amount of funds and abnormal capital outflows of listed companies (870 million yuan of loans issued by Jinyu Small Loans) is also a key procedure for fraud verification.
(IV) The transformation of audit digital technology is imminent
The preliminary statistics of this paper found that 76.67% of the 30 typical financial fraud listed companies punished by the CSRC in 2020 were still unqualified by the auditors in the year of fraud, and the gap in audit expectations was still difficult to bridge. The latest research shows that due to the influence of five aspects, such as professional ethics, ability to perform duties, practice level, internal control dependence and practice standards, the actual standards implemented by CERTIFIed public accountants may be lower than the standards stipulated in the auditing standards, and the quality of audit supply (i.e., the implementation gap) is the main reason for the gap in audit expectations (Huang Shizhong, 2021). With the iterative upgrading of business model innovation and fraud methods, it is imperative to identify transaction fraud revenue fraud, and the digital transformation of auditing is imminent. This paper believes that on the one hand, certified public accountants can learn from the existing financial fraud identification system or tool, from multiple dimensions such as industry business, financial taxation, corporate governance, internal control and digital characteristics, intelligently obtain the financial fraud warning signals or signs of the audited unit, and formulate a targeted fraud risk response strategy. On the other hand, with the help of big data, artificial intelligence and other information technology empowerment, as far as possible to establish a fine-grained industry and business database, to obtain as much data from different sources as possible, to lay a solid data foundation for the use of risk-oriented audit model, and then improve the ability of certified public accountants to perform audit procedures, find fraud, and effectively prevent audit failures.
▷ Author: Ye Qinhua | Department of Accounting, Xiamen University; Fan Ye | Xiamen National Accounting Institute; Huang Shizhong | Dean of Xiamen National Accounting Institute
▷Source: Finance & Accounting, Issue 15, 2021
▷ Responsible editor: Ren Yuxin
▷ Duty Editor: Li Feiran Chen Lihua
▷ Typography design: Liu Ying