Larry Crumbley - Governmental 2012

Transcription

© D.L.
Crumbley
© D.L.
Crumbley
Forensic Accounting: Some Strategies
for Detecting & Preventing Fraud
Forensic Report
D. Larry Crumbley, CPA, CFF, Cr.FA, CFFA, FCPA
KPMG Endowed Professor
Department of Accounting
2833 Business Education Complex
Louisiana State University
Baton Rouge, LA 70803
225-578-6231
225-578-6201 Fax
[email protected]
Dr. Crumbley is the
Editor of the Journal of Forensic and Investigative
Accounting, free online,
Former chair of the Executive Board of Accounting
Advisors of the American Board of Forensic Accountants,
Member of the NACVA’s Fraud Deterrence Board, and
On the AICPA’s Fraud Task Force (2003-2004).
A frequent contributor to the Forensic Examiner, Professor
Crumbley is a co-author of CCH Master Auditing Guide,
along with more than 50 other books and 350 articles. His
book entitled Forensic and Investigative Accounting,5th
edition, is published by Commerce Clearing House (800-2247477). Some of his 13 educational novels have as the main
character a forensic accountant. His goal is to create a
television series based upon the exciting life of a forensic
accountant and litigation consultant.
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Definition of Forensic Auditor
TALLY STICKS
Someone who can look behind the
facade--not accept the records at
their face value--someone who has a
suspicious mind that the documents
he or she is looking at may not be
what they purport to be and someone
who has the expertise to go out and
conduct very detailed interviews of
individuals to develop the truth,
especially if some are presumed to
be lying.
Robert G. Roche, a retired chief of the IRS Criminal Investigation
Division of the IRS
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Narrow Approach
Narrow vs. Broad Definition
• Narrow: Fraud Detection Is Major Area.
• Broad: Employed to seek, interpret, and
communicate transactional and reporting
event evidence in an objective, legally
sustainable fashion, not only in situations
where there are specific allegations of
wrongdoing, but also in situations where
interested parties judge that the risk of
loss from wrongdoing is such that proper
prudence requires legally sustainable
evidence to support the conclusion that
no wrongdoing is occurring (James
Edwards).
Accounting
Forensic
Accounting
Internal and External
Auditing
Planning
Risk Assessment
Internal controls
Audit Evidence
Reporting
Accounting
Litigation Matters
and Investigations
Fraud
Prevention and Deterrence
Detection
Investigation
Remediation
U.S. Dept. of Justice, Education and Training in Fraud and
Forensic Accounting: A Guide for Educational Institutions,
Stakeholder Organizations, Faculty and Students, Draft Copy,
December 23, 2005.
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Definition of Forensic Accounting
Broad Approach
Bankruptcy
Family law
Auditing
Valuation
Fraud
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Forensic accounting is the application of
accounting, tax, auditing, finance,
quantitative analysis, investigative and
research skills, and an understanding of
the legal process for the purpose of
identifying, collecting, analyzing, and
interpreting financial or other data or
issues in connection with:
Antitrust matters
Insurance claims
Accounting
1) Litigation services: providing assistance
for actual, pending or potential legal or
regulatory proceedings before a trier of
fact in connection with the resolution of
disputes between parties, or
Analyses
Damages
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2) Non-litigation
services:
performing
analyses or investigations that may require
the same skills used in 1, above, but may
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not involve the litigation process.
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Puff Adder
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Short History
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1. Late 1800’s – Find fraud
2. 1930’s- Puff Adder –encyclopedia
3. 1933-1934-independent audits
4. 1950’s-Eighth edition Montgomery auditing reduced
formal stress on fraud detection.
5. January 1957- H.W. Bevis, AR, questioned the benefit of
discovering minor employee thefts.
6. 1960s-auditors claimed no responsibility.
7. Financial audits: Consistency.
8. Audit surveillance: test of details (disappeared).
9. Stock market bubble
10.Panel on Audit Effectiveness (2000)
11.Enron/ WorldCom/ Parmalat/ HealthSouth
12.Sarbanes-Oxley/ PCAOB
13.SAS No. 99
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One Small Clue
Forensic Accounting Factors
• Time: Forensic accounting focuses on
the past, although it may do so in
order to look forward (e.g., damages,
valuations).
• Purpose: Forensic accounting is
performed for a specific legal forum
or in anticipation of appearing before
a legal forum.
• Peremptory: Forensic accountants
may be employed in a wide variety of
risk management engagements within
business enterprises as a matter of
right, without the necessity of
allegations (e.g., proactive).
----------------------------------------------With a single clue a forensic
accountant can solve a fraudulent
mystery.
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A former Scotland Yard scientist tried to create
the world’s biggest fraud by authenticating $2.5
trillion worth of fake U.S. Treasury bonds.
When two men tried to pass off $25 million
worth of the bonds in Toronto in 2001, a
Mountie noticed the bonds bore the word
“dollar” rather “dollars.”
Police later raided a London bank vault and
discovered that the bonds had been printed with
an ink jet printer that had not been invented
when the bonds were allegedly produced.
Zip codes were used even though they were not
introduced until 1963.
Sue Clough, “Bungling Scientist Is Jailed for Plotting World's Biggest
Fraud,” News.telegraph.co.uk, January 11, 2003.
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Top Niche Services - 2012
Forensic Accounting Areas
Investigative Auditing
Litigation Support
Forensic: Latin for “forum,”
referring to a public place or court.
Black’s Law Dictionary: Forensic,
belonging to the courts of justice.
Note: Corporate spooks are used to check on
competitors.
1. International tax
2. State and local taxes
3. Business valuation
77%
75%
74%
4. Attest services
5. Forensic/ fraud
6. Estate/trust/gift tax planning
7. Litigation support
8. Nonprofit organizations
9. Industry specialization
10. M & A
73%
70%
69%
67%
67%
62%
59%
Source: Accounting Today 2012
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AICPA’s Position
AICPA’s Position (cont.)
• Does not require auditors to carryout specific
forensic procedures, but rather provide guidance
on how to include forensic techniques within
processes outlines in SAS 99. This combination will
enhance the detection and prevention of fraudulent
financial statement reporting and misappropriation
of assets; thus protect investors and financial
statement users.
• Public accounting firms could use forensic
accountants to help revise their approach to
planning and fieldwork on all audits, while
requiring forensic accountants only on high risk
audit clients to aid in the interpretation of forensic
testing results and preventive control enhancements.
• The inclusion of audit procedures focused towards
detecting misappropriation of corporate assets may
lead to the identification of weaknesses within
corporate governance or control weaknesses. Frauds
that are identified which represent a material
misappropriation of assets could significantly
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impact public perception.
• Professional forensic accountants can best be used
by ensuring such procedures are properly developed
and executed in-line with internal audit and audit
committee concerns. Forensic accountants could then
be engaged in high-risk situations, or when a fraud
is suspected.
• Companies should not use the forensic services of
their outside audit firm, unless it pertains to the
annual audit.
• Putting a price on a substantive test or forensic
auditing procedure may be smart for business;
however, the inherent risk is that short-cuts geared
towards reducing audit costs may eventually cause
investors to question the companies’ true financial
position.
AICPA – Discussion Memo Question Responses
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Specialties Within
Forensic and
Investigative Accounting
Corruption on Steroids:
Bell, California
• Eight current and former
employees, including mayor and
ex-city manager
• Ex-city manager, Rizzo, had a
salary of $800,000.
• Approximately 38,000 citizens.
Average per capita income of
$24,800.
• Rizzo’s annual pension and
benefit would have been
$976,771, topping $1 million
two years later.
• Employee Crime Specialist.
• Asset Tracing Specialist.
• Litigation Services Specialist
and Expert Witness.
• Insurance Claims.
• Valuation Analysis.
• False Claims Act Violations.
• Due diligence investigations.
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Some Forensic Audits
Rita Crundwell - $53 Million
Fraud
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• Forensic audit of Geneseo, Illinois.
• Florida GOP chairman’s promised forensic
audit.
• Forensic Audit needed at the National Library
service
• Summerville Town council will not go ahead
with forensic audit.
• Forensic audit of state spending would save
money.
• Forensic audit is growing in the Federal
government.
• Walling ford Housing Authority Board of
Commissioners choose a forensic firm.
• Mayor-elect Rahm Emanuel to order day-one
forensic audit of all department.
• Forensic Investigation Report, Cheyenne, and
Arapaho Tribes.
• School District audit to dig deeper.
• Former controller, city of Dixon, Illinois,
since 1983.
• SEC says she fraudulently stole $53
million.
• Population of 15,733. Annual budget: $8$9 million.
• Used monies to finance 311 quarter
horses and lavish life style.
• Bank account City of Dixon and RSCDA.
• From 1990 to 2012, transferred funds
from city bank accounts.
• Created fictitious invoices purportedly
from state of Illinois.
John Metcalfe, Rita Crundwell v. Harriette Walters: Who Embezzled Better? The Atlantic Cities
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Unclaimed Tax Refunds
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Number One: Harriette Walters
Love for an ex-boyfriend caused a Colorado
Department Revenue Supervisor to steal $11
million in unclaimed tax refunds from
Colorado state. Michelle was in love with the
married Hysear Randell.
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• Supervisor of the Real Property Tax
Adjustment Unit in Washington, D.C., Harriette
Walters, used at least 92 payments to dummy
corporations in a scam to obtain $31.7 million
($344,565 per refund).
Michelle Cawthra testified that she deposited
unclaimed tax refunds and other money into
Hysear Randell’s bank account over two years.
She forged documents and created fake
businesses. Michelle used computer passwords
of other workers so she would not be detected.
Source: http://www.baltimoresun.com/news/sns-ap-usodd-tax-refund-scam,0,...
• Fraud was never noticed by city officials,
internal, or external auditors. Auditors never
examined why the city’s property tax refunds
were steadily rising.
• Sham companies’ bank accounts were
controlled by Walters’ brother.
• Many applications for refund were identical to
prior ones.
• In a FBI raid of her house, 100 pieces of
jewelry, a mink coat, 90 designer purses, 68
pairs of shoes, designer luggage, Rolex watch,
silver bar cart, and more were found. She had a
$1.4 million in bills at Neiman Marcus on a
$81,000 yearly government salary.
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Refund Schemes
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Governmental Fraud
• A television station’s former
accounting director pleaded guilty
to stealing more $1.8 million from
her employees and spending it on
jewelry, paintings, and fur coats.
• She would overpay the station’s
travel bills and divert the refunds
to her own credit card bills and
personal accounts.
• She was sentenced to 7 ½ years in
prison on a single count of theft
from CBS affiliate WBBM – TV
Source: AP, “Ex-Accountant at CBS Affiliate Sentenced,” Las Vegas
Sun, November 5, 2003.
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Where Is $9 Trillion? The U.S. Federal Reserve can not
account for $9 trillion in off-balance sheet transactions.
Also, no one at the Federal Reserve has any idea what are
the losses on its $2 trillion portfolio.
On May 12, 2009, Inspector General Elizabeth Coleman
could not explain the $1 trillion plus expansion of the
Federal Reserve’s balance sheet since September 2008.
While testifying before Congress, Coleman said the IG
does not have jurisdiction to audit the Federal
Reserve.86
If a U.S. business lost $9 trillion or created $9 trillion on
their balance sheet, they would suffer severe penalties.
Source: Julie Crawshaw, “Federal Reserve Cannot Account
for $9 Trillion,” Newsmax.com. May 12, 2009.
http://moneynews.newsmax.com/financenews/feds_lost_ni
ne_trillion/2009/05/12/213463.html
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Finding Unreported
Income/Hidden Assets
Forensic Accountants
“Rather than combing torn clothing,”
forensic accountants “comb through
corporate books, looking for oddities
that could signal swindles,” says Bruce
Dubinsky. Investigations can be
extremely complex, with crates and
crates of documents and thousands of
computer files. Investigators look for
flags or patterns that would not
normally occur.
1.
2.
3.
4.
Look at the lifestyles.
Look at the expenses.
Look at the cash flow.
Look at the business
operations.
5. Look at the industry ratios.
6. Consider using private
investigators.
7. Use the net worth method.
Source: Mark Maremont, “Tyco Is Likely to Report
New Woes,” Wall Street Journal, April 30, 2003, p.
C-1.
Mark Kohn, “Unreported Income and Hidden Assets,” Forensic
Accounting in Matrimonial Divorce, Philadelphia: R.T.
Edwards, 2005, pp.49-57.
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Find It, or I’ll Sue
Forensic Accounting Knowledge Base
Accountants must be attuned to
detecting fraud at every level of
service, including standard
accounting services, compilations,
reviews, and bank reconciliations. If
there is fraud and you don’t detect it,
you are going to be sued, and you
will likely lose, as the public
perception is the accountant is the
watchdog.
LAW
Criminology
Investigative
auditing
Accounting
Robert J. DiPasquale, Parsippany, N.J.
Forensic Accountant
Source: H.W. Wolosky, “Forensic Accounting to the Forefront,”
Practical Accountant, February 2004, pp. 23-28.
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Silk, Silk, Silk
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Fraud Strategies Differ
Predication
1.
2.
3.
4.
5.
Forensic Accountants
Internal Auditors
External Auditors
Fraud Examiners
Certified Fraud Deterrence
Analysts (CFD) or CFFAs
6. Forensic CPA Society (FCPA)
7. Governmental Accountants
•
•
•
The ACFE group indicates that in
the private sector fraud
investigation should not be
conducted without proper
predication.
Examples: Anonymous tips,
complaints, audit inquires,
conflict of interest.
Thus, predication is the basis for
undertaking a fraud investigation.
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Forensic-Type Organizations
•
•
•
•
•
•
•
•
•
The Trillion Dollar Gorilla
American College of Forensic Examiners (2750 E. Sunshine,
Springfield, MO 65804; 800-423-9737; www.acfei.com. DABFA
and Cr.FA; 2000)
Certified Fraud Examiners (Association of CFEs, The Gregor
Bldg., 716 West Avenue Austin, TX 78701; 800-245-3321;
www.cfenet.com).
Certified Insolvency and Reorganization Accountant (CIRAs).
Accountants, lawyers, consultants included in insolvency and
bankruptcy matters. 3-part exam. 4,000 hours. 541.858.1665. AIRA,
221Stewart Avenue, Suite 207, Medford, Or. 97501.
[email protected]
Forensic CPA Society (FCPA); formed in July 2005, Spokane,
WA. [email protected].
Certified Forensic Financial Analyst (NACVA, Salt Lake City,
Utah 84106; 801-486-0600). Also, Certified Fraud Deterrence
(CFD) analyst.
National Litigation Support Services Association (NLSSA, III
East Wacker Drive, Suite 990, Chicago, IL 60601; 800-869-0491).
Not-for-profit. About 20 firms. $1,825.
Canadian Institute of Chartered Accountants (CICA) – CA.IFA
– Alliance for Excellence in Investigative Accounting.
Certified Forensic Investigator (CFI) – Canada Early 1980’s.
www.homewoodave.com
Certified Fraud Specialist (CFS), not-for-profit, educational antifraud corporation located in Sacramento, Calif., for those dealing in
white-collar crime, fraud, and abuse issues. Association of Certified
Fraud Specialists. http://acfsnet.org.
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(in Billions)
U.S. Business1
$256.32
Federal Government
State Government
2
3
Tax-exempts4
Local Government5
Annual Fraud (trillion)
239.75
354.21
134.5
68.4
$ 1.053
1. 2002 Statistics of Income, $1,281.6 trillion time 20%.
2. $2.3975 trillion budget times 10%
3. $3,542.1 million times 10%
4. $897 billion in revenue times 15%.
5. $684.6 billion times 10%.
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Advantage of Compliance
Spending
Fraud Multiplier
Employee Fraud = $ for $ reduction in net
income
Suppose $100,000 bottom line reduction.
Suppose 20% profit margin
How much new revenue needed to offset the
lost income?
$100,000 = $500,000
20%
General Counsel Roundtable
says that each $1 of compliance
spending saves organizations, on the
average, $5.21 in heightened
avoidance of legal liabilities, harm to
the organization’s reputation, and lost
productivity.
So ACFE says $652 billion lost per year (2006).
$652 billion = $3.26 trillion needed revenue
20%.
----------------------------------------------------This amount lost to fraud and abuses is
twice the size of the U.S. military budget.
Source: Jonny Frank, “Fraud Risk Assessments,” Internal Auditor, April
2004, p. 47.
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Schemes Committed by Perpetrators in the
Accounting Department – 367 Cases
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Frequency of AntiAnti-Fraud Controls*
* ”External Audit of F/S” = independent external audits of the organization’s financial
statements
“Internal Audit / FE Department” = internal audit department or fraud examination
department
“External Audit of ICOFR” = independent audits of the organization’s internal controls
over financial reporting
“Management Certification of F/S” = management certification of the organization’s
financial statements
Source: 2012 Wells Report, ACFE.
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Scienter Necessary
Frequency of Occupational Fraud Schemes
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• To prove any type of fraud, prosecutors
must show that scienter was present.
• That is, the fraudster must have known
that his or her actions were intended to
deceive.
------------------------------------------------The allure of numbers to most of us, is
like the excitement of settling sand--a
narcoleptic surety. Crafty criminals
prey on this boredom. They pile on
the numbers, spewing meaningless
records in the false books.
Cory Johnson
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Occupational Fraud Per Industry
Certain Fraud is Increasing
Source: KPMG Fraud Study
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Missing Fraud
Comparison of Selected Fraud Surveys
Type
KPMG
PwC
ACFE
Questionnaire
Interview
Questionnaire
Time Period
2005-2006
2011
2012
Number of participants
(population)
4,056 (6,797)
3,877
1,388 (34,275)
Response
59.7%
Unknown
4%
Estimated fraud in U.S.
Not given
Not given
$3.5 trillion (global)
% of companies
experiencing fraud
74% reporting
misconduct
34% (Global)
Unclear
Highest fraud industry
Public sector
Communications
Banking/ Financial Services
Second highest fraud
industry
Global
Manufacturers
Insurance
Govt. and Public
Administration
Top – Fraud detection – Tips
Not given
18%
43.3%*
Fraud detection – Internal
audits
Not given
14%
14.4%
Fraud detection – by
accident
Not given
8%
7.0%
Some recover of fraud
Not given
Unknown
51.3% [2012]
Gender of perps - male
Not given
Not given
65.0%
Likely age
Not given
Not given
41-45
Fraud by senior mgt.
Not given
18%
Not given
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Auditors will continue to miss fraud because
much of their work is predicted on the
assumption that separation of duties
prevents fraud (i.e., one person hold the
money and another person keeps track of it).
The Equity Funding case shakes the
foundations of auditing in that so much is based
on the assumption that people don’t collude
very long. These people work together as an
efficient team for a very long time [9 years].
Lee Seidler
------------------------------------------“When the sun goes down, then the sneaks will
play at night.”
Fraud by Accounting dept.
Not given
Not given
22.0%
Fraud with undergraduate
degree
Not given
Not given
36.9%
Common control measure
Suspicious
Transaction
Monitoring
External audit
Second common control
measure
Internal audits
Code of Conduct
From Porter Wagoner “Sneaks Crawl at Night.”
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*Management review, 14.6%
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Kessler Survey (2001)
How Fraud Is Detected
2012
2010
2008
1.
Tips
43.3%
40.2%
46.2%
2.
Management
review
14.6%
15.4%
2.
By accident
3.
Internal audit
4.
Internal controls
5.
6.
7.0%
8.3%
20%
14.4%
13.9%
19.4%
NA
NA
23.3%
External audits
3.3%
4.6%
9.1%
Notification by
police
3.0%
1.8%
3.2%
• About 13% of employees are
fundamentally dishonest.
• Employees out-steal shoplifters.
• About 21% of employees are honest.
• But 66% are encouraged to steal if
they see others doing it without
repercussion.
Source: “Studies Show 13% of employees are fundamentally dishonest,”
KesslerNews, November 1, 2001,
www.investigation.com/articles/library/2001articles.
---------------------------------------------------------------------------------------
• 30% of people in U.S. are dishonest.
• 30% situational dishonest.
• 40% are honest all of the time.
Source: 2012/ 2010/ 2008 Wells Reports, ACFE.
Source: R.C. Hollinger, Dishonesty in the Workplace, Park Rider, N.Y.:
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London House Press, 1989, pp. 1-5.
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Financial Audit v. Forensic Audit
The typical financial audit is a sampling
activity that doesn’t look at every transaction
and can therefore be exploited by someone who
knows how to rig the books.
Forensic accounting focuses on a
specific aspect of the books and examines
every digit. While the average accountant is
trying to make everything add up, a forensic
accountant is performing a detailed financial
analysis to find out why everything doesn’t or
shouldn’t add up.
It’s a far more time-consuming enterprise
and can be significantly more expensive than
regular auditing work.
Jake Poinier, “ Fraud Finder,” Future Magazine, Fall 2004,
http://www.phoenix.edu/students/future/oldissues/Winter2004/fraud.htm
Two Major Types of Fraud
Investigations
• Reactive: Some reason to suspect
fraud, or occurs after a significant
loss.
• Proactive: First, preventive
approach as a result of normal
operations (e.g., review of internal
controls or identify areas of fraud
exposure). There is no reason to
suspect fraud. Second, to detect
indicia of fraud.
Source: H.R. Davia, “ Fraud Specific Auditing,” Journal of
Forensic Accounting, Vol. 111, 2002, pp. 111-120
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Proactive Is Best
Proactive vs. Reactive Approaches
Proactive approaches include
Effective internal controls,
Financial and operational audits,
Intelligence gathering,
Logging of exceptions, and
Reviewing variances.
Reactive detection techniques
include
Investigating complaints and
allegations,
Intuition, and
Suspicion.
Jack Bologna and Robert Lindquist, Fraud Auditing and Forensic Accounting, 2d
Edition, New York: John Wiley, 1995, p. 137.
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When the IRS began requiring banks
to issue Form 1099s reporting interest,
the reported interest income increased
by $8 billion (even though for 3 years
the IRS did not have computer
matching capacity).
When the IRS began to require
taxpayers to list a social security
number for dependents, the next year
the number of reported dependents
dropped by seven million. More than
11,000 of these taxpayers claimed
seven or more dependents in 1986, but
they claimed none in 1987.
When the IRS began to require
taxpayers to list a name, address, and
social security number for babysitters,
two years later 2.6 million babysitters
disappeared.
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Fraud Deterrence Better Than Fraud
Investigation
1. Fraud deterrence less expensive.
2. Deterrence is more
comprehensive.
3. Fraud deterrence produces
greater savings.
4. Deterrence is faster.
5. Fraud deterrence promotes better
customer relations.
Daniel Finnegan, “Deterring Fraud,” Quality Planning
Corporation, 1991.
Walkthroughs
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An auditor must perform a walkthrough
of a company’s significant processes (each
major class of transactions).
Can not be achieved secondhand.
According to PCAOB, in a walkthrough
an auditor traces “company transactions and
events – both those that are routine and
recurring and those that are unusual – from
origination, through the company’s accounting
and information systems and financial report
preparation processes, to their being reported in
the company’s financial statements.”
Auditors should perform their own
walkthroughs which provides auditors with
appropriate evidence to make an intelligent
assessment of internal controls.
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Source: PCAOB Briefing Paper, Proposed Auditing Standards, October 7, 2003.
Wandering Around
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Measures Helpful in Preventing Fraud
•Informal observations while in the business.
•Especially valuable when assessing the
internal controls.
•Observe employees while entering and
leaving work and while on lunch break.
•Observe posted material, instructions, job
postings.
•Observe information security and
confidentiality.
•Observe the compliance with procedures.
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1. Strong Internal Controls (3.66)
2. Willingness of companies to prosecute
(3.44)
3. Regular fraud audit (3.40)
4. Fraud training for auditors (3.33)
5. Anonymous fraud reporting
mechanisms (3.27)
6. Background checks of new employees
(3.25)
7. Established fraud policies (3.12)
8. Ethical training for employees (2.96)
9. Workplace surveillance (2.89)
Source: 2004 Wells Report
52
13
Financial Audit v. Forensic Audit
Contrasting Auditing, Fraud Examination, &
Forensic Accounting
The typical financial audit is a sampling
activity that doesn’t look at every transaction
and can therefore be exploited by someone who
knows how to rig the books.
Forensic accounting focuses on a
specific aspect of the books and examines
every digit. While the average accountant is
trying to make everything add up, a forensic
accountant is performing a detailed financial
analysis to find out why everything doesn’t or
shouldn’t add up.
It’s a far more time-consuming
enterprise and can be significantly more
expensive than regular auditing work.
Source: G.S. Smith and D.L. Crumbley, “Defining a
Forensic Audit,” Journal of Digital Forensics,
Security, and Law, 2009, Vol. 4, No. 1, p. 69.
Auditing is a macro process, and forensic
accounting is a micro process.
53
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Jake Poinier, “ Fraud Finder,” Future Magazine, Fall 2004,
http://www.phoenix.edu/students/future/oldissues/Winter2004/frau
d.htm
54
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Inexperienced Forensic Auditors
Social Engineering Schemes
• Find out who did it. Do not worry about all
the endless details.
• Dumpster diving – Sifting through
companies’ dumpsters (Proctor & Gamble
went through Unilever’s dumpster. 80
valuable documents).
– Lock Dumpsters.
– Use across-cut shredder.
– Check dumpster outside client's
building (e.g., restaurant).
• Shoulder surfing (e.g., looking for
passwords; then plant stuff on your
computer).
• Tailgating: following someone into a
business behind someone with authorized
access, then lost your identity badge.
• Be creative, think like the fraudster, and do
not be predictable. Lower the auditing
threshold without notice.
• Take into consideration that fraud often
involves conspiracy.
• Internal control lapses often occur during
vacations, sick outages, days off, and rest
breaks, especially when temporary
personnel replace normal employees.
H. R. Davia, Fraud 101, New York: John Wiley & Sons, 2000, pp. 42-45.
56
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Social Engineering Schemes
(contd.)
• Phishing – increasing.
• Pretexting – assume the identity of
an authority figure. Find a picture of
an identity badge.
• Phreaking – pretending to be in a
position of authority to obtain
information.
Seven Investigative Techniques
1. Public document review and
background investigation (nonfinancial documents).
2. Interviews of knowledgeable
persons.
3. Confidential sources.
4. Laboratory analysis of physical and
electronic evidence.
5. Physical and electronic
surveillance.
6. Undercover operations.
7. Analysis of financial transactions.
Source: R.A. Nossen, The Detection, Investigation and Prosecution of Financial
Crimes, Thoth Books, 1993.
58
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Forensic Accounting Tools/
Techniques
•
•
•
•
•
•
•
•
•
•
•
Forensic Accounting Tools/
Techniques (cont.)
•
•
Chain of Custody.
Questioned Documents (e.g. ink analysis).
Continuous Controls.
Timeline Analysis.
Tracing Schedule.
Link Analysis.
Invigilation.
Genogram.
Proof of Cash.
Entity Charts.
Full - and False – Inclusion Tools.
•
•
•
•
•
•
•
•
•
59
Aberrant pattern detection (e.g., Benford Analysis)
Duplicate numbers test (Excel/Idea/Account
payables)
Rounded numbers test
GAP analysis
Lifestyle analysis
Attributes sampling
Document map[a separate pane that displays a list of
headings in a document in order to quickly navigate
through the document and keep track of your
location on it
Event analysis (e.g., attacks of hackers on a
computer system)
Stratification percentage comparison
Net worth analysis, etc.
Analytic techniques (e.g., horizontal, etc.)
60
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Duplicate Numbers Test
GAP Analysis
Use Gap Analysis to look for
missing items that should be in
numerical sequence:
• Checks (even voided checks)
• Credit memos
• Invoices
• Journal entries
Duplicate numbers test identifies
suspicious recurrences of specific
numbers.
• Invoice numbers
• Check numbers
• Dollar amounts
Voided checks may indicate
misappropriation or written to a
shell corporation.
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Chain of Custody
Round Numbers Red Flag
• Just as in the movies or on a television
show such as CSI, forensic
accountants must safeguard evidence
through a financial chain of evidence.
• There must be a way to show that the
evidence has not been tampered with
or damaged.
• If documents are seized, the forensic
accountant should put his or her
initials and date of the seizure on the
back of each document.
• Or put the document in a transparent
envelope and write a description on
the envelope.
• Store the original and work only with
a copy.
Areas where rounded number should
not be expected:
Amounts on tax returns(T&E).
Inventory counts.
Regulatory filings.
Accounts receivable balances.
Journal entries.
Any measure presumed to be exact.
Shows Estimation, Approximation, or Fraud. XL Audit
Commander, free, Excel add-on
Http:// ezrstats.com
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Continuous Monitoring
Enforcement Manual
Enforcement Manual
History and Custody of Documents
U.S. Department of Labor
Pension and Welfare Benefits
Administration
Date _______________________________
Case Number________________________
Case Name __________________________
1. How were the documents obtained?
____ By consent (note any significant comments of the principal
circumstances which occurred)?
____ By legal process (describe).
2.
3.
• Correlation is well suited to environments where there are
(a) a large number of audit units (departments, divisions,
franchisees, or customers, etc.), (b) a series of timestamped revenues, expenses or loss amounts, and (c) the
goal of developing a formal process to compare each audit
unit against a valid benchmark.
or third party witness and any unusual
• Correlation and time-series analysis are techniques that
could be used by forensic accountants in a monitoring role
to find evidence of intentional or unintentional errors in
situations where there are many audit units.
What is the relationship between the documents and the person submitting them?
Were manual transcripts or facsimile copies made of any
part?.
______ Yes ______No
If Yes, list documents copies. Manner of reproduction
© D.L.
Crumbley
of the documents either in whole or in
4. Have all copies been compared with the original documents and identified?
_____Yes _____No
If No, why not?
5. Were the original documents described herein under your control or supervision at all times prior to their
return to the principal, third party witness, or representative?
_____Yes _____No
If No, set forth circumstances of any transfer in control.
6. Did the principal, third party witness, or a representative request access to the documents during your
custody?
___ Yes ___ No
If Yes, who requested access and what action was taken?
Signature ___________________
Title ________________________
• The techniques could be used to proactively search for
errors without any preconceived belief as to their
existence, magnitude, or pervasiveness, or where the
forensic accountant seeks to provide additional evidence
showing that such errors occurred after the errors were
detected using some other detection method.
• If intentional errors were discovered using other methods
of discovery, then the techniques could be used by the
forensic accountant to show that the revenue or
expenditure or loss streams of an audit unit differed
significantly from a valid benchmark.
M. J. Nigrini, “Monitoring Techniques Available to the Forensic Accountant,” J. of Forensic
Accounting, Vol. 7, 2006, pp. 321-344.
65
Continuous Monitoring
• Management engages an independent outside supplier to
install and manage software to continuously analyze every
transaction within business applications to detect improper
activities and anomalies that indicate errors, control
overrides, and fraud [Oversight Systems].
• The software sorts incidents into errors, misuse, and fraud
(a detective control).
• Suspicious transactions can be identified and categorized
for future follow-up.
• Flag items such as manual income-increasing adjustments,
adjustments made late in the year, large dollar amounts.
• Large companies with revenues over $1 billion.
• Over the course of a year monitoring each module (e.g.,
A/P, Sales, G/L) is designed to cost approximately the
amount the company would pay for one fulltime internal
auditor per module.
• One company saved $2 million of external auditing fees
for using C/M in the 404 area.
D. R. Hermanson, B. Moran, C. S. Rossie, and D. T. Wolfe, “Continuous Monitoring of Transactions to Reduce Fraud, Misuse,
and Errors,” J. of Forensic Accounting, Vol. 7, 2006, pp. 17-30.
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Timeline Analysis
• Timeline analysis (TA) may be used
to show the timing of a dispute, and
certain software tools can prepare trial
exhibits.
• Investigative analysis software can
show all detail from the beginning of
the event until the apprehension of the
target.
• TA helps forensic accountants
communicate the timing of case
related events and summarizes the
investigation.
• Each link of the timeline chart
includes a reference to a source or a
direct link to a database. An insurance
fraud scheme timeline from i2 Inc is
shown in the next Table:
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Tracing Schedule
Insurance Fraud Scheme
• A tracing schedule can be used
to show the flow of funds from
bank-to-bank, from bank-toentity, from entity-to-entity, or
from person-to-person.
• A tracing schedule is helpful in
money laundering cases.
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Link Analysis
Table 5.1 Link Analysis
• Link analysis (LA) is a subset of
network analysis which shows
associations between people and data.
• For example, a link analysis could
compare the mailing addresses of
company executives and the cell
phone numbers that they have dialed
during a given time frame.
• LA provides crucial relationships
between many objects of different
types that are not apparent from
isolated pieces of data.
• Table 5.1 is an example of LA with
respect to the primary suspect, David
Hoover.
Wikipedia, the free encyclopedia, en.wikipedia.org. Stuart Weiss,
“Forensic Accounting Tools and Techniques,” The Value
Examiner, January/ February, 2007, pp. 12-13.
71
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Invigilation
Invigilation Technique
• Invigilation is a rather expensive
investigating technique that can be
used in potential fraud situations to
discover the fraud and can later be
used in the courtroom.
• Here detailed records are kept before
and after the invigilation period to
determine the amount of fraud.
• During the invigilation period strict
controls are imposed (e.g., cameras) so
that the fraud is virtually impossible.
• Or the invigilation period could be
while the suspect is on vacation.
No controls
Controls or
vacation
No controls
14 days
14 days
14 days
$67,000 lost
$0 lost
$62,000 lost
73
Genogram
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• A genogram is a pictorial display of
personal relationships among related
or unrelated parties.
• There are software programs that are
custom designed for genograms, such
as GenoPro 2007 ($49 at
www.genopro.com).
• Simple symbols represent the gender
(box for male and circle for female),
with various lines to illustrate family
relationships.
• People who are not related would not
be connected with a line, but could be
placed on the genogram.
• They can lead to determining the
motive of a crime or provide evidence
that the person had no direct
involvement in the fraud.
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Genogram
75
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Proof of Cash
Tracking Small Sums
•
FAs can employ aberrant pattern detection using digital analysis.
Benford’s Law is the DNA equivalent of numeric testing using
geometric progressions against actual transactions. Another
technique, full and false inclusion, is known as the yellow
crime scene tape of forensic accounting. It insures that no
extraneous data is included and no appropriate data is excluded.
Another very interesting technique uses Genograms, which are
visual representations of personal relationships. It is a tool that is
been borrowed from family counseling.
•
First, FAs track people. Then the money is easy to find. The
money takes different forms, of course: cash, accounts, hard
assets such as real estate and automobiles, intangible assets like
patents, copyrights, trademarks, promissory notes, betting
records. Both money and people leave trails: phone records,
voting records, even genealogy research. In fact, the trails left in
a free society are very useful in catching terrorists who attempt
to use our freedom to their advantage.
•
Source: Darrell Dorrell, Financial Forensics: The Body of
Knowledge, John Wiley & Sons
• The proof of cash procedure is similar
to a bank reconciliation, except more
detailed and extensive.
• This procedure can be used to verify
that cash accounts on the books are in
agreement with the cash transactions
recorded by the bank.
• The Wyoming Department of Audit’s
proof is shown as Table 5.2.
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78
Entity Charts
Table 5.2
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• Entity charts show entities and owners
with the relationship between them.
• The charts can show how income and
assets are diverted, particularly among
seemingly unrelated parties and entities.
• Microsoft Excel drawing tools may be
used to prepare entity charts.
• For example, an entity chart could show
the creation date of off-shore bank
accounts and the subsequent decrease
in the target’s U.S. bank accounts.
• Or identification of other unrelated
parties may suggest additional
investigation is needed.
D. D. Dorrell and G. A. Gadawski, “Financial Forensics II,” May, 2005, Vol.
3, No. 3, p. 50.
79
80
20
Full – and – False Inclusion Tests
• These tests are used to ascertain the
proper universe of data under
investigation, so that no appropriate
data is excluded and no extraneous
data is included.
Financial Models
© D.L.
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A financial model may be defined as “an abstract,
simplified, mathematical construct related to a part
of reality and created for a particular purpose.”
AICPA Practice Aid 06-2 suggests a financial
model could be used in these situations:
• Reviewing or developing planning concepts in the
client organization.
• Full-and-false inclusion tests may be
helpful for finding hidden assets.
• Selecting, gathering, compiling, validating, and
assessing data required in the planning process.
• Yellow crime scene tape of FA,
according to Darrell Dorrell.
• Determining the relationships and interactions
among the key factors in client operations and
finances.
• Reviewing financial, planning, and operating
assumptions with the client.
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Financial Models (cont.)
Questioned Documents
• Constructing a formal model of key factors,
relationships, and interactions.
• Analyzing, testing, and presenting results produced
by running the model using various combinations of
assumptions, relationships, and activity levels.
• Revising or updating the output as time passes
using amended or incremental inputs.
• Submitting the model to the client for future use
and maintenance with appropriate documentation
and training.
Sources:
Edward A. Bender, An Introduction to Mathematical Modeling (New York:
John Wiley & Sons, 1978), p. 3.
Preparing Financial Models, Practice Aid 06-2, New York: AICPA, 2006,
pp.2-3.
83
Invoices and other documents may be
fake or altered when
• Font sizes or types are not consistent
• No address is shown for the vendor or customer;
this situation is especially suspicious if a vendor
has not identified an address to which a check can
be sent.
• The document has no identifying numbers such as
invoice number, purchase order number, or
customer number.
• All invoice numbers – on invoices from vendors –
are numbered sequentially, with no numbers
skipped.
• No tax is shown for taxable items.
• No shipping or freight cost is shown for items that
would have been shipped at the purchaser’s
expense.
• Little or no detail is provided on the invoice or
document.
T. W. Golden, S. L. Skalak, and M. M. Clayton, A Guide to Forensic Accounting Investigation,
Hoboken, N.J.: John Wiley & Sons, 2006, pp. 156-157.
84
21
Forensic Linguist
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Social Media in Divorce
According to the suit, Heebe enlisted a former FBI profiler
to review 595 comments left by "Henry L. Mencken"
below stories posted on NOLA.com.
The comments were compared to legal filings made by
federal prosecutors in their sweeping probe of the River
Birch landfill, which is co-owned by Heebe and his fatherin-law. The profiler found striking similarities in the
language, the suit says.
The petition notes that "Mencken" uses obscure words,
such as "dubiety" and "redoubt," that also appear in federal
filings in the River Birch case.
The suit says the analysis was conducted by forensic
linguist James Fitzgerald whose work for the FBI "proved
instrumental" in the arrest and successful prosecution of
Ted Kaczynski as the Unabomber, following a lengthy
investigation that included analysis of the mail bomber's
writings.
Gordon Russell, “Landfill owner Fred Heebe claims NOLA.com commenter is federal prosecutor”,
NOLA.com, March 13, 2012
• Attorneys report an increase in using
social media in divorce and family
law cases (e.g. Twitter, MySpace,
YouTube, LinkedIn).
• Facebook, especially, has been a
gold mine for evidence in divorce
disputes.
• Facebook's relaxed privacy policies
make investigations easier, some
attorneys say.
• Private investigators report a surge
in demand for Facebook searches.
Stephanie Chen, “Divorce attorneys catching cheaters on Facebook”, CNN, June 1, 2010
86
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E-ZPass Catching Cheaters
Carbon Dating Paper and
Signatures
• E-ZPass and similar electronic toll collection systems
are emerging as a new and powerful means to prove
infidelity.
• Generally mounted inside a vehicle's windshield
behind the rearview mirror, the remote-sized, EZPass devices communicate with antennas at toll
plazas, automatically deducting money from the tagholder's prepaid account and recording when and
where the vehicle crossed the toll.
• Many states provide electronic toll information in
response to court orders for criminal and civil cases,
including divorces, which are used to prove the
defendant was not where he or she claimed to have
been.
• "E-ZPass is an E-ZPass to go directly to divorce
court, because it's an easy way to show you took the
off-ramp to adultery," said Jacalyn Barnett, a New
York divorce lawyer who has used E-ZPass records a
few times.
• There are reports of using radioactive carbon dating
and microscopy to prove the age of a document and
the age of the signature differ by a matter of years.
Dating the other writing on the paper further
corroborates the allegation of forgery.
• Sources have reported that in Atlanta, the procedure
has been used on the “original” note produced in
court by the pretender lender, proving the
document was a forgery even though the borrower
conceded the signature was authentic.
• If a document is dated 5 years ago, and the signature,
endorsement or assignment execution that is dated
on the paper is more recent, or the actual signature is
more recent than the rest of the document (the paper,
the other writing etc.) then the signature was not on
the document at or near the time of the document’s
creation.
Chris Newmarker, “E-ZPass records out cheaters in divorce court.” AP, 2007.
87
FORENSIC FILES: CARBON DATING THE PAPER AND THE SIGNATURE TO PROVE FORGERY
Neil Garfield, January 25, 2011
88
22
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Carbon Dating Paper and
Signatures
• If it’s the borrower’s signature that has been
technologically reproduced and introduced as an
original, it means that the actual original note is
somewhere else. It also raises the possibility that
more “originals” are circulating in those
fictitious “Trusts” or “pools” purporting to claim
the obligation, note or mortgage.
• If the signature or the paper that is presented as
an assignment dated at or near the time of
closing with the borrower, but either the paper,
the signature, the witness signature or the notary
signature or stamp does not coincide with the
date of the purported document, the same
analysis holds: it is a forgery.
FORENSIC FILES: CARBON DATING THE PAPER AND THE SIGNATURE TO PROVE FORGERY
Neil Garfield, January 25, 2011
89
Forensic Information System for
Handwriting (FISH) U.S.
Department of Justice
The document-part image is acquired by scanning the entire document and
selecting the desired part by using a 6.5 x 6.5 cm ruled square. Once the block
of writing is selected, the document is rescanned, producing an enlargement
of the part on the screen. By adjusting the contrast between the writing and
the paper surface to conform to that of the original document, the examiner
can present features, such as tapered beginning and ending strokes or light
connecting strokes, as they appear on the original document. The examiner
may also remove unwanted features from the document image. The feature
extraction process can being according to the type of writing indicated on the
document-part data entry screen,
A ` Perforation match
Paper shreds demonstrating different optical properties
under ambient and specialized lighting
Inks of different intensities used on the same document
90
The Hitler Diaries Debacle
(1980s)
It was an analysis of the ink and paper used to
write the diaries that revealed them as fakes. An
ultraviolent-light examination revealed that the
paper contained an ingredient that wasn't used in
paper until 1954. Hitler died in 1945. Further
forensic tests on the ink showed it had been
applied to the paper within the last 12 months.
As it turns out, though, the handwriting analysis
was in fact correct – the person who’d written the
diaries had also written the exemplars. Konrad
Kujau, later found out to be an experienced con
artist, had also forged the exemplars the police
were using as comparison documents.
The first step is the text-insensitive feature extraction (TIM), an automatic
process in which FISH marks the exact center of the part and draws eight
vectors out to the edges. The system then uses black-and-white pixel chain
formations and auto-correlation functions to mathematically treat and store
the writing, the TIM is then saved and isolation for selected features begins.
This involves circling the desired letter or combination.
The next extraction deals with tracing or line-following. A set of
measurements then marks the height of the base ovals. At least 10
measurements are taken. After the interactively measured features are
recorded a screen appears that lists the number of measurements taken, the
median measurement, and the standard deviation for each category.
Published by Sunday Times when Rupert Murdoch
was executive editor.
91
92
Julia Layton, How Handwriting Analysis Works
23
Who Uses IDEA?
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IDEA Benefits
•
•
•
•
•
•
Sort
Compare
Manipulate
Sample
Extract data
Mathematical
testing
• Exception
reports
• Aging
• External and Internal
Auditors
• Forensic Accountants/ Fraud
Investigators
• Financial managers
• General and systems
consultants
• Educators
• Statisticians
• Information systems
professionals
• Statistics
• Find missing
data
• Analytics
• Convert test
files to data base
• Create summary
reports
93
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Benford’s Law
Using Data Mining
•
•
• Match employee addresses against
vendor addresses.
• Sort vendor list by size to determine
the most highly paid suppliers.
• Review the structure of vendor
names.
• Uncover indications of ghost
employees (e.g., N.O. Police dept.).
• Fraudulent expense reports (even
amounts, $6).
• Repeated withdrawals of even
amounts from petty cash.
95
Distribution of initial digits in natural numbers is not random
Predictable patterns:
0= ----1= 30.1%
2= 17.6%
3= 12.5%
4= 9.7%
5= 7.9%
6= 6.7%
7= 5.8%
8= 5.1%
9= 4.6%
12%
11.4%
10.9%
10.4%
10%
9.7%
9.3%
9%
8.8%
8.5%
10.2%
10.1%
10.1%
10.1%
10%
10%
9.9%
9.9%
9.9%
9.8%
There is software to detect potentially invented numbers in many situations.
Compare actual frequency with Benford’s frequency.
96
24
Benford’s Law Uses
•
•
•
•
•
•
•
•
•
•
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When Benford Analysis Is or Is Not Likely Useful
When Benford Analysis is Likely Useful
Investments sales/purchases
Check register.
Sales history/Price history.
401 contributions.
Inventory unit costs.
Expenses accounts.
Wire transfer information.
Life insurance policy values.
Bad debt expenses.
Asset/liability accounts.
Accounts receivable (number
sold times price). Accounts
payable (number bought
times price).
Transaction-level data – No need to sample.
Disbursements, sales,
expenses.
On large data sets – The more observations,
the better.
Full year’s transactions.
Accounts that appear to conform – When
the mean of a set of numbers is greater than
the median and the skewness is positive.
Most sets of accounting
numbers.
When Benford Analysis Is Not Likely Useful
Source: Richard Lanza, “Digital Analysis- Real World Example,” IT
Audit, July 1, 1999,pp. 1-9.
97
Examples
Sets of numbers that result from
mathematical combination of numbersResult comes from two distributions.
Examples
Data set is comprised of assigned numbers
Check numbers, invoice
numbers, zip codes.
Numbers that are influenced by human
thought.
Prices set at psychological
thresholds ($1.99), ATM
withdrawals.
Accounts with a large number of firmspecific numbers.
An account specifically set up
to record $100 refunds.
Accounts with a built in minimum or
maximum.
Set of assets that must meet a
threshold to be recorded.
Where no transaction is recorded.
Thefts, kickbacks, contract
rigging.
Source: Durtschi, Hillison, and Pacini, “The Effective Use of Benford’s Law to Assist in
Detecting Fraud in Accounting Data,” J. of Forensic Accounting, Vol. V, 2004, p. 24.
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IDEA Exercise
Use IRS Form 1099 Threat
• For fraudsters and embezzlers, use
the threat of filling a Form 1099 for
amounts stolen.
• Ask for an installment payback.
• If they stop payment, report them to
the IRS on a Form 1099.
99
100
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Source Documents
Look For Fraud Symptoms
• Source Documents.
• Journal Entries.
• Accounting Ledgers.
•
•
•
•
•
•
•
•
Cancelled Checks.
Employee time cards.
Sales invoices.
Shipping documents.
Expense invoices.
Purchase documents.
Credit card receipts.
Register tapes.
•
•
•
•
•
Revenue Agent Reports.
Loan documents.
Forms 1099s/990s.
Insurance documents.
Brokerage account statements.
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Source Documents Fraud Symptoms
• Photocopies of missing documents.
• Counterfeit/false documents.
• Excessive voids/credits.
• Second endorsements.
• Duplicate payments/same payee.
• Large numbers of reconciling items.
• Older items on bank reconciliations.
• Ghost employees.
• Lost register tapes.
• Lots of round numbers.
• Too many beginning 9’s.
• Overpayment of wages.
• Bogus claims.
• White outs and erasers.
102
Journal Entries Fraud Symptoms
• Out-of-balance.
• Lacking supporting documents.
• Unexplained adjustments.
• Unusual/numerous entries at end of
period.
• Written entries in computer
environment.
• Many round numbers.
• Too many beginning 9’s.
• Weekend entries.
• Entries by unauthorized people.
103
104
26
© D.L.
Crumbley
A Valid Contract?
© D.L.
Crumbley
Consideration of Fraud-AU Section 316
•
•
•
•
•
•
The characteristics of fraudulent entries
or adjustments. Inappropriate journal
entries and other adjustments often have
certain unique identifying characteristics,
including entries. PCAOB:
A. Made to unrelated, unusual, or seldomused accounts;
B. Made by people who typically do not make
journal entries;
C. Recorded at the end of the period or as
post-closing entries that have little or no
explanation or description;
D. Made either before or during the
preparation of the financial statements
that do not have account numbers; or
E. Containing round numbers or consistent
ending numbers.
Offer/ Acceptance
Lawful objective
Capacity of parties to perform
Something of value exchanged
Appropriate form (e.g., in writing)
Entered into freely
106
105
Breach of Contract
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© D.L.
Crumbley
Some Contract/ Procurement Frauds
• Breach of contract: a party fails to perform or
says he/ she will not perform. Other party can
sue for damages.
• The intentional failure to perform a contract,
however, does not necessarily constitute fraud.
• Must show that the party did not intend to
perform the contract and deliberately misled
the other party.
• Civil or criminal action: party knowingly and
willfully that the contract (or statement) was
false with the intent to deceive or defraud.
• With this extra burden, may not be worthwhile
to try to prove the fraud. Just get rid of the
person because of a conflict of interest.
1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
11.
12.
13.
Bribes and Kickbacks.
Bid Rigging.
Defective Pricing.
Phantom Vendors [www.picalo.org].
Product substitution.
Conflict of Interests.
False Claims.
Cost Mischarging.
Contract Specification Failures.
Duplicate, false, or inflated invoices.
Split purchases.
Unnecessary purchases.
Defective delivery.
H.R. Davia et. al, Accountant’s Guide to Fraud Detection and
Control, John Wiley, 2000, p.62.
107
108
27
Types of Bid Rigging
1.
2.
3.
4.
5.
6.
© D.L.
Crumbley
Bribes/ Kickbacks Scenario
Collective bidding.
Exclusive bidders.
Change order requests.
Manipulation of bids.
Leaking bid information.
Unbalanced bidding.
© D.L.
Crumbley
Something of Value
Later Influence an Official Act
Cash
Gifts
Trips
Entertainment
Drugs
Sexual favors
Loans
Credit cards
Fees
Spouse’s high salary
Discounts (e.g., house)
Awarding Selection
Higher Prices
Excessive Quantity
Accepting Lower Quality
No, Delayed, or Short Delivery
Prove the corrupting influence circumstantially
through factors on the right, or outsider received
more and more business at the insider gets more
and more value.
109
Some Bribery Red Flags
•
•
•
•
•
•
•
•
•
© D.L.
Crumbley
110
Duty to Cooperate
© D.L.
Crumbley
Lack of standard invoices.
Requests for fund to be routed to a foreign bank.
Requests for checks made payable to “cash” or to
“the bearer.”
Commission substantially higher than going rate.
Requests for a large line of credit from a customer.
Insistence by a government official that a certain
third-party agent or supplier be used.
Lack of staff or facilities to actually perform the
service.
Request by a local agent for a rate increase in the
middle of negotiations.
Suggested need to utilize more than on local agent.
Source: M. T. Biegelman and J. T. Bartow, Executive Roadmap to
Fraud Prevention and Internal Controls, John Wiley, 2006,
pp. 325-326.
111
112
28
Audit Rights
© D.L.
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© D.L.
Crumbley
Purchasing Agent’s Kickback Checklist
1. Audits under clause 2 may be conducted of:
a)
the Contractor's practices and procedures as they relate to the Contract, including security
procedures;
the manner in which the Contractor performs its obligations under the Contract;
the compliance of the Contractor's invoices and reports with its obligations under the Contract;
the Contractor's compliance with all its obligations under the Contract;
the Contractor's compliance with its confidentiality, privacy, security and Commonwealth
policy obligations under the Contract; and
any other matters determined by [Agency] to be relevant to the performance of the Contractor's
obligations under the Contract.
b)
c)
d)
e)
f)
2. Audits
i.
The Contractor must participate in audits of the Contract at the frequency and in relation to the
matters specified by [Agency], (including on an ad hoc basis if requested by [Agency]), for the
purpose of ensuring that the Contract is being properly performed and administered. [Agency]
may appoint an independent person to assist in the audits. Audits may consider all aspects of
the Contractor's performance including but not limited to any performance indicators,
benchmarks or targets.
The Contractor must participate promptly and cooperatively in any audits conducted by
[Agency] or its nominee.
Except for those circumstances in which notice is not practicable or appropriate (eg. caused by
a regulatory request with shorter notice or investigation of theft or breach of contract), and
without limiting any other right, recourse or remedy of [Agency], must give the Contractor
reasonable notice of an audit and where reasonably practicable an indication of which
documents and/or class of documents the auditor may require.
Subject to any express provisions in the Contract to the contrary each party must bear its own
costs of any audits.
Subject to clauses 2.6 and 3.6, the requirement for, and participation in, audits does not in any
way reduce the Contractor's responsibility to perform its obligations in accordance with the
Contract.
ii.
iii.
iv.
v.
vi.
[Agency] must use reasonable endeavours to ensure that audits performed pursuant to clause
2.1 do not unreasonably delay or disrupt in any material respect the Contractor's performance of
its obligations under the Contract.
vii.
[Any amendments to the Contract resulting from audits must be effected by agreement in
writing between the parties in accordance with the Contract amendment provisions of the
Contract.]
The Contractor must promptly take, at no additional cost to [Agency], corrective action to
rectify any error, non-compliance or inaccuracy identified in any audit in the way the
Contractor has under the Contract:
(a) supplied any goods or services; or
(b) calculated fees, or any other amounts or charges billed to [Agency].
viii.
113
•
•
•
•
•
•
•
•
•
•
•
•
Be sure different personnel handle the following duties:
vendor approval, purchase requisitions, purchase
approval, receiving, and payment (e.g., separation of
duties).
Source: J. T. Wells, “The Case of Pilfering Purchasing Manager,” Journal
of Accountancy, May, 2004.
114
© D.L.
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© D.L.
Crumbley
More Phony Vendors Red Flags
Red Flags for Phantom Vendors
•
•
•
•
•
•
•
•
He or she doesn’t take time off.
The purchasing agent has personal financial
problems.
The agent’s lifestyle is too extravagant for his or
her income.
Close personal relationship between purchasing
agent and vendor.
Favoritism toward one vendor.
Excessive purchases from one vendor.
Prices charged are higher than market average.
Expenditures come in just under the review limit.
Multiple purchases over a short period.
Substandard products or services.
Accelerated payment of invoices.
Sole-source purchases of merchandise or services.
Invoices for unspecified consulting or other
poorly defined services.
Unfamiliar vendors.
Vendors that have only a post-office-box
address.
Vendors with company names consisting
only of initials. Many such companies are
legitimate, but crooks commonly use this
naming convention.
Rapidly increasing purchases from one
vendor.
Vendor billings more than once a month.
Vendor addresses that match employee
addresses.
Large billings broken into multiple smaller
invoices, each of which is for an amount
that will not attract attention.
•
•
•
•
•
•
•
•
Ensure those involved in purchasing cannot approve
vendors.
Before approving a new vendor, evaluate its legitimacy
by
Obtaining its corporate records and other relevant
documents.
Checking its credit rating.
Confirming that it is listed in telephone directories.
Contacting its references from clients and others.
Being particularly cautious about a vendor with a postoffice-box address or a name composed entirely of
initials.
Determining whether its business address matches any
employee’s home address.
Once the company approves a new vendor, the CPA should
closely monitor the account by
•
•
•
Watching for increases in the amount or frequency of
billings.
Observing variances from budgets or projections.
Comparing its prices with those charged by other
sources.
Source: J. T. Wells, “Billing Schemes Part I: Shell Companies That
Don’t Deliver,” Journal of Accountancy, July, 2002.
115
Source: J. T. Wells, “Billing Schemes Part I: Shell Companies That
Don’t Deliver,” Journal of Accountancy, July, 2002.
116
29
© D.L.
Crumbley
Assess Financial Health
Ratio
Purpose
Negative
Indicator
Financial
Position:
Unrestricted Net Assets
Expenses
Measures a government’s
ability to provide basic
government services
Decreasing
Financial
Performance:
Change in Net Assets
Total Net Assets
Measures a government’s
financial performance during
the current fiscal year by
comparing the change in the
Net Assets derived from the
Statement of Activities to the
total net assets.
Decreasing
(General Revenues +
Transfers) / Expenses
Measures the extent to which
the cost of services are paid for
out of general revenues.
Decreasing
Liquidity:
(Cash + Current
Investments +
Receivables) / Current
Liabilities
Measures the extent to which
current liabilities are covered
by the more liquid current
assets.
Decreasing
Solvency:
Long-term Debt / Assets
Measures a government’s longterm financial viability by
comparing the extent to which
assets are financed by
incurring long-term debt.
Increasing
(Change in Net Assets +
Interest Expense) /
Interest Expense
Measures the government’s
ability to generate a stream of
inflows sufficient to make
interest payments.
Early Warning Signals of Possible Trouble for Municipal
Entities
1.Current year operating deficit
2.Two consecutive years of Operating Fund deficit
3.Current year operating deficit that is larger than the previous
year’s deficit
4.A General Fund deficit in the current year – balance sheet –
current position
5.A current General Fund deficit (two or more years in the last
five)
6.Short-term debt outstanding at the end of the fiscal year, greater
than five percent of main Operating Fund Revenues
7.A two-year trend of increasing short-term debt outstanding at
fiscal year end
8.Short-term interest and current year-end service greater than 20
percent of total revenues
9.Property taxes greater than 90 percent of the tax limit
10.Debt outstanding greater than 90 percent of the debt limit
11.Total property tax collections less than 92 percent of total levy
12.A trend of decreasing tax collections – two consecutive years in
a three-year trend
13.Declining market valuations – two consecutive years – threeyear trend
14.Expanding annual unfunded pension obligations
Decreasing
Source: B.A. Chaney, D.M. Mead, and K.R. Schermann, “The New Governmental 117
Source: H.C. Grossman and T.E. Wilson, “Assessing Financial
Health,” Handbook of Governmental Accounting & Finance,
Somerset, N.J.: John Wiley & Sons, 1992, pp. 38-1 to 38-13.
118
Reporting Model,” Journal of Governmental Management, Spring 2002, p. 29.
Assess Financial Health of
Governmental Units
© D.L.
Crumbley
Ratios
Negative
Indicator
Credit
Industry
Benchmark
Cash and investments/current
liabilities
Decreasing
Less than 1%
Operating surplus (deficit)/total
revenue
Decreasing
5% or
consecutive
Elastic revenue (sales, utilities,
other elastic taxes)/total revenue
Decreasing
Varies
State and federal aid / total
revenue
Increasing
Varies
Current liabilities/total revenue
Increasing
5%
Uncollected property taxes/
current tax levy
Increasing
Greater than 8%
Fixed costs/ total expenditures
Increasing
Varies
Debt service/total revenue
Increasing
Greater than 20%
Tax levy/tax limit
Increasing
Greater than 90%
Debt outstanding/debt limit
Increasing
Greater than 90%
Source: S.M. Winckler and Dewey Ward, “Can City Hall Go Broke? The Going Concern
119
Issue,” Journal of Accountancy, May 1984.
© D.L.
Office of New York State Comptroller
Crumbley
Indicator 1: Revenue and Expenditures Per Capita
Recurring Revenues Per Capita
a. Gross Revenues
Population
b. Gross Expenditures
Population
c. Recurring Revenues (Gross Revenues – One-Time Revenues)
Population
Negative Trend: Indicator 1b increasing faster than indicator 1a or 1c.
Indicator 2: Real Property Taxes Receivable
Real Property Taxes Receivable
Real Property Tax Revenue
Negative Trend: The percentage increases over time.
Indicator 3: Fixed Costs – Personal Services and Debt Service
a. Salaries and Fringe Benefits
Gross Expenditures
b. Debt Service Expenditures
Gross Expenditures
c. Salaries and Fringe Benefits + Debt Service
Gross Expenditures
Negative Trend: Percentages increasing over time.
Some analysts use a variation of the 3b ratio based upon debt service
expenditures as a percentage of revenues. A ratio of 25% for debt
service expenditures to “own source” revenues is considered a danger
signal.*
120
* J.R. Razek et. al, Introduction to Governmental and Not-For-Profit
Accounting, Prentice-Hall, 2000, p. 412.
30
© D.L.
Crumbley
Indicator 4: Operating Surplus/Deficit
a. Gross Revenues – Gross Expenditures
Gross Expenditures
b. Gross Revenues – Gross Expenditures – One-Time Revenues
Gross Expenditures
Negative Trend: Percentages decreasing over time.
Indicator 5: Unreserved Fund Balance and Appropriated
Fund Balance
a. Unreserved Fund Balance
Gross Expenditures
b. Appropriated Fund Balance
Gross Expenditures
Deficits in major funds in excess of 1.5% of fund expenditures or
$50,000 (whichever is greater) are generally causes for concern.
Some analysts use a variation of this ratio: the budgetary
cushion. Here the fund balance is compared to revenues. The
greater the fund balance as a percentage of revenues, the more
likely a local government may weather hard times. A good rule
of thumb is that a fund balance should be at least 5% of
revenues.[1]
[1] J.R. Razek et. al, op. cit., p. 411.
Indicator 6: Liquidity
Cash and Investment as a Percentage of Current Liabilities
Cash and Investments as a Percentage of Gross Monthly Expenditures
a. Cash and Investments
Current Liabilities
b. Cash and Investments
Gross Expenditures/12
A government should generally have year-end cash equal to about
50% of current liabilities and 75% of average monthly expenditures.
A governmental accounting textbook states that this quick ratio (or
acid test) omits receivables and amounts due from other funds
because of difficulties converting them into cash. They suggest that a
large state government should consider a quick ratio of less than 50
percent as an indicator of financial stress.*
Indicator 7: Long-Term Debt
Long-Term Debt
Population
Negative Trend: Percentage increase over time
Note: An increase in #7 would likely trigger a future increase in #3
formula as well as a decrease in #8.
Indicator 8: Capital Outlay
Capital Outlay
Gross Expenditures
Negative Trend: Percentage decreasing over time
Note: This eighth indicator is an early warning sign of financial stress.
* Razek and Hosch, ibid., p.411.
121
122
Indicator 9: Current Liabilities
Current Liabilities
Gross Revenues
Negative Trend: Percentage increasing over time
Indicator 12: Public Safety
Public Safety Cost
Gross Expenditures
Indicator 10: Intergovernmental Revenues
Intergovernmental Revenues
Gross Revenues
Negative Trend: Percentage increasing over time.
Indicator 13: Tax Limit Exhausted
Tax Levy
Tax Limit
The tax limit is the maximum amount of taxes that can be levied
based upon some statutory authority.
Indicator 11: Economic Assistance Costs
Economic Assistance Cost
Gross Expenditures
Negative Trend: Percentage increasing over time.
Indicator 14: Debt Limit Exhausted
Total Debt Subject to Limit
Debt Limit
Debt limit is the maximum amount of debt that can be issued
under applicable statutory authority. Compare this ratio with
indicators 3 and 7.
123
124
31
Some Exercises
© D.L.
Crumbley
1. You have the following data for a city in the southwest. Calculate the
quick ratio. Is this ratio favorable or unfavorable?
Current Liabilities
$28 million
Cash
$27 million
Investments (current)
$36 million
Accounts Receivables
$12 million
Due from other funds
$2.5 million
2. You have the following information about a mid-west city. Calculate
the ratios of fund balance to revenues and determine if they are
favorable or unfavorable.
General Fund
$62 million
Unreserved Fund
$54 million
General Fund Revenues
$401 million
3. You determine the following data about a local government in the
southeast. Determine the ratios of unreserved fund balance and
reserved fund balance to total revenues. Are these ratios favorable?
Revenues from Property Taxes
$36 million
Unreserved Fund Balance
$5 million
Reserved Fund Balance
$3.5 million
4. Assume the following facts about a local government. Determine the
Tax Limit Exhausted and the Debt Limit Exhausted ratios.
Tax Limit
$11 million
Debt Limit
$13 million
Tax Levy
$8.5 million
Total Debt subject to Limit
$9 million
5. Assume that Debt Service Expenditures is $16.2 million and Total
Revenues is $70.1 million. Calculate the Debt Service/total revenue
ratio. Is the ratio favorable?
Exercise Answers
Some Exercises
© D.L.
Crumbley
6. Determine if the following situations are negative indicators of
the financial health of a government unit.
a. Cash and investments divided by current liabilities ratio is
decreasing over several years.
b. Current liabilities divided by total revenues ratio is decreasing.
c. Fixed costs divided by total expenditures ratio is increasing.
d. Real Property Taxes Receivables divided by Real Property Tax
Revenue ratio is increasing over time.
e. Debt Service expenditures as a percentage of revenues is greater
than 25%.
f. Debt Service Expenditures divided by Gross Expenditures ratio
is decreasing over time.
g. Gross Revenues – Gross Expenditures : Decreasing over time.
Gross Expenditures
h. The debt service expenditures as a percentage of revenues is
25% or larger.
i. A fund balance is greater than 10% of revenues.
j. Unreserved fund balance divided by gross expenditures ratio is
decreasing over time.
k. The quick ratio of a large state government is 2.2 to 1.
l. Long-Term Debt divided by population ratio is decreasing over
time.
m.Current Liabilities divided by Gross Revenues ratio is
increasing over time.
n. Tax Levy divided by Tax Limit ratio is decreasing over time.
125
© D.L.
Crumbley
126
Exercise Answers
© D.L.
Crumbley
6. Determine if the following situations are negative indicators of the
financial health of a government unit.
a. Cash and investments divided by current liabilities ratio is decreasing
over several years. Negative
b. Current liabilities divided by total revenues ratio is decreasing. Positive
c. Fixed costs divided by total expenditures ratio is increasing. Negative
d. Real Property Taxes Receivables divided by Real Property Tax
Revenue ratio is increasing over time. Negative
e. Debt Service expenditures as a percentage of revenues is greater than
25%. Negative
f. Debt Service Expenditures divided by Gross Expenditures ratio is
decreasing over time. Positive
g. Gross Revenues – Gross Expenditures : Decreasing over time.
Gross Expenditures
Negative
h. The debt service expenditures as a percentage of revenues is 25% or
larger. Negative
i. A fund balance is greater than 10% of revenues. Favorable
j. Unreserved fund balance divided by gross expenditures ratio is
decreasing over time. Negative
k. The quick ratio of a large state government is 2.2 to 1. Favorable
l. Long-Term Debt divided by population ratio is decreasing over time.
Favorable
m.Current Liabilities divided by Gross Revenues ratio is increasing over
time. Negative
n. Tax Levy divided by Tax Limit ratio is decreasing over time.
Favorable
Favorable
127
128
32
Acquisition/Payment Cycle
From 62 standard audit procedures, external and
internal auditors judged these 20 procedures to be more
efficient is detecting fraud in the acquisition and
payment cycle (in descending order).
• Examine bank reconciliation and observe whether they
are prepared monthly by an employee who is
independent of recording cash disbursement or custody
of cash.
• Examine the supporting documentation such as
vendor’s invoices, purchase orders, and receiving reports
before signing of checks by an authorized persons.
• Examine the purchase requisitions, purchase orders,
receiving reports, and vendors’ invoices which are
attached to the vouchers for existence, propriety,
reasonableness and authenticity.
•Examine internal controls to verify the cash
disbursement are recorded for goods actually rendered to
the company.
Acquisition/Payment Cycle (Contd.)
• Confirm inventories in public warehouse and on
consignment.
•Examine internal controls to insure the vendor’s
invoices, purchase orders, and receiving reports are
matched and approved for payment.
• Examine internal controls for the following documents:
vendor’s invoices, receiving reports, purchase orders,
and receiving reports.
• Trace a sample of acquisitions transactions by
comparing the recorded transactions in the purchase
journal with the vendor’s invoices, purchase requisitions,
purchase orders, and receiving reports.
• Establish whether any unrecorded vendors’ invoices or
unrecorded checks exist.
• Examine the internal control to verify the proper
approvals of purchase requisitions and purchase orders.
•Discuss with personnel and observe the segregation of
duties between accounts payable and custody of signed
checks for adequacy.
• Reconciled recorded cash disbursement with
disbursements on bank statements.
Glen D. Moyes and C. Richard Baker, “Auditors’ Beliefs About the Fraud
Detection Effectiveness of Standard Audit Procedures,” Journal of
Forensic Accounting, Vol. 4, 2003, p. 204-205
129
Detection Effectiveness of Standard Audit Procedures,” Journal of Forensic
Accounting, Vol. 4, 2003, p. 204-205
130
Acquisition/Payment Cycle (Contd.)
• Discover related party transactions.
• Examine the internal control to verify the approvals
of payments on supporting documents at the time that
checks are signed.
• Discuss with personnel and observe the procedures
of examining the supporting documentation before the
signing of checks by an authorized person.
• Examine canceled checks for authorized signatures,
proper endorsements, and cancellation by the bank.
• Account for the numerical sequence of prenumbered
documents (purchase orders, checks, receiving reports,
and vouchers).
• Trace a sample of cash payment transactions.
• Trace resolution of major discrepancy reports.
Sales/Collection Cycle
These 10 audit procedures were judged as being
more effective for detecting fraud in the sales and
collection cycle (in descending order)
• Observe the proper and appropriate segregation of
duties.
• Review monthly bank reconciliation and observe
independent reconciliation of bank accounts.
• Investigate the difference between accounts receivable
confirmation and customer account receivable balances
in the subsidiary ledger and describe all these
exceptions, errors, irregularities, and disputes.
• Review sales journal, general ledger, cash receipts
journal, accounts receivable subsidiary ledger, and
accounts receivable trial balance for large or unusual
amounts.
• Verify accounts receivable balance by mailing positive
confirmations.
Accounting, Vol. 4, 2003, p. 204-205
131
Accounting, Vol. 4, 2003, p. 209
132
33
Sales/Collection Cycle (Contd.)
• Examine internal controls to verify that each cash
receipts and credit sales transactions are properly
recorded in the accounts receivable subsidiary ledger.
• Examine subsequent cash receipts and the credit file
on all accounts over 120 days and evaluate whether the
receivable are collectible.
• Compare dates of deposits with dates in the cash
receipts journal and the prelisting cash receipts.
• Examine copies of invoices for supporting the bills of
lading and customers’ orders.
Inventory/Warehouse Cycle
These 14 standard audit procedures were judged
by external and internal auditors as being more effective
for detecting fraud in the inventory and warehousing
cycle 9in descending order):
• Follow up exceptions to make sure they are resolved.
• Review major adjustments for propriety.
• Review inventory count procedures: a. Accounting for
items in transit (in and out); b. Comparison of counts
with inventory records; and c. Reconciliation of
difference between counts and inventory records.
• Review adequacy of physical security for the entire
inventory.
• Confirm inventories in public warehouse.
• Review procedures for receiving, inspecting, and
storing incoming items and for shipments out of the
warehouses.
Accounting, Vol. 4, 2003, p. 209
133
Inventory/Warehouse Cycle (Contd.)
• Trace shipments to sales records, inventory records,
and bill of lading (shipping documents).
• Determine if access to inventory area is limited to
approval personnel.
• Observe the physical count of all location.
• Recount a sample of client’s counts to make sure the
recorded counts are accurate on the tags (also check
descriptions and unit of count, such as dozen or gross)
• Trace inventory listed in the schedule to inventory
tags and the auditor’s recorded counts for existence,
descriptions, and quantity.
• Trace shipments to sales journal.
• Perform compilation tests to insure that inventory
listing schedules agrees with the physical inventory
counts.
135
Accounting, Vol. 4, 2003, p. 206-207.
Detection Effectiveness of Standard Audit Procedures,” Journal of Forensic 134
Accounting, Vol. 4, 2003, p. 206-207
Payroll/Personnel Cycle
These 12 audit procedures were judged the more
effective for detecting fraud in the payroll and personnel
cycle (in descending order):
• Sample terminated employees and confirm that they
are not included on subsequent payrolls and confirm
propriety of termination payments.
• Observe the actual distribution of payroll checks to the
employees.
• Observe the duties of employees being performed to
insure that separation of duties between personnel,
timekeeping, journalizing payroll transactions, posting
payroll transactions, and payroll disbursement exists.
• Examine internal controls to verify that hiring, pay
rates, payroll deductions, and terminations are
authorized by the personnel department.
• Sample personnel files and physically observe the
presence of personnel in the work place.
Detection Effectiveness of Standard Audit Procedures,” Journal of Forensic 136
Accounting, Vol. 4, 2003, p. 208.
34
© D.L.
Crumbley
Payroll/Personnel Cycle (Contd.)
• Examine internal control over payroll records to
verify that payroll transactions are properly
authorized.
Exercises
1.
• Review the files of new hires for appropriate
approvals, pay rates, and dates of accession.
2.
• Review the payroll journal, general ledger, and
employee individual pay records for large or unusual
amounts.
3.
• Examine internal controls to verify that unclaimed
payroll checks are secured in a vault or safe with
restricted access.
• Examine internal controls to verify that employee
time cards and job order work tickets are reconciled.
4.
Accounting, Vol. 4, 2003, p. 208.
5.
137
You receive a tip on the company’s hot line that
there has been some fraud in the collections area.
What five audit steps would you suggest using in
order to find the fraud?
During a brainstorming session, a suggestion is
made that the most likelihood of fraud in a
particular division is in the area of acquisition and
payment cycle. Outline five audit steps to help
find any potential fraud.
While auditing a company you notice an
employee in payroll who is living beyond his
means (e.g., clothes, automobiles, housing). His
wife does not work. Suggest six audit steps to
help satisfy you there is no fraud in the payroll
and personnel cycle.
An anonymous e-mail is sent to an internal
auditor that there is fraud in the inventory/
warehousing cycle. Suggest some appropriate
audit steps.
What is meant by the hockey stick pattern?
138
© D.L.
Crumbley
© D.L.
Crumbley
The End Is Here
139
140
35

Larry Crumbley - Governmental 2012

Transcription

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