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179 Cards in this Set
- Front
- Back
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 |
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 |
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improper disclosures defn
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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.
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improper disclosures related to financial statement fraud
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liability omissions subsequent events management fraud related party transactions accounting changes |
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liability omissions
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type of improper disclosure falure to disclose loan covenants or contingent liabilities |
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subsequent events
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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 |
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management fraud
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type of improper disclosure management withholds information from shareholders |
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related party transactions
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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 |
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red flags associated with improper disclosures
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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 |
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improper asset valuation |
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 |
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four types of improper asset valuation
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inventory valuation accounts revievable business combinations fixed assets |
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inventory valuation
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improper asset valuation failing to write down inventory manipulation of the physical counts fake documents fictitious inventory |
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accounts receivable
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improper asset valuation fictitious receivables failure to write off accounts receivable as bad debts |
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Business combinations
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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 |
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fixed assets common schemes
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booking fictitious assets misrepresenting asset valuation improperly capitalizing inventory and start up costs |
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booking fictitious assets
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fixed asset scheme false creation of assets affects account totals on a companys balance sheet |
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misrepresenting asset value
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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 |
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understating assets
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understatement can be done directly or through improper depreciation capitalizing non asset cost |
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capitalizing non asset cost
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excluded from cost of a purchased asset are interest finance charges incurred in the purchase |
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misclassifying assets
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manipulation can skew financial ratio and help comply with loan covenants or other borrowing requirements
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red associated with improper asset valuation
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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 |
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two types of misstatements are considered relevant for audit purposes
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misstatements arising from fraudulent financial reporting misstatements arising from misappropriation of assets |
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financial statement analysis
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vertical horizontal ratio |
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vertical
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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 |
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horizontal
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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
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vertical analysis is the expression of the
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relationship or percentage of an item on a financial statement to a specific base item
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horizontal analysis analysis uses
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percentage comparison from one accounting period to the next
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ratio analysis
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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. |
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typical investigation team could include
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certified fraud examiners legal cousel internal auditors security personnel IT and computer forensics experts human resources personnel management representative external consultants |
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evidence
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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.
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obtaining evidence may involve
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covert operations surveillance informants dumpster diving subpoenas search warrants voluntary consent |
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general rules should be observed with regard to the collection and handling of evidence
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obtain original documents do not touch originals maintain good filing chain of custody preserving the document |
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organizing documentary evidence
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chronologies to do lists using computer software |
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sources of information
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locating individuals or verifying their identity researching assets or financial positions documenting lifestyles discovering banking relationships identifying business affiliations uncovering litigation history |
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in house sources
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personnel files internal phone records computer files physical files time sheets financial records prior audit files corporate policies company communications access codes security videos |
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public information
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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 |
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format
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author/date summary introduction/purpose body results follow up/ recommendations |
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List the five types of interview questions
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introductory nonsensitive infomational closing assessment |
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introductory questions
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provide the introduction establish rapport establish interview theme observe reactions |
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informational questions
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open questions closed questions leading questions |
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closing questions
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reconfirming facts gathering additional facts concluding the interview |
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assessment questions
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norming or calibrating physiology of deception |
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verbal clues to deception
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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 |
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nonverbal clues
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full body motions anatomical physical resonses illustrators hands over mouth manipulators fleeing positions crossing the arms reaction to evidence fake smiles |
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admission seeking questions
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presence of outsiders |
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steps in the admission seeking inverview
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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 |
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