Forensic Accounting

Research

Chapter 10

Types of value added services

Risk assessment of fraud and illegal acts

Legal counsel asks you to investigate embezzlement scheme involving hidden assets

Vendor kickback determination Fact-finding for alleged frauds

involving bribery, wire fraud, securities fraud, etc. All of these involve forensic accounting

or litigation support

Fraud defined

Intentional deception, simply lying, cheating, or stealing

A generic term, embracing all multifarious means which human ingenuity can devise, and which are resorted to by one individual to get advantage over another by false suggestions or by suppression of truth. It includes surprise, trickery, cunning, dissembling, and any unfair way by which another is cheated.

Fraud defined (contd.)

Fraud includes the following elements:A misrepresentation of a material fact

Known to be falseJustifiably relied uponResulting in a loss

Types of frauds

Fraudulent financial reporting (management fraud)Actions whereby management attempts to inflate reported earnings or other assets in order to deceive outsiders

Overstating assets/revenues, price fixing, contract bidding fraud, understating expenses/liabilities

Types of frauds (contd.)

Misappropriation of assets (employee fraud)Actions of individuals whereby they misappropriate (steal) money or other property from their employers

Embezzlement, theft of company property, kickbacks

Types of fraud (contd.)

Employee embezzlement – fraud in which employees steal company assets either directly – stealing cash or inventory –or indirectly – taking bribes or kickbacks

Management fraud – deception by top management of an entity primarily through the manipulation of the financial statements in order to mislead users of those statements

Investment scams – the sale of fraudulent and often worthless investments (telemarketing and Ponzi scheme type frauds)

Types of fraud (contd.)

Vendor fraud – fraud resulting from overcharging for goods purchased, shipment of inferior goods, or non-shipment of inventory even when payment has been received

Customer fraud – fraud committed by a customer by not paying for goods received or deceiving the organization in various ways to get something for nothing

Miscellaneous fraud – all others – altering birth records or grade reports, etc.

Examples of fraud activities

Misappropriation of assets Skimming Forgery Kiting Phony refunds Larceny Fraudulent

disbursements Lapping Fictitious write-offs Duplicate payments Nonexistent vendor Kickbacks Misdirected shipments Theft Unauthorized personal

use of assets Fictitious burglary Phantom employees Falsified time cards

Fraudulent financial reporting Fictitious revenues Asset overstatement Unrecorded liabilities Improper disclosure

Corruption Conflict of interest Bribery Illegal gratuities Economic extortion

The Fraud Triangle

Three factors in the triangle (usually all 3 exist in a fraud) Motivation (perceived pressure or

incentive) Perceived opportunity Rationalization

Effective internal controls limit fraud

If an organization can contain any one of the three elements, fraud will most likely not occur

Overview of financial fraud examination

Two basic categories of fraud an auditor investigates when examining material misstatement risk assessment Fraudulent financial reportingMisappropriation of assets

Overview of financial fraud examination

(contd.) Financial reporting fraud red flags

Incentive/pressuresHigh degree of competition or market

competition in conjunction with declining profit margins

Perceived or real adverse effects of reporting poor financial results

Personal guarantees by management or board members of entity debt

Overview of financial fraud (contd.)

Financial reporting fraud (contd.)Opportunities – flags

Highly complex transactionsMajor international operations

Deficiencies in internal controls

Overview of financial fraud (contd.)

Financial reporting fraud (contd.)Attitudes/rationalization flags

Ineffective communication or enforcement of ethical standards

Excessive interest by management in maintaining or increasing the entity’s earnings trend

Overview of financial fraud (contd.)

Misappropriation of asset risk factorsSusceptibility of assets to misappropriationLarge amounts of cash on hand

Easily convertible assets (bonds, diamonds)

Controls (lack of)

Overview of financial fraud (contd.)

Steps of the fraud examinationIndentify issue/plan the investigation

Gather the evidence/the investigation phase

Evaluate the evidenceReport he findings to management?/legal counsel

Computer technology in fraud investigation (contd.)

Data mining software Software tool that models a

database for the purpose of determining patterns and relationships among the data

SAS Enterprise Miner-modeling software

Wizrule – used for data cleaning (searching for clerical errors) or anomaly detection.

Computer technology in fraud investigation

(contd.) Data mining software (contd.)

IDEA (Audimation Services, inc) – allows user to display, analyze, manipulate, sample or extract data

Monarch – allows investigator to convert electronic editions of reports into text files

ACL for windows – data inquiry, analysis, and reporting software

Analyst’s notebook – assists investigators by uncovering, interpreting, and displaying complex information in easily understood charts.

Public records – see figure 10-7

Courthouse records – lawsuits, judgments, property filings, bankruptcy filings

Company records – SEC filings, Dun and Bradstreet has private company data, D/B/A filings with state or county, real estate filings

Online databases The Internet – KnowX, Instant

Checkmate, Zoominfo, etc.