Final Exam Fraud

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Who commits financial statement fraud

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1. Senior management2. Mid- and lower-level employees3. Organized criminals

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To conceal true business performance

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Overstate performance

Understate performance

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Overstate performance

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i. To meet or exceed earnings or revenue growth expectations of stock market analystsii. To comply with loan covenantsiii. To increase the amount of financing available from asset-based loansiv. To meet a lender’s criteria for granting/extending loan facilitiesv. To meet corporate performance criteria set by the parent companyvi. To meet personal performance criteriavii. To trigger performance-related compensation or earn-out paymentsviii. To support the stock price in anticipation of a merger, acquisition or sale of personal stockholdingix. To show a pattern of growth to support a planned offering or sale of the business

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Understate performance

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i. To defer “surplus” earnings to the next accounting periodii. To take all possible write-offs in one “big bath” now so future earnings will be consistently higheriii. To reduce expectations now so future growth will be better perceived and rewardediv. To preserve a trend of consistent growthv. To reduce the value of an owner-managed business for purposes of a divorce settlementvi. To reduce the value of a corporate unit whose management is planning a buyout

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Why do people commit financial statement fraud?

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To conceal true business performance

To preserve personal status/control

To maintain personal income/wealth

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How do people commit financial statement fraud?

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Playing the accounting system

Beating the accounting system

Outside the accounting system

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Define fraud as it relates to financial statements.

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preparing false financial statements

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Playing the accounting system

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the accounting system is manipulated (e.g. change in depreciation methods or accounting estimates) to generate specific desired results (i.e. increase or decrease net income)

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Beating the accounting system

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false and fictitious information is input into the accounting system to manipulate reported results

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Outside the accounting system

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the fraudster fabricates financial statements using equipment such as a typewriter or personal computer

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Defining Financial Statement Fraud

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deliberate misstatements or omissions of amounts or disclosures of financial statements to deceive financial statement users, particularly investors and creditors

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Financial statement fraud may involve the following schemes

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falsification, alteration, or manipulation of material financial records, supporting documents, or business transactions.

material intentional omissions or misrepresentations of events, transactions, accounts, or other significant information from which financial statements are prepared.

deliberate misapplication of accounting principles, policies, and procedures used to measure, recognize, report, and disclose economic events and business transactions.

intentional omissions of disclosures or presentation of inadequate disclosures regarding accounting principles and policies and related financial accounts.

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Financial statement related schemes

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fictitious revenues

Timing differences

concealed liabilities and expenses

improper disclosures

improper asset valuation

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Fictitious revenues

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a scheme that involves the recording of sales or services that did not occur

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Fictitious revenues - Sales with conditions

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a sale is recorded even though some terms have not been fulfilled

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Fictitious revenues - Pressures to boost revenues

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External pressures – bankers, stockholders, families, and communities

Internal pressures – departmental budget requirements

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Red flags associated with fictitious revenues

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i. Rapid growth or unusual profitability

ii. Recurring negative cash flows from operations

iii. Significant transactions with related parties

iv. Significant, unusual, or highly complex transactions

v. Unusual growth in the number of days' sales in receivables

vi. Significant sales to entities with unknown ownership

vii. Large number of sales by a small number of company units

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Timing differences

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recording revenues and/or expenses in improper accounting periods

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Timing differences - Matching revenues with expenses

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according to generally accepted accounting principles (GAAP) revenues should be matched with expenses in the same period and failing to do so violates GAAp

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Timing differences - Premature revenue recognition

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Revenue should be recognized when a sale is complete.

recognizing revenue before the actual transfer of ownership occurs.

SEC Staff Accounting Bulletin Topic 13, “Revenue Recognition,” establishes that the following criteria must be satisfied to recognize revenue:i. Persuasive evidence of an arrangement exists

ii. Delivery has occurred or services have been rendered

iii. The seller’s price to the buyer is fixed or determinable

iv. Collectability is reasonably assured

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Timing differences - Long term contracts

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i. Completed contract method – records revenue when contract is complete

ii. Percentage of completion method – recognizes revenue and expenses as project progresses. This method is subject to manipulation.

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Timing differences - Channel stuffing ("trade loading")

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customers are encouraged to overbuy merchandise through offers of large discounts and extended payment terms

steals from the next period's sales

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Timing differences- Recording expenses in the wrong period

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i. Due to pressures to meet budget projections

ii. Lack of proper accounting controls

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Red flags associated with timing differences

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i. Rapid growth or unusual profitability

ii. Recurring negative cash flows from operations

iii. Significant, unusual, or highly complex transactions

iv. Unusually high, or unusual increase in, gross margin

v. Unusual growth in the number of days' sales in receivables

vi. Unusual decline in the number of days' purchases in accounts payable

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Concealed liabilities and expenses

three methods

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understating liabilities and expenses to make the company look more profitable

a. Liability/expense omissions

b. Capitalized expenses

C. failure to disclose warranty costs and liabilties

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Concealed liabilities and expenses- Liability/expense omissions

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one of the most difficult schemes to detect because there is no audit trail

simply failing to record them

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Concealed liabilities and expenses- Capitalized expenses

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improper capitalization of expenses causes income to be overstated in the current period. Subsequently, as assets are depreciated, income will be understated.

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Concealed liabilities and expenses- Expensing capital expenditures

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improper expensing of capital assets causes income to be understated and, therefore, reduces tax liability

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Concealed liabilities and expenses- Returns and allowances and warranties

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failure to disclose and accrue appropriate expenses and liabilities for potential product returns or warranty repairs

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e. Red flags associated with concealed liabilities and expenses

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i. Recurring negative cash flows from operations

ii. Significant estimates that involve subjective judgments or uncertainties that are difficult to corroborate

iii. Nonfinancial management’s excessive participation in the selection of accounting principles or the determination of significant estimates

iv. Unusually high, or unusual increase in, gross margin

v. Allowances for accounting estimates that are out of line with industry peers

vi. Unusual decline in the number of days' purchases in accounts payable

vii. Unusual reduction in accounts payable

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Improper disclosures involve

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liability omissions

subsequent events

management fraud

related party transactions

accounting changes

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Improper disclosures- Liability omissions

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generally include the failure to disclose loan covenants or contingent liabilities

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Improper disclosures- Subsequent events

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events occurring after the close of the period may have a significant impact on the financial statements and should be disclosed

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Improper disclosures- Management fraud

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disclosure is required of significant fraud committed by officers, executives, and others in positions of trust

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improper disclosures- Related-party transactions

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a company doing business with entities that can be controlled or significantly influenced by that company must disclose the relationship

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improper disclosures- Accounting changes

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FASB ASC 250, “Accounting Changes and Error Corrections,” requires disclosure of changes in:i. Accounting principlesii. Accounting estimatesiii. Reporting entities

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Red flags associated with improper disclosures

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i. Dominating managerii. Ineffective board of directors or audit committee oversightiii. Ineffective communication or enforcement of ethical values and standardsiv. Rapid growth or unusual profitabilityv. Significant, unusual, or highly complex transactionsvi. Significant related-party transactionsvii. Significant bank accounts or branch operations in tax-haven jurisdictionsviii. Overly complex organizational structureix. Known history of violations of securities laws or other regulationsx. Inappropriate accounting policy justified on the basis of materialityxi. Limiting auditor access to information during an audit

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Improper asset valuations

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Generally, assets should be recorded at their historical (acquisition) cost.

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Improper asset valuations - Inventory valuation

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i. Lower of cost or marketii. Overstating inventory through fictitious (phantom) inventory

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Improper asset valuations - Accounts receivable

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i. Fictitious accounts receivableii. Failure to write down

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Improper asset valuations - Business combinations

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Fraud-related issues include

Temptation to over-allocate the purchase price to in-process research and development assets, to write them off immediately

Establish excessive reserves with the intention to release them into earnings at a future date

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Improper asset valuations Fixed assets

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i. Booking fictitious assets – by creating false documents or recording equipment that is leased as ownedii. Misrepresenting asset value – fixed assets should be recorded at their historical (acquisition) costiii. Improperly capitalizing inventory and start-up costs• Capitalizing non-asset costs – interest and finance charges should be excluded from the cost of an asset• Misclassifying assets – can skew financial ratios to comply with loan requirements

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Red flags associated with improper asset valuation

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i. Recurring negative cash flows from operationsii. Significant declines in customer demandiii. Significant estimates that involve subjective judgments or uncertainties that are difficult to corroborateiv. Nonfinancial management’s excessive participation in the selection of accounting principles or the determination of significant estimatesv. Unusually high, or unusual increase in, gross marginvi. Unusual growth in the number of days' sales in receivablesvii. Unusual growth in the number of days' purchases in inventoryviii. Allowances for accounting estimates that are out of line with industry peersix. Unusual change in the relationship between fixed assets and depreciationi. Unusual increase in assets

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Description and characteristics of fraud

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Misstatements arising from fraudulent financial reportingi. Manipulation or alteration of accounting recordsii. Misrepresentations or intentional omissionsiii. Intentional misapplication of accounting principlesb. Misstatements arising from misappropriation of assets – theft or defalcation

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Obtaining information needed to identify risks of material misstatement due to fraud

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a. Making inquiries of management and others within the entity b. Considering the results of analytical procedures c. Considering fraud risk factors d. Considering other information

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Identifying risks that may result in material misstatement due to fraud

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a. Typeb. Significancec. Likelihoodd. Pervasiveness

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Assessing the identified risks after taking into account an

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evaluation of the entity’s programs and controls

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Overall responses to the risk of material misstatement

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i. Assignment of personnel and supervisionii. Consider selection and application of accounting principlesiii. Incorporate an element of unpredictability in auditing procedures

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Responses involving the nature, timing, and extent of procedures to be performed to address the identified risks

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i. Substantive testsii. Tests of the operating effectiveness of the entity's programs and controls

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a. Assessing risks of material misstatement due to fraud throughout the audit

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i. Discrepancies in the accounting recordsii. Conflicting or missing evidential matteriii. Problems experienced by the auditors during the audit

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Evaluating whether analytical procedures indicate a previously unrecognized risk of fraud –

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unusual or unexpected relationships should be considered

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c. Evaluating risks of material misstatement at or near the completion of fieldwork

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to assess whether further audit procedures are needed

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d. Responding to misstatements that may be the result of fraud

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i. Attempt to obtain additional evidenceii. Consider the implications for other aspects of the auditiii. Discuss the matter with an appropriate level of managementiv. If appropriate, recommend the client consult with legal counsel

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9. Communicating about possible fraud to

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management, the audit committee, and others

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10. Documenting the auditor’s

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consideration of fraud

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B. Percentage analysis

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vertical and horizontal

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Vertical analysis

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analyzes the relationships between the items on each of the financial statements by expressing the components as percentages of a specific base item

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Horizontal analysis

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analyzes the percentage change in individual financial statement items from one year to the next

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Financial ratios

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measures the relationship between two different financial statement amounts

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Deterrence of financial statement fraud incorporates the principles of the fraud triangle.

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1. Reduce pressures to commit financial statement fraud2. Reduce the opportunity to commit financial statement fraud3. Reduce rationalization of financial statement fraud

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When Is an Investigation Necessary?

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Internal investigations can arise from a number of circumstances, including determining the source of and losses from an alleged fraud, complying with federal statutes, and mitigating the company’s liability related to employee misconduct.

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II. Planning the Investigation

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Once the decision has been made to pursue an investigation, it is important to consider how the company can carry out the investigation in the most efficient, effective manner.

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A. Selecting the Investigation Team

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– team should be limited to only those persons who are vital to the fraud examination process.1. Typical investigation team may include certified fraud examiners, legal counsel, internal auditors, human resources personnel, and management representatives.

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B. Certified Fraud Examiners

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CFEs are trained to conduct complex fraud examinations from inception to conclusion.

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Legal Counsel

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crucial to have counsel involved in “directing” the investigation.

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Internal Auditors

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– internal auditors are often used to review internal documentary evidence.

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IT and Computer Forensics Experts

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computer forensics professionals are used to capture and analyze digital data.

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Human Resources Personnel/Management Representative

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advice from a human resources specialist or management representative might be needed.

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Investigation team

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Human Resources Personnel/Management Representative

IT and Computer Forensics Experts

Internal Auditors

Legal Counsel

Certified Fraud Examiners

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Developing evidence. Investigate techniques include

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A. Covert Operations

B. Pretexting

C. Using Informants

D. Subpoenas

E. Search Warrants

F. Voluntary Consent

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Covert Operations

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the investigator assumes a fictitious identity to gather evidence.

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Pretexting

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obtaining information through some sort of falsehood or deception.

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Using Informants

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can be used successfully in private investigations if handled properly.

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Subpoenas

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call for the production of documents and records.

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Search Warrants

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used when a law enforcement officer believes certain records have been used in the commission of a crime.

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Voluntary Consent

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– is often the simplest means to obtain documentation, and the preferred method in many fraud examinations.

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Preserving Documentary Evidence

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The investigator must take care to properly preserve the evidence to ensure its admissibility in a court of law.

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Chain of Custody

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a record must be made when the evidence is received or when it leaves the care, custody, or control of the fraud examiner.

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A memorandum of interview should state:

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a) What items were received

b) When they were received

c) From whom they were received

d) Where they are maintained

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Preserving the Document

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– the examiner should never write or mark on the original document other than his unobtrusive initials for identification.

1. Photocopies and laser-printed documents should always be stored in paper folders or envelopes.2. If fingerprint examinations are anticipated, gloves should be used to handle the documents.

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Organizing Documentary Evidence

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Documents obtained must be properly organized early on in an investigation, and they should continuously be reorganized. Good organization includes:1. Segregating documents by either witness or transaction2. Making a “key document” file for easy access to the most relevant documents3. Establishing a database of a large amount of information early on in the case

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Chronologies

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– a chronology of events should be commenced early in the case in order to establish the chain of events leading to the proof.

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To-Do Lists –

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– the list should be kept in a manner which allows a cumulative record of investigation tasks

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Using Computer Software to Organize Documents and other Data –

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investigators can establish a database in which to store pertinent information about the case and the documents that have been assembled.

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Sources of Information

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A variety of information sources is available to the fraud examiner to assist in locating individuals, researching assets, discovering creditor relationships, and uncovering litigation history.

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In-House Sources

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investigators can learn a great deal about a subject by examining records of his employing organization, if they can gain access to those records.

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Public Information

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– records that a governmental unit is required by law to keep to discharge its duties imposed by law.1. Voter registration and marriage license records2. Real property records – if an individual buys or sells a house or piece of property, or becomes subject to a state or federal lien, the transaction will be reflected in the county real property indexes.3. Property tax records4. Health and fire departments5. Utility company records6. Permits – will be on file with local building authority if a business/individual constructs a new building.

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State Records

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1. Business filings – the law requires the filing of documents of business ownership to conduct business in a name other than one’s own2. Articles of incorporation – corporations are formed by filing articles of incorporation with the Secretary of State in the state where the company does business. These records are public.3. Fictitious names/DBA registrations – DBA information for proprietorships or partnerships is usually filed at the county level, but some states require filing at the state level also4. Uniform Commercial Code filings – can disclose when/where a person obtained a personal loan and the type of property that he or she pledged to secure the loan5. Workers’ compensation information – documents that show the date of the incident, the employer at the time, type of injury, and the job-related disability6. State tax filings – Licenses and applications for permits may reveal hidden assets or investments7. Professional associations and licensing boards – maintain records identifying individuals holding special licenses or memberships8. Litigation history – files on all active and closed lawsuits are maintained by court clerks9. Bankruptcy records – bankruptcy documents are usually located in the federal bankruptcy court for the district where the debtor resided10. The Internet – provides access to a wealth of information; however, investigators should remember that much of the information on public websites is questionable

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Report Writing

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Fraud examinations usually conclude with a formal written report of the investigation results.

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Purpose of the Report

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A good investigation report must be accurate and understandable so that others may know what transpired without having to talk to the report’s author. It should:1. Convey evidence2. Add credibility3. Accomplish objectives of case

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Know the Reader

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the investigator must identify the expected reader to ensure the report appears professional and achieves its purpose. The report should:1. State only the facts2. Not contain errors3. Have a follow-up section

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Format –

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– Using a standard report format will reduce the amount of time spent writing a report, while ensuring that all significant information is included. A standard report should include the following sections:1. Author/date2. Summary – should set out the main points of the report in a few sentences and include the findings and outcome of the investigation3. Introduction/purpose – should give more detail on what the report is about and prepare the reader for what is to come4. Body – identifies the employee(s) and other individuals implicated/involved in the matter5. Results – this section may include only a sentence or two, or be supplemented with spreadsheets or graphics6. Follow-up/recommendation – identifies any investigation procedures that remain outstanding, and makes any recommendations related to procedures and controls

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Opinions or Conclusions in Report

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no opinions of any kind should be included in the written report, other than on technical matters

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Interviewing Witnesses

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the process of asking questions of individuals who might have information to resolve allegations of wrongdoing.

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Introductory Questions

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1. Provide the introduction

2. Establish rapport – e.g., engage in small talk to break the ice

3. Establish the interview theme – the goal is to motivate the subject to assist in the interview

4. Observe reactions

5. General rules for the introductory phase of the interview

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Informational Questions

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to gather unbiased factual information; these questions should be non-confrontational and non-threatening

1. Open questions – call for a monologue response2. Closed questions – require a "yes" or "no" answer3. Leading questions – ask the subject to confirm what is already known4. Question sequences – proceed from the general to the specific5. Informational question techniques6. Methodology7. Dealing with difficult people 8. Volatile interviews – have the potential to bring about strong emotional reactions in the interviewee.

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Closing Questions

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1. Reconfirming facts – generally, the use of leading questions is suggested

2. Gathering additional facts – the use of open questions provides the subject an opportunity to furnish other relevant facts or opinions

3. Concluding the interview

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Assessment Questions –

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to establish the credibility of the respondent

1. Norming or calibrating – the process of observing behavior before asking critical questions

2. Physiology of deception – lying produces stress, and in order to relieve this stress, the body will exhibit certain behavioral quirks

3. Verbal clues to deception

4. Nonverbal clues

5. Methodology – proceed from least to most sensitive questions

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3. Verbal clues to deception

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a. Changes in speech patterns i. speed ii. tone iii. pitchb. Repetition of the question – to gain more time to respondc. Comments regarding the interview – complaints about: i. physical environment ii. length of interviewd. Selective memorye. Making excusesf. Oaths – to attempt to add credibility to their liesg. Character testimony – to add credibility to a false statementh. Answering with a question – rather than deny allegations outrighti. Overuse of respect – when accused of wrongdoing, this reaction is unnaturalj. Increasingly weaker denials – common reaction from a dishonest person k. Failure to deny – qualifying the denial (e.g., to the best of my recollection or as far as I remember)l. Avoidance of emotive words – (e.g., “steal,” “lie,” “crime”)m. Refusal to implicate other suspectsn. Tolerant attitudes – toward illegal or unethical conducto. Reluctance to terminate interviewp. Feigned unconcern

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non verbal clues to deception

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a. Full-body motions – change of posture, moving away from interviewerb. Anatomical physical responses i. increased heart rate ii. shallow or labored breathing iii. excessive perspirationc. Illustrators – motions made primarily with the handsd. Hands over the mouthe. Manipulators – displacement activities done to reduce nervousnessf. Fleeing positions – lower portion of the body facing toward the doorg. Crossing the arms – defensive reactionh. Reaction to evidence – feigned disinterest in the evidencei. Fake smiles – confined to the upper half of the mouth

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Admission-Seeking Questions – designed to:

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• Clear an innocent person, or

• Encourage the culpable person to confess

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Presence of outsiders

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a. May present legal problems in “broadcasting” allegations to a third partyb. May make it more difficult to obtain a confession

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Miranda warnings –

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does not apply to private employers’ investigations

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Theme development –

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offers a morally acceptable reason for the confessor’s behavior

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Steps in the admission-seeking interview

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Direct accusation

Observe reaction – a guilty person will react with silence or a weak denial

Repeat accusation

It is difficult for the accused to change a denial because he or she would be admitting to lying. Therefore, by preventing an outright denial, it makes it easier for the accused to confess.

Establish rationalization – This (morally acceptable) explanation allows the accused to justify the offense with his or her conscience.

Diffuse alibis – Use of one of the following methods may be employed to convince the accused of the weight of the evidence against him or her.

Benchmark admission

Verbal confession – occurs when the accused furnishes detailed information about the misdeed. The following information should be obtained:

Taking a signed statement – has greater credibility than a verbal confession and should include a statement of:

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Interrupt denials : This may be accomplished through

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i. Delaysii. Interruptionsiii. Reasoning

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Establish rationalization

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i. Unfair treatmentii. Inadequate recognitioniii. Financial problemsiv. Aberration of conductv. Family problemsvi. Accuser’s actionsvii. Stress, drugs, alcoholviii. Revengeix. Depersonalizing the victimx. Minor moral infractionxi. Altruismxii. Genuine need

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Diffuse alibis –

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i. Display physical evidenceii. Discuss witnessesiii. Discuss deceptionsiv. Present alternative – forces the accused to make a choice between a morally acceptable reason for the offense and one that offers no (good) excuse

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Benchmark admission

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I. A subconscious decision to confessii. Reinforce rationalization

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Verbal confession

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i. The accused knew the conduct was wrongii. Facts known only to perpetratoriii. Estimate of number of instances/amountsiv. Motive for offensev. When offense commencedvi. When/if offense was terminatedvii. Others involvedviii. Physical evidenceix. Disposition of proceedsx. Location of assetsxi. Specifics of each offense

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Taking a signed statement

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i. Voluntary confessions – no duressii. Intent – intention to commit the actiii. Approximate dates of offenseiv. Approximate amounts of lossesv. Approximate number of instancesvi. Willingness to cooperatevii. Excuse clause – confessor’s moral excuse should be mentionedviii. Have the confessor read the statementix. Truthfulness of statementx. Preparing a signed statement

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Preparing a signed statement

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• Should not be drafted by the confessor• A separate written statement for each offense• Instruct the confessor to read and sign the statement without delay

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Define fraud as it relates to financial statements.

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preparing false financial statments

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Identify the three main groups of people who commit financial statement fraud

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senior management

mid and lower level employees

organized criminals

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List the three primary reasons people commit financial statement fraud

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to conceal true business performance

to preserve personal status/control

to maintain personal income/wealth

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Describe the three general methods used to commit financial statement fraud

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playing the accounting system (generates the results they want using the acct system)

beating the accounting system (puts false information into the acct system)

going outside the accounting system ( produces whatever they want)

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Define financial statement fraud and related schemes.

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deliberate misstatements or omissions of amounts or disclosures of financial statements to deceive financial statement users, particularly investors and creditors

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financial statement fraud may involve the following schemes

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falsification, alteration, or manipulation of material financial records, supporting documents, or business transactions

material intentional omissions or misrepresentations of events, transactions, accounts, or other significant info from which financial statements are prepared

deliberate misapplication of acct principles, policies, and procedures used to measure, recognize, report, and disclose economic events and business transactions

intentional omissions of disclosures or presentation inadequate disclosures regarding accounting principles and policies and related financial amounts

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five classifications of financial statement fraud

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fictitious revenues

timing differences

concealed liabilities and expenses

improper disclosures

improper asset valuation

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fictitious revenues

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recording of sales of goods or services that did not occur. fictitious sales most often involve fake or phantom customers, but can also involve legitimate customers.

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sales with conditions

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are a form of a fictitious revenue scheme in which a sale is booked even though some terms have not been completed and the rights and risks of ownership have not passed the purchaser.

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red flags associated with fictitious revenues

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rapid growth or unusual profitability

recurring negative cash flows from operations or an inability to generate cash flows from operations while reporting earnings and earnings growth

significant transactions with related parties or special purpose entities not in the ordinary course of business or where those entities are not audited or are audited by another firm

significant, unusual, or highly complex transactions

unusual growth in the number of days sales in receivables

a significant volume of sales to entities whose substance and ownership is not known

an unusual surge in sales by a minority of units within a company, or of sales recorded by corporate headquarters

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Explain how timing difference schemes are committed, as well as the motivation for, and result of, committing such fraud

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the recording of revenue or expenses in improper time periods. this can be done to shift revenues or expenses between one period and the next, increasing or decreasing earnings as desired

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matching revenues with expenses

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according to GAAP expenses should match revenue in the same accounting period

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premature revenue recognition

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revenue should be recognized when the sale is complete... when the title is passed from the seller to the buyer..

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channel stuffing

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trade loading- refers to the sale of an unusually large quantity of a product to distributers, who are encouraged to overbuy through the use of deep discounts and/or extended payment terms.

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recording expenses in the wrong period

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timely recording of expenses is often compromised due to pressures to meet budget projections and goals, or due to lack of proper accounting controls

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red flags associated with timing differences

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rapid growth or unusual profitability

recurring negative cash flows from operation or an inability to generate cash flows from operations while reporting earnings and earnings growth

significant, unusual, or highly complex transactions

unusual increase in gross margin or margin in excess of industry peers

unusual growth in the number of days sales in receivables

unusual decline in the number of days purchases in accounts payable

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concealed liabilities and expenses

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understating liabilities and expenses can be manipulated to make a company appear more profitable

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there are three common methods for concealing liabilities and expenses

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liability expense omissions

capitalized expenses

failure to disclose warranty costs and liabilites

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liability/expenses omissions

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easiest way to conceal liabilities/expenses

failure to record debt

difficult to uncover: review pst-financial statement date transactions

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capitalized expenses

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conceal liabilities/expenses

if expenditures are capitalized as assets and not expensed during the period income will be overstated

used by worldcom

increase income and assets, since they are amortized over a period of years rather than immediately

to minimize its net income due to tax considerations or to increase earnings in future periods, improperly capitalizing expenses by expensing costs that should be capitalized.

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returns and allowances and warranties

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improper recording of sales returns and allowances occurs when a company fails to properly record or present the expense associated with sales returns and customer allowances stemming from customer dissatisfaction

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red flags associated with concealed liabilities and expenses

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recurring negative cash flows from operations or inability to generate cash flows from operations while reporting earnings and earnings growth

assets, liabilities, revenues, or expenses based on significant estimates that involve subjective judgements or uncertainties that are difficult to corroborate

nonfinancial management's excessive participation in or preoccupation with the selection of accounting principles or the determination of significant estimates

unusual increase in gross margin or margin in excess of industry peers

allowances for sales returns, warranty claims, and so on that are shrinking in percentage terms or are otherwise out of line with industry peers

unusual reduction in the number of days purchases in accounts payable

reducing accounts payable while competitors are stretching out payments to vendors

Front 135

improper disclosures defn

Back 135

accounting principles require that financial statements and notes include all the information necessary to prevent a reasonably discerning user of the financial statements from being misled.

Front 136

improper disclosures related to financial statement fraud

Back 136

liability omissions

subsequent events

management fraud

related party transactions

accounting changes

Front 137

liability omissions

Back 137

type of improper disclosure

falure to disclose loan covenants or contingent liabilities

Front 138

subsequent events

Back 138

type of improper disclosure

events occurring or becoming known after the close of the period may have significant effect on the fin statements and should be disclosed. fraudsters often avoid disclosing

Front 139

management fraud

Back 139

type of improper disclosure

management withholds information from shareholders

Front 140

related party transactions

Back 140

type of improper disclosures

when a company does business with another entity whose management or operating policies can be controlled or significantly influenced by the company or by some other part incommon

there must be full disclosure

Front 141

red flags associated with improper disclosures

Back 141

domination of management by a single person or small group without compensating controls

ineffective BOD or audit commmitte oversight over the fin reporting process and internal control

ineffective communication, implementation, support, or enforcement of the entity's values or ethical standards by management or the communication of inappropriate values or ethical standards

rapid growth or unusual profitability

significant, unusual, or highly complex transactions

significant related party transactions not in the ordinary course of business or with related entities not audited or audited by another firm

significant bank accounts or subsidiary or branch operations in tax haven jurisdiction for which there appears to be no clear business jurisdiction

overly complex organizational structure

known history of violations of securities laws, or other laws and regulations, or claims against the entity, senior management, or board members alleging fraud

recurring attempts by management to justify marginal or inappropriate accounting on the basis of materiality

formal or informal restrictions on the auditor that inappropriately limit access to people or information or the ability to communicate effectively with the BOD

Front 142

improper asset valuation

Back 142

financial statement fraud schemes

inflate current assets at the expense of long term assets

misclassification of long term assets as current assets

under secured loan covenants are on unsecured and under secured lines of credit and other short term borrowings- sometimes these misclassifications are referred to as window dressing

Front 143

four types of improper asset valuation

Back 143

inventory valuation

accounts revievable

business combinations

fixed assets

Front 144

inventory valuation

Back 144

improper asset valuation

failing to write down inventory

manipulation of the physical counts

fake documents

fictitious inventory

Front 145

accounts receivable

Back 145

improper asset valuation

fictitious receivables

failure to write off accounts receivable as bad debts

Front 146

Business combinations

Back 146

over allocate the purchase price to in process research and development assets, in order to then write them off immediately.

establish excessive reserves for various expenses at the time of acquisition, intending to quietly release those excess reserves into earnings at the future date

Front 147

fixed assets common schemes

Back 147

booking fictitious assets

misrepresenting asset valuation

improperly capitalizing inventory and start up costs

Front 148

booking fictitious assets

Back 148

fixed asset scheme

false creation of assets affects account totals on a companys balance sheet

Front 149

misrepresenting asset value

Back 149

fixed asset scheme

fixed assets should be recorded at costs

although assets may appreciate in value, this increase in value generally should not be recognized on company financial statments

Front 150

understating assets

Back 150

understatement can be done directly or through improper depreciation

capitalizing non asset cost

Front 151

capitalizing non asset cost

Back 151

excluded from cost of a purchased asset are interest finance charges incurred in the purchase

Front 152

misclassifying assets

Back 152

manipulation can skew financial ratio and help comply with loan covenants or other borrowing requirements

Front 153

red associated with improper asset valuation

Back 153

recurring negative cash flows from operations or an inability to generate cash flows from operations while reporting earnings and earnings growth

significant declines in customer demand and increasing business failures in either the industry or overall economy

assets liabilities revenues or expenses based on significant estimates that involve subjective judgments or uncertainties that are difficult to corroborate

non financial managements excessive participation in or preoccupation with the selection of accounting principles or the determination of significant estimates

unusual increase in gross margin or margin in excess of industry peers

unusual growth in the number of days in receivables

Front 154

two types of misstatements are considered relevant for audit purposes

Back 154

misstatements arising from fraudulent financial reporting

misstatements arising from misappropriation of assets

Front 155

financial statement analysis

Back 155

vertical

horizontal

ratio

Front 156

vertical

Back 156

technique for analyzing the relationships between the items on an income statement, balance sheet, or statement of cash flows by expressing components as percentages

common sizing

Front 157

horizontal

Back 157

technique for analyzing the percentage change in individual financial statement items from one year to the next. the first period in the analysis is considered the base, and the changes to subsequent periods are computed as a percentage of the base period

Front 158

vertical analysis is the expression of the

Back 158

relationship or percentage of an item on a financial statement to a specific base item

Front 159

horizontal analysis analysis uses

Back 159

percentage comparison from one accounting period to the next

Front 160

ratio analysis

Back 160

means of measuring the relationship between two different financial statement amounts

the relationship and comparison are the keys to the analysis, which allows for internal evaluations using financial statement data.

Front 161

typical investigation team could include

Back 161

certified fraud examiners

legal cousel

internal auditors

security personnel

IT and computer forensics experts

human resources personnel

management representative

external consultants

Front 162

evidence

Back 162

anything perceivable by the five senses, including any proof, such as testimony of witnesses, records, documents, facts, data, or tangible objects, that is legally presented at trial to prove a contention and to induce a belief in the minds of a jury.

Front 163

obtaining evidence may involve

Back 163

covert operations

surveillance

informants

dumpster diving

subpoenas

search warrants

voluntary consent

Front 164

general rules should be observed with regard to the collection and handling of evidence

Back 164

obtain original documents

do not touch originals

maintain good filing

chain of custody

preserving the document

Front 165

organizing documentary evidence

Back 165

chronologies

to do lists

using computer software

Front 166

sources of information

Back 166

locating individuals or verifying their identity

researching assets or financial positions

documenting lifestyles

discovering banking relationships

identifying business affiliations

uncovering litigation history

Front 167

in house sources

Back 167

personnel files

internal phone records

computer files

physical files

time sheets

financial records

prior audit files

corporate policies

company communications

access codes

security videos

Front 168

public information

Back 168

local or county records

vote registration records

marriage license records

real property records

property tax records

death records

health and fire departments

sheriff county prosecuter

county fire marshal

utility company records

permits

state records

business filings

foreign corporation registration

fictitious names business as registration

uniform commercial code filings

employee labor records

workers comp info

state tax filing

prof assoc and licensing boards

courts

litigationhistory

divorce records

personal injury suit records

financial suit records

bankruptcy records

probate records

invernet

commercial online services

directories

blogs

social networking

Front 169

format

Back 169

author/date

summary

introduction/purpose

body

results

follow up/ recommendations

Front 170

List the five types of interview questions

Back 170

introductory

nonsensitive

infomational

closing

assessment

Front 171

introductory questions

Back 171

provide the introduction

establish rapport

establish interview theme

observe reactions

Front 172

informational questions

Back 172

open questions

closed questions

leading questions

Front 173

closing questions

Back 173

reconfirming facts

gathering additional facts

concluding the interview

Front 174

assessment questions

Back 174

norming or calibrating

physiology of deception

Front 175

verbal clues to deception

Back 175

changes in speech patterns

repetition of the question

comments regarding the interview selective memory

making excuses

oaths

character testimony

answering with a question

overuse of respect

increasingly weaker denials

failure to deny

avoidance of emotive words

refusal to implicate other suspects

tolerant attitutes

reluctance to terminate interview

reigned unconcern

Front 176

nonverbal clues

Back 176

full body motions

anatomical physical resonses

illustrators

hands over mouth

manipulators

fleeing positions

crossing the arms

reaction to evidence

fake smiles

Front 177

admission seeking questions

Back 177

presence of outsiders

Front 178

steps in the admission seeking inverview

Back 178

direct accusations

observe reaction

repeat accusation

interrupt denials

delays

interuptions

reasoning

establish rationalization

unfair treatment

inadequate recognition

financial problems

aberration of conduct

family problems

accusers actions

stress, drugs, alcohol

revenge

depersonalizing the victim

minor moral infraction

altruism

genuine need

diffuse alibis

display physical evidence

discuss witnesses

discuss deceptions

present alternative

benchmark admission

reinforce rationalization

verbal confession