Fraud & Corruption Final

8/8/2019 Fraud & Corruption Final

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Fraud & CorruptionFraud & CorruptionByBy

AliAli AmaniAmani Member of Supreme Court of Iranian Association of Certified Public Accountants (IACPA)Member of Supreme Court of Iranian Association of Certified Public Accountants (IACPA) IICA,IMA,AAA,CFE,IIA,BAA,EAA,CAAAIICA,IMA,AAA,CFE,IIA,BAA,EAA,CAAA

GholamhosseinGholamhossein DavaniDavani Member of High council of Iranian Association ofMember of High council of Iranian Association of CertifeidCertifeid Public Accountants (IACPA )Public Accountants (IACPA ) IICA,IMA,AAA,CFE,IIA,BAA,EAA,CAAAIICA,IMA,AAA,CFE,IIA,BAA,EAA,CAAA

Dayarayan Auditing & Financial Services Firm(RSMi Iran)Dayarayan Auditing & Financial Services Firm(RSMi Iran)


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Ladies & Gentelman.Ladies & Gentelman.

I am very glad to have the opportunity toI am very glad to have the opportunity to

speak at this conference, as it gives me thespeak at this conference, as it gives me thechance to stress the importance ofchance to stress the importance of Fraud &Fraud &

Corruption and specially thanks for ProfessorCorruption and specially thanks for Professor

SoalsSoals for inviting me to make the openingfor inviting me to make the opening

address at thisaddress at this

conferenceconference


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Your honor,

Just now sitting at the patio with your honorable

sibling and having a bite of board with her honor, Iwas informed that your honor has prattled andreappointed price Movasegholdoleh, governor ofQom, formerly deposed due to bribery and buying

off.I had him sent to Tehran under guard, so that yourMajesty will understand that one can not rule acountry on his auntprescriptions.

Forgive me for being over impertinent,Taghi

Amir Kabirs (Current Pre minister) letter to King Naseraldin Shah


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If men were angels, no governmentIf men were angels, no governmentwould be necessary. If angels werewould be necessary. If angels were

to govern men, neither external norto govern men, neither external nor

internal controls on governmentinternal controls on government

would be necessary.would be necessary.

James Madison,James Madison, The Federalist Papers, No.The Federalist Papers, No. 5151,, 17881788


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Just as one can not let go of the taste of honey or

poison on the tip of his tongue, a governmental

agent dealing with governmental budget, can not

avoid tasting at least a little of the Kings wealth.

Kaochila ertashsetra,

Indian edifications, first decade Annone Domini


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Fraud:Fraud:

Any illegal act characterized by deceit,Any illegal act characterized by deceit,concealment, or violations of trust to obtainconcealment, or violations of trust to obtain

money, property, services, avoid payment; ormoney, property, services, avoid payment; or

secure personal or business advantagesecure personal or business advantage (IIA(IIA))


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Definition of FraudDefinition of Fraud

A generic term, embracing all multifariousA generic term, embracing all multifarious

means which human ingenuity can devise, andmeans which human ingenuity can devise, and

which are resorted to by one individual to getwhich are resorted to by one individual to getadvantage over another by false suggestions oradvantage over another by false suggestions or

by suppression of truth, and includes allby suppression of truth, and includes all

surprise, trick, cunning, dissembling, and anysurprise, trick, cunning, dissembling, and any

unfair way by which another is cheated.unfair way by which another is cheated.

Johnson v.Johnson v. McDonald,McDonald, 3939 PP22dd 150150


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In the broadest sense, aIn the broadest sense, afraudfraudis a deception made foris a deception made forpersonal gain, although it has a more specific legalpersonal gain, although it has a more specific legalmeaning, the exact details varying betweenmeaning, the exact details varying between

jurisdictions. Manyjurisdictions. Manyhoaxeshoaxesare fraudulent,are fraudulent, althoughalthoughthose not made for personal gain are not bestthose not made for personal gain are not bestdescribed in this way. Not all frauds are hoaxesdescribed in this way. Not all frauds are hoaxes --electoral fraudelectoral fraud ,,for example.for example. Fraud permeates manyFraud permeates manyareas of life, includingareas of life, includingartart ,,archaeologyarchaeologyandandsciencescience ..In the broadIn the broadlegallegalsense a fraud is any crime or civilsense a fraud is any crime or civilwrong for gain that utilises some deception practicedwrong for gain that utilises some deception practicedon the victim as its principal methodon the victim as its principal method..


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InIncriminal lawcriminal law ,,fraudfraudis the crime or offense ofis the crime or offense ofdeliberatelydeliberatelydeceivingdeceivinganother in order to damageanother in order to damagethemthem usually, to obtain property or services fromusually, to obtain property or services from

him or her unjustly.him or her unjustly.Fraud can be accomplishedFraud can be accomplishedthrough the aid ofthrough the aid offorgedforgedobjects. In the criminal lawobjects. In the criminal lawofofcommon lawcommon lawjurisdictions it may be called "theftjurisdictions it may be called "theftby deceptionby deception ,," "" " larcenylarcenyby trickby trick ,," "" " larcenylarcenyby fraudby fraudand deception" or something similar. Fraud can beand deception" or something similar. Fraud can becommitted through many methods, includingcommitted through many methods, includingmailmail ,,wirewire ,,phonephone ,,and theand theinternetinternet (see(seecomputer crimecomputer crimeandandinternet fraudinternet fraud..))


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Acts which may constitute criminal fraud includeActs which may constitute criminal fraud include:: bait and switchbait and switch confidence tricksconfidence trickssuch as thesuch as thefraudfraud ,,Spanish PrisonerSpanish Prisoner,,and theand theshell gameshell game false advertisingfalse advertising identity theftidentity theft

false billingfalse billing forgeryforgeryof documents or signaturesof documents or signatures taking money which is under your control, but not yourstaking money which is under your control, but not yours((embezzlementembezzlement)) health fraudhealth fraud ,,selling of products of spurious use, such asselling of products of spurious use, such asquackquackmedicinesmedicines creation of false companies orcreation of false companies or"" long firmslong firms "" false insurance claimsfalse insurance claims

bankruptcy fraudbankruptcy fraud ,,is a US federal crime that can lead to criminal prosecution underis a US federal crime that can lead to criminal prosecution underthe charge of theft of the goods or servicesthe charge of theft of the goods or services

investment fraudsinvestment frauds ,,such assuch asPonzi schemesPonzi schemes securitiessecuritiesfrauds such asfrauds such aspump and dumppump and dump


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FraudFraud means:means:

Inducing a course of action by deceit or otherInducing a course of action by deceit or other

dishonest conductdishonest conduct Involves acts or omissions or the making ofInvolves acts or omissions or the making of

false statementsfalse statements

Can be orally or in writingCan be orally or in writing ObjectObject to obtain a benefit or evade a liabilityto obtain a benefit or evade a liability


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Fraud:Fraud:

The term fraud may be defined as intentionalThe term fraud may be defined as intentional

misrepresentation of financial information by one ormisrepresentation of financial information by one ormore individuals among management, employees ormore individuals among management, employees orthird parties. Fraud may involve:third parties. Fraud may involve:

Falsification or alteration of accounting records orFalsification or alteration of accounting records or

other documentsother documentsMisappropriation of assets or theft;Misappropriation of assets or theft;Suppression or omission of the effects of transactionsSuppression or omission of the effects of transactionsfrom records or documents.from records or documents.Recording of transactions without substances.Recording of transactions without substances.

Intentional misapplication of accounting policies orIntentional misapplication of accounting policies orWillful misrepresentations of transactions or of theWillful misrepresentations of transactions or of theentity's state of affairs.entity's state of affairs.


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Nature of the Frauds (Source:Coso report)Nature of the Frauds (Source:Coso report)

Cumulative amounts of frauds were relatively large in light of the relativelyCumulative amounts of frauds were relatively large in light of the relativelysmall sizes of the companies involved. The average financial statementsmall sizes of the companies involved. The average financial statementmisstatement or misappropriation of assets was $misstatement or misappropriation of assets was $2525 million and the medianmillion and the medianwas $was $44..11 million. While the average company had assets totaling $million. While the average company had assets totaling $533533 million,million,

the median company had total assets of only $the median company had total assets of only $1616 million.million. Most frauds were not isolated to a single fiscal period. Most frauds overlappedMost frauds were not isolated to a single fiscal period. Most frauds overlappedat least two fiscal periods, frequently involving both quarterly and annualat least two fiscal periods, frequently involving both quarterly and annualfinancial statements. The average fraud period extended overfinancial statements. The average fraud period extended over 2323..77 months,months,with the median fraud period extendingwith the median fraud period extending 2121 months. Onlymonths. Only 1414 percent of thepercent of thesample companies engaged in a fraud involving fewer thansample companies engaged in a fraud involving fewer than 1212 months.months.

Typical financial statement fraud techniques involved the overstatement ofTypical financial statement fraud techniques involved the overstatement ofrevenues and assets. Over half the frauds involved overstating revenues byrevenues and assets. Over half the frauds involved overstating revenues byrecording revenues prematurely or fictitiously. Many of those revenue fraudsrecording revenues prematurely or fictitiously. Many of those revenue fraudsonly affected transactions recorded right at period end (i.e., quarter end oronly affected transactions recorded right at period end (i.e., quarter end oryear end). About half the frauds also involved overstating assets byyear end). About half the frauds also involved overstating assets byunderstating allowances for receivables, overstating the value of inventory,understating allowances for receivables, overstating the value of inventory,property, plant and equipment and other tangible assets, and recording assetsproperty, plant and equipment and other tangible assets, and recording assetsthat did not exist.that did not exist.


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Fraud and abuse covers various issues including:Fraud and abuse covers various issues including: Conflicts of interests e.g. a corrupt relationship canConflicts of interests e.g. a corrupt relationship can

involve an employee setting up a company, theinvolve an employee setting up a company, thecompany supplies goods and services to thecompany supplies goods and services to theorganization, the employee does not tell theorganization, the employee does not tell theorganization about itorganization about it

Breach of trust e.g. leaking of confidential orBreach of trust e.g. leaking of confidential orsensitive informationsensitive information

Employee malpractice e.g. excessive use of theEmployee malpractice e.g. excessive use of thetelephone for private calls, etelephone for private calls, e--mail abusemail abuse

Criminal offenceCriminal offence


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corruptioncorruptionnounnoun11 [[U] illegal, immoral or dishonest behavior, especially by people inU] illegal, immoral or dishonest behavior, especially by people inpositions of powerpositions of power

corroputcorroputverb [T]verb [T]to make someone or something become dishonest or immoral:to make someone or something become dishonest or immoral:

n.)n.) The act of changing, or of being changed, for the worse; departure fromThe act of changing, or of being changed, for the worse; departure fromwhat is pure, simple, or correct; as, a corruption of style; corruption inwhat is pure, simple, or correct; as, a corruption of style; corruption inlanguage.language.

(n.)(n.) The act of corrupting or of impairing integrity, virtue, or moralThe act of corrupting or of impairing integrity, virtue, or moralprinciple; the state of being corrupted or debased; loss of purity or integrity;principle; the state of being corrupted or debased; loss of purity or integrity;depravity; wickedness; impurity; bribery.depravity; wickedness; impurity; bribery.

(n.)(n.) The product of corruption; putrid matter.The product of corruption; putrid matter. (n.)(n.) The act of corrupting or making putrid, or state of being corrupt orThe act of corrupting or making putrid, or state of being corrupt orputrid; decomposition or disorganization, in the process of putrefaction;putrid; decomposition or disorganization, in the process of putrefaction;putrefaction; deterioration.putrefaction; deterioration.


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corruption ascorruption as doing something beyond the existing rules regulation intendingdoing something beyond the existing rules regulation intendingpersonal or group interest or doing something illegally for personal or grouppersonal or group interest or doing something illegally for personal or groupinterest. Respondents think that terrorism, theft, snatching, robbery, bribing are theinterest. Respondents think that terrorism, theft, snatching, robbery, bribing are thedifferent forms of corruption. Vote rigging, use of muscles power in election,different forms of corruption. Vote rigging, use of muscles power in election,

trafficking of children and women, rape, cheating, abductiontrafficking of children and women, rape, cheating, abduction-- these are the anotherthese are the anotherform of corruption.form of corruption.

Respondents also comment that corruption can be economic, social as well asRespondents also comment that corruption can be economic, social as well aspolitical.political.

The following comments by the participants support this finding:The following comments by the participants support this finding: doing something illegally is corruptiondoing something illegally is corruption doing something violating existing set of rules regulations and law is corruptiondoing something violating existing set of rules regulations and law is corruption

doing something beyond principles is corruptiondoing something beyond principles is corruption doing something for the personal interest violating the prevailing system and socialdoing something for the personal interest violating the prevailing system and social

values is corruptionvalues is corruption

vote rigging is a corruptionvote rigging is a corruption dispute of land is corruptiondispute of land is corruption ((terrorism),terrorism), bribing, theft is corruptionbribing, theft is corruption bribing, nepotism in the case of employment is corruptionbribing, nepotism in the case of employment is corruption

unconsciousness is one sort of corruptionunconsciousness is one sort of corruption drug abuse,drug abuse, drug smuggling is a corruptiondrug smuggling is a corruption for the sack of own interest, all the economical, social injustice is corruptionfor the sack of own interest, all the economical, social injustice is corruption negligence of duty is corruptionnegligence of duty is corruption misuse of political power is corruptionmisuse of political power is corruption


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CorruptionCorruption is defined in sectionis defined in section 8383 of theof the Criminal Code (WA)Criminal Code (WA) and is takenand is takento mean any public officer who, without lawful authority or a reasonableto mean any public officer who, without lawful authority or a reasonableexcuse:excuse:

acts upon any knowledge or information obtained by reason of his or heracts upon any knowledge or information obtained by reason of his or heroffice or employment;office or employment;

acts in any matter, in the performance or discharge of the functions of hisacts in any matter, in the performance or discharge of the functions of hisor her office or employment, in relation to which he or she has, directly oror her office or employment, in relation to which he or she has, directly orindirectly, any pecuniary interest; orindirectly, any pecuniary interest; or

acts corruptly in the performance or discharge of the functions of his or heracts corruptly in the performance or discharge of the functions of his or heroffice; oroffice; or

employment, so as to gain a benefit, whether pecuniary or otherwise, foremployment, so as to gain a benefit, whether pecuniary or otherwise, for

himself or herself or any person, or so as to cause a detriment, whetherhimself or herself or any person, or so as to cause a detriment, whetherpecuniary or otherwise, to any person, is guilty of a crime and is liable topecuniary or otherwise, to any person, is guilty of a crime and is liable toimprisonment forimprisonment for 33 years.years.


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Money Laundering:Money Laundering:

Money laundering is the process by whichMoney laundering is the process by whichcriminals attempt to conceal the true origin andcriminals attempt to conceal the true origin and

ownership of their criminal activities. Ifownership of their criminal activities. If

undertaken successfully, it also allows them toundertaken successfully, it also allows them to

maintain control over those proceeds andmaintain control over those proceeds andultimately to provide a legitimate cover for theirultimately to provide a legitimate cover for their

source of funds. Their dirty funds appear clean.source of funds. Their dirty funds appear clean.

It is generally linked with money required toIt is generally linked with money required tofinance cross border drug trafficking, arms dealfinance cross border drug trafficking, arms deal

or tax evasion or other similar crimes.or tax evasion or other similar crimes.


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THEORIES OF FRAUD:THEORIES OF FRAUD:

A number of theoretical models have been constructed inA number of theoretical models have been constructed in

the past in an attempt to explain why people commit fraud.the past in an attempt to explain why people commit fraud.Some of the key characteristics of recent models includeSome of the key characteristics of recent models includethe following:the following:

A perceived opportunity such as the absence of or circumvention ofA perceived opportunity such as the absence of or circumvention of

controls that enable fraud to be prevented or detected.controls that enable fraud to be prevented or detected.An offender with a motivation to steal money, whether through cupidity,An offender with a motivation to steal money, whether through cupidity,living beyond one's means, the existence of debts some times associatedliving beyond one's means, the existence of debts some times associatedwith drug or gambling addiction, presence of a financial crisis or variouswith drug or gambling addiction, presence of a financial crisis or variouswork related pressures.work related pressures.The presence of a rationalization for acting illegally, such as belief thatThe presence of a rationalization for acting illegally, such as belief thatthe victim can afford the loss, that the funds stolen will be repaid or thatthe victim can afford the loss, that the funds stolen will be repaid or that

the money will be used for a good purpose by the offender; and finally.the money will be used for a good purpose by the offender; and finally.The absence of a capable guardian, whether through proper businessThe absence of a capable guardian, whether through proper businessadministration, lack of fraud prevention resources or the absence of anadministration, lack of fraud prevention resources or the absence of aneffective police service or regulatory authority.effective police service or regulatory authority.


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History of FraudHistory of Fraud Considering the enormous impact, relatively littleConsidering the enormous impact, relatively littleresearch has been done on the subject of occupationalresearch has been done on the subject of occupationalfraud and abuse. Much of the current literature isfraud and abuse. Much of the current literature isbased on the early works of Edwin H. Sutherlandbased on the early works of Edwin H. Sutherland((18831883--19501950), a criminologist at Indiana University.), a criminologist at Indiana University.Sutherland coined the termSutherland coined the term WiteWite--CollarCollar crime incrime in19391939..

Sutherland believed that crime was a learned activitySutherland believed that crime was a learned activityat a time when most experts believed that crime wasat a time when most experts believed that crime wasgenetically based.genetically based.


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WHITE COLLAR CRIMEWHITE COLLAR CRIME

In 1995, Albanese explained whiteIn 1995, Albanese explained white--collar crime as:collar crime as: PlannedPlannedor organized illegal acts of deception or fraud, usuallyor organized illegal acts of deception or fraud, usuallyaccomplished during the course of legitimate occupationalaccomplished during the course of legitimate occupationalactivity, committed by an individual or corporate entity.activity, committed by an individual or corporate entity. It isIt isclear from these two definitions that a certain form of behaviorclear from these two definitions that a certain form of behavior

is required for whiteis required for white--collar offences, which distinguishes itcollar offences, which distinguishes itfrom conventional crimes like robbery and assault. Forfrom conventional crimes like robbery and assault. For

practical reasons, it is proposed that the definition of whitepractical reasons, it is proposed that the definition of white--collar crime be as follows:collar crime be as follows: WhiteWhite--collar crime is the unlawful,collar crime is the unlawful,intentional commitment of deceit, deception, concealment,intentional commitment of deceit, deception, concealment,manipulation, breach of trust, subterfuge or any other similarmanipulation, breach of trust, subterfuge or any other similartrickery, by an individual, syndicate or organization, normallytrickery, by an individual, syndicate or organization, normallyafter meticulous planning, with out the use of physicalafter meticulous planning, with out the use of physicalviolence which causes actual economic prejudice or potentialviolence which causes actual economic prejudice or potentialeconomic prejudice to another.economic prejudice to another.


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WhiteWhite--collar crime is distinguished from other conventional crimescollar crime is distinguished from other conventional crimes

like robbery by way of the following general characteristics:like robbery by way of the following general characteristics:

Unlike robbery which involves the use of force, whiteUnlike robbery which involves the use of force, white--collar offences arecollar offences arecharacterized by careful planning and deception, usually without the use of violence;characterized by careful planning and deception, usually without the use of violence;

Some form of premeditation and fraudulent activity is typical;Some form of premeditation and fraudulent activity is typical;There is usually an element of concealed misappropriation or deception;There is usually an element of concealed misappropriation or deception;

The whiteThe white--collar offence is often of a complicated nature which makes it difficult tocollar offence is often of a complicated nature which makes it difficult toprosecute; the crime normally has low visibility in order to obscure its existence;prosecute; the crime normally has low visibility in order to obscure its existence;

There is usually a diffusion of responsibility for the crime;There is usually a diffusion of responsibility for the crime;Diffusion of victimization is also a characteristic of theses types of crimesDiffusion of victimization is also a characteristic of theses types of crimesThere does not seem to be a trueThere does not seem to be a true victimvictim when a person defrauds the company hewhen a person defrauds the company heworks for;works for;

Although the element of fraud is usually found in most whiteAlthough the element of fraud is usually found in most white--collar schemes, thesecollar schemes, theseoffences can go much further including corruption, forgery, theft and complicatedoffences can go much further including corruption, forgery, theft and complicatedstatutory offences like money laundering of which deceit is usually an element; statutory offences like money laundering of which deceit is usually an element; WhiteWhite--collar offences are often demarcated ascollar offences are often demarcated as rational crimesrational crimes;;

A whiteA white--collar criminalcollar criminals occupation or working conditions often providess occupation or working conditions often providesopportunities that may be exploited.opportunities that may be exploited.


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Some reasons why fraud happens include:Some reasons why fraud happens include:

failure to look for itfailure to look for it internal audit cover and fraud risk managementinternal audit cover and fraud risk management

skills not always adequateskills not always adequate

poor data integrity and securitypoor data integrity and security inappropriate authority levelsinappropriate authority levels

recruitment of dishonest employeesrecruitment of dishonest employees

abuse of separation of dutiesabuse of separation of duties


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The Fraud TriangleThe Fraud Triangle

Incentives/PressuresIncentives/Pressures

OpportunitiesOpportunities Attitudes/RationalizationAttitudes/Rationalization


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Types of FraudTypes of Fraud

Fraudulent financial reportingFraudulent financial reporting

Misappropriation of assetsMisappropriation of assets


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TYPES OF FRAUDTYPES OF FRAUD

Frauds can be categorized by the type ofFrauds can be categorized by the type of

victim involved. The most common groups ofvictim involved. The most common groups of

victims encountered by investigators include:victims encountered by investigators include:

InvestorsInvestors CreditorsCreditors

BusinessesBusinesses

Banks or other financial institutionsBanks or other financial institutions Central or local governmentCentral or local government

Fraud by manipulating financial marketsFraud by manipulating financial markets


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Stock FraudStock Fraud A crime in which securities investing or trading laws haveA crime in which securities investing or trading laws have

been violated. Stock fraud encompasses many things includingbeen violated. Stock fraud encompasses many things includingstocks, bonds, commodities and other investments. Stock fraudstocks, bonds, commodities and other investments. Stock fraudis illegal and can be described as deceptive practices in theis illegal and can be described as deceptive practices in the

stock and commodity markets. Stock fraud occurs whenstock and commodity markets. Stock fraud occurs wheninvestors are enticed to buy securities based upon falseinvestors are enticed to buy securities based upon falsestatements or records. Stock fraud includes providing falsestatements or records. Stock fraud includes providing falseinformation on a companies financial statement, profit and lossinformation on a companies financial statement, profit and lossstatements, SEC filings, lying to an auditor, stockstatements, SEC filings, lying to an auditor, stock

manipulation schemes, insider trading, and embezzlement.manipulation schemes, insider trading, and embezzlement.Stock fraud is otherwise known as securities fraud.Stock fraud is otherwise known as securities fraud.


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2006 Identity Fraud Survey Report

Source:JavelinStratgy&Research


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Brief History of Financial FraudBrief History of Financial Fraud

19071907 toto 19191919 Charles Ponzi, inventor of theCharles Ponzi, inventor of thepyramid or "Ponzi" scheme, was sentenced topyramid or "Ponzi" scheme, was sentenced to

1010 years in prison for larceny and fraud. Heyears in prison for larceny and fraud. He

had raised $had raised $1515 million before he was caught.million before he was caught.


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19291929 International Power's stock priceInternational Power's stock pricedroppeddropped 7878%% in one day when it wasin one day when it was

revealed that they "cooked the books". Therevealed that they "cooked the books". The

Securities and Exchange Commission (SEC)Securities and Exchange Commission (SEC)

was created in response to the rampantwas created in response to the rampant

fraud of the gofraud of the go--gogo 19201920's which were's which were

exposed in theexposed in the 19291929 stock market crash.stock market crash.


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19321932 Ivar Kreuger was caught switchingIvar Kreuger was caught switchingassets and liabilities and making up assets.assets and liabilities and making up assets.

He raised $He raised $500500 million before he wasmillion before he was

caught. In Marchcaught. In March 19321932 he shot himself inhe shot himself in

Paris.Paris.


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19371937 Phillip Musica (aka Frank DonaldPhillip Musica (aka Frank DonaldCoster) was caught with $Coster) was caught with $1010 million ofmillion of

inventory and $inventory and $99 million of accountsmillion of accounts

receivable that didn't exist.receivable that didn't exist.


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19631963 Anthony (Tino) De Angelis of Allied CrudeAnthony (Tino) De Angelis of Allied CrudeVegetable Oil Refining Co. used bottles of water, notVegetable Oil Refining Co. used bottles of water, not

oil, as collateral for $oil, as collateral for $175175 million in loans.million in loans. 19731973 EquityEquityFunding Corporation's net worth of $Funding Corporation's net worth of $143143..44 million wasmillion wasdiscovered to bediscovered to benegativenegative $$4242..11 million. The companymillion. The companyhad been recording fictitious income sincehad been recording fictitious income since

19651965.. Stanley Goldblum andStanley Goldblum and 2222 other people wereother people weresentenced for fraud.sentenced for fraud. 19881988 Wedtech (Welbilt ElectronicWedtech (Welbilt ElectronicDie Co) was caught using the percentage of completionDie Co) was caught using the percentage of completionmethod to record revenue that didn't exist, bribingmethod to record revenue that didn't exist, bribinggovernment officials, lying on government proposalsgovernment officials, lying on government proposalsand contracts, and falsifying invoices. The scandaland contracts, and falsifying invoices. The scandal

involved Congress and the Reagan administration.involved Congress and the Reagan administration.Auditors sued for $Auditors sued for $105105 million in damages.million in damages.


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19871987 Lincoln Savings and Loan costs taxpayers $Lincoln Savings and Loan costs taxpayers $22..55 billionbillionfor fraud schemes that involved members of Congress.for fraud schemes that involved members of Congress.Charles Keating recorded profits on junk bonds and realCharles Keating recorded profits on junk bonds and realestate loans that they knew were worthless, and he hisestate loans that they knew were worthless, and he his

family received $family received $3434 million in salary and sales of Americanmillion in salary and sales of AmericanContinental Corporation stock before the scheme crashed.Continental Corporation stock before the scheme crashed.Savings and Loan scandals cost taxpayers an estimatedSavings and Loan scandals cost taxpayers an estimated$$500500 billion during thebillion during the 19801980's.'s. 19891989 MiniScribeMiniScribeCorporation, a disk drive manufacturer, fooled theirCorporation, a disk drive manufacturer, fooled their

auditors forauditors for 22 years by filling their inventory boxes withyears by filling their inventory boxes withbricks. The auditing company, Coopers & Lybrand, had tobricks. The auditing company, Coopers & Lybrand, had topay $pay $100100 million in an outmillion in an out--ofof--court settlement.court settlement.


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19911991 The Bank of Commerce and Credit International (BCCI), knownThe Bank of Commerce and Credit International (BCCI), knowntoday as "The Bank of Crooks and Criminals International", was usedtoday as "The Bank of Crooks and Criminals International", was used

to launder money by drug smugglers and embezzling dictatorsto launder money by drug smugglers and embezzling dictatorsthroughout the world. When the bank was finally shut down, in Julythroughout the world. When the bank was finally shut down, in July19911991, it was found to have stolen, lost, or swindled $, it was found to have stolen, lost, or swindled $2020 billion.billion. 19911991Maxwell Communications president Robert Maxwell resorted toMaxwell Communications president Robert Maxwell resorted tolooting when his publishing empire started to collapse, taking $looting when his publishing empire started to collapse, taking $11..44billion including $billion including $800800 million from theemployee pension fund alone.million from theemployee pension fund alone.He was found dead on NovemberHe was found dead on November 55,, 19911991.. 19981998 When Cendant wasWhen Cendant was

created from thecreated from the 19971997 merger of HFS and CUC, HFS managementmerger of HFS and CUC, HFS managementdiscovered that CUC (Compdiscovered that CUC (Comp--UU--Card) had been cooking the books, byCard) had been cooking the books, byreporting false membership sales, since at leastreporting false membership sales, since at least 19831983. They were. They werecharged with fraud on Aprilcharged with fraud on April 1616,, 19981998. The company had to pay billions. The company had to pay billionsto defrauded investors, and the auditor, Ernst & Whinny, paid $to defrauded investors, and the auditor, Ernst & Whinny, paid $335335million in an outmillion in an out--ofof--court settlement.court settlement. 20002000 Micro Strategy had theirMicro Strategy had theirshare price collapse from $share price collapse from $333333 to $to $8686 when they announced theirwhen they announced their

financial reports would be restated to show huge losses. Investors hadfinancial reports would be restated to show huge losses. Investors hadpushed the price up based on the hype from one of the tech industry'spushed the price up based on the hype from one of the tech industry'smost flamboyant CEO's, Michael Saylor, along with bogus financialmost flamboyant CEO's, Michael Saylor, along with bogus financialstatements. The share price was $statements. The share price was $33 one year later.one year later. 20012001 Enron,Enron,WorldCom.WorldCom.


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BETTER AUDITS,L

ESS FRAUDBETTER AUDITS,L

ESS FRAUD

As financial and economic pressures tighten for corporateAs financial and economic pressures tighten for corporateexecutives, it is more important than ever for auditors toexecutives, it is more important than ever for auditors todevelop sound frauddevelop sound fraud--detection audit techniques. The auditdetection audit techniques. The auditdeficiencies alleged by the SEC betweendeficiencies alleged by the SEC between 19871987 andand 19971997 are, inare, inour view, issues the profession and individual firms canour view, issues the profession and individual firms caneffectively address. The recommendations included in thiseffectively address. The recommendations included in thisarticle may help firms reduce the chance of undetectedarticle may help firms reduce the chance of undetectedmaterial financial statement fraud as they strive to continuallymaterial financial statement fraud as they strive to continuallyimprove fraud risk assessment tools. The audit deficiencies theimprove fraud risk assessment tools. The audit deficiencies the

SEC identified also have important implications for standardSEC identified also have important implications for standardsetters as they seek to strengthen professional standards relatedsetters as they seek to strengthen professional standards relatedto the auditors fraud detection responsibilities.to the auditors fraud detection responsibilities.


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The result was the following new set of skills neededThe result was the following new set of skills needed

by accountantsby accountants

Better technology skillsBetter technology skills

Better analytical skillsBetter analytical skillsto understand complexto understand complextransactions (derivatives, reserves, leverage, etc.)transactions (derivatives, reserves, leverage, etc.)

Better communication skillsBetter communication skills to participate in decisionto participate in decision--making teamsmaking teams

Better interviewing skillsBetter interviewing skills

Better skills working in teamsBetter skills working in teams A better global understandingA better global understanding

Better understanding of fraudBetter understanding of fraud

What gave accountants an advantage in the past is no longer nearly as valuable!What gave accountants an advantage in the past is no longer nearly as valuable!


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Competencies/Skills LearnedCompetencies/Skills Learned

Risk analysisRisk analysis

Controls and control environmentControls and control environment

Better auditing skillsBetter auditing skills Knowledge of the legal systemKnowledge of the legal system

Availability of information (public, private,Availability of information (public, private,

databases, etc.)databases, etc.) ProblemProblem--solving abilitysolving ability

Todays winners are those who have access to the best information a fraud course teaches how

to access information


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For better Audits educators must:For better Audits educators must:

Need to teach Ethics moreNeed to teach Ethics more Need to teach students about fraudNeed to teach students about fraudofferoffer

aa fraudfraud coursecourse

Need to teach students how to thinkNeed to teach students how to think We have taught them how to copy, not thinkWe have taught them how to copy, not think

We have asked them to memorize, not thinkWe have asked them to memorize, not think

We have done what is easiest for us and easiest forWe have done what is easiest for us and easiest forour studentsour students


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First and foremost is the urgent need for change:First and foremost is the urgent need for change: External and internal auditors must train thoroughly in fraudExternal and internal auditors must train thoroughly in fraud--

detection procedures and attitudes.detection procedures and attitudes.

The university education of the next generation of auditorsThe university education of the next generation of auditors

should reflect the new emphasis on fraud deterrence, detection,should reflect the new emphasis on fraud deterrence, detection,and investigation.and investigation.

The formal standards governing audit processes and objectivesThe formal standards governing audit processes and objectivesshould evolve without delay to an updated and more rigorousshould evolve without delay to an updated and more rigorousapproach to fraud detection.approach to fraud detection.

Executives and directors must become fully aware of the threatExecutives and directors must become fully aware of the threatof fraud and do all they can to institute measures to deter it,of fraud and do all they can to institute measures to deter it,ranging from robustly enforced codes of ethics to internalranging from robustly enforced codes of ethics to internalcontrols that make fraud less likely and easier to detect.controls that make fraud less likely and easier to detect.


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The six key drivers of audit quality (identified inThe six key drivers of audit quality (identified in AuditAuditQualityQuality) are:) are:

Leadership,Leadership, including tone at the top and audit firm strategy;including tone at the top and audit firm strategy; People of competence, quality and integrity;People of competence, quality and integrity; Client Relationships, including effective management ofClient Relationships, including effective management of clientclient

portfolios and working with individual clients;portfolios and working with individual clients;

Working Practices and quality control procedures;Working Practices and quality control procedures; Internal Monitoring by audit firms of leadership, people, clientInternal Monitoring by audit firms of leadership, people, client

relationships and working practices; andrelationships and working practices; and External Monitoring under public oversight to encourage andExternal Monitoring under public oversight to encourage and

assist firms to improve audit quality.assist firms to improve audit quality.


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Risk & Fraud cycle


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Role of Internal & External auditors in fraud detectionRole of Internal & External auditors in fraud detection

Internal AuditorsInternal Auditors Assessment ofFraud Implications for External AuditorsAssessment ofFraud Implications for External Auditors Warning Signs:Warning Signs: Implications for External AuditorsImplications for External Auditors

External Auditors Can Partner with Internal AuditorsExternal Auditors Can Partner with Internal Auditors The AICPAThe AICPAs have issued SASs have issued SAS 9999,, Consideration of Fraud in a FinancialConsideration of Fraud in a Financial

StatementAuditStatementAudit,, directs external auditors to ask a companydirects external auditors to ask a companys internal audits internal auditpersonnel about the risk of fraud and any knowledge of actual or suspectedpersonnel about the risk of fraud and any knowledge of actual or suspectedfraud. The impetus for this directive comes from the important role internalfraud. The impetus for this directive comes from the important role internalauditors play in corporate governance. As recognized by the Treadwayauditors play in corporate governance. As recognized by the TreadwayCommission Report inCommission Report in 19871987, internal auditors are expected to assume an active, internal auditors are expected to assume an activerole in preventing and detecting fraudulent financial reporting.role in preventing and detecting fraudulent financial reporting.


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Fraud ConditionsFraud Conditions

According to SASAccording to SAS 9999, three fundamental, three fundamentalconditions are generally present when fraudulentconditions are generally present when fraudulentfinancial reporting occurs:financial reporting occurs:

11) incentive or pressure to perpetrate fraud,) incentive or pressure to perpetrate fraud,

22) an opportunity to carry out the fraud,) an opportunity to carry out the fraud,

33) attitude or rationalization to justify the fraudulent action.) attitude or rationalization to justify the fraudulent action.Within each of the three fundamental conditions, there are aWithin each of the three fundamental conditions, there are a

number of specific warning signs of fraud, including somenumber of specific warning signs of fraud, including somefactors directed toward corporate governancefactors directed toward corporate governance..


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AuditorAuditors Professional responsibilitys Professional responsibility

Certified auditors are required by Statement on Auditing Standards no.Certified auditors are required by Statement on Auditing Standards no. 9999,,Consideration of Fraud in a Financial StatementAudit,Consideration of Fraud in a Financial StatementAudit, to assess the riskto assess the riskthat financials are materially misstated.that financials are materially misstated.

The Association of Chartered Certified Accountants (ACCA) welcomes theThe Association of Chartered Certified Accountants (ACCA) welcomes the

opportunity to comment on the revised International Standard on Auditingopportunity to comment on the revised International Standard on Auditing240240 The AuditorThe Auditors Responsibility to Consider Fraud in an Audit ofs Responsibility to Consider Fraud in an Audit ofFinancial StatementsFinancial Statements proposed by the International Auditing andproposed by the International Auditing andAssurance Standards Board (IAASB).Assurance Standards Board (IAASB).

The Institute of Chartered Accountants in England and Wales (ICAEW)The Institute of Chartered Accountants in England and Wales (ICAEW)issued comprehensive guidance notes for Chartered Accountants followingissued comprehensive guidance notes for Chartered Accountants followingthe Money Laundering Regulations enactment inthe Money Laundering Regulations enactment in 19931993. Regarding. Regardingconventional frauds, ICAEW issued SASconventional frauds, ICAEW issued SAS 110110..11 on fraud and error andon fraud and error andfixed up the responsibility of auditorsfixed up the responsibility of auditors


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In FebruaryIn February 19971997, the AICPA auditing standards board (ASB) will issue, the AICPA auditing standards board (ASB) will issue

Statement on Auditing Standards (SAS) no.Statement on Auditing Standards (SAS) no. 8282,, Consideration of Fraud inConsideration of Fraud ina Financial StatementAudita Financial StatementAudit((product no.product no. 060675060675). The new standard). The new standardarticulates the independent auditorarticulates the independent auditors responsibility to plan and perform thes responsibility to plan and perform theaudit to obtain reasonable assurance as to whether the financial statementsaudit to obtain reasonable assurance as to whether the financial statementsare free of material misstatement, whether caused by error or fraud, andare free of material misstatement, whether caused by error or fraud, andprovides expanded operational guidance in fulfilling that responsibility.provides expanded operational guidance in fulfilling that responsibility.

Specifically, SAS no.Specifically, SAS no. 8282 Describes two types of fraud fraudulent financial reporting andDescribes two types of fraud fraudulent financial reporting and

misappropriation of assets.misappropriation of assets.

Requires the auditor to specifically assess the risk of material misstatementRequires the auditor to specifically assess the risk of material misstatementdue to fraud. It provides categories of risk factors that should be considereddue to fraud. It provides categories of risk factors that should be consideredand examples that might indicate the presence of fraud.and examples that might indicate the presence of fraud.

Provides guidance on how the auditor responds to the results of theProvides guidance on how the auditor responds to the results of theassessment and provides guidance on how this should be done and on howassessment and provides guidance on how this should be done and on howto evaluate test results.to evaluate test results.

Requires the auditor to document identified risk factors and any relatedRequires the auditor to document identified risk factors and any relatedresponse.response.


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Three of these ISAs (UK and Ireland), which concern theThree of these ISAs (UK and Ireland), which concern the

areas of audit risk and fraud, include a number ofareas of audit risk and fraud, include a number ofrequirements that are additional to those set out in therequirements that are additional to those set out in the

SASs theory replace. This Bulletin providedSASs theory replace. This Bulletin provided

supplementary guidance for auditors of charities onsupplementary guidance for auditors of charities on

these additional requirements, by replacing the sectionsthese additional requirements, by replacing the sectionsof PracticeNote (PN)of PracticeNote (PN) 1111 The Audit of Charities in theThe Audit of Charities in the

United Kingdom (Revised)United Kingdom (Revised) Which cover:Which cover:

SASSAS 210210:: Knowledge of the businessKnowledge of the business,,

SASSAS 300300:: Accounting and internal control systems andAccounting and internal control systems andaudit risk assessmentsaudit risk assessments;; andand

SASSAS 110110:: Fraud and errorFraud and error..


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Iranian AuditorIranian Auditors Responsibility to ConsiderFraud &s Responsibility to ConsiderFraud &Error in anError in an auditaudit ofFinancial statements AccordanceofFinancial statements Accordance

with Iran audit standards sec.with Iran audit standards sec.2424

SAS Says:SAS Says:

Its managementIts managements responsibility:s responsibility:Setting the proper toneSetting the proper tone

Creating and maintaining a culture of honesty and ethicsCreating and maintaining a culture of honesty and ethicsEstablishing appropriate controlsEstablishing appropriate controls


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Auditor's Responsibility under GenerallyAuditor's Responsibility under Generally

Accepted Auditing StandardsAccepted Auditing Standards

It is important for audit committees to understand whatIt is important for audit committees to understand whatan audit is and what it is not. Usually, audit committeesan audit is and what it is not. Usually, audit committeesare most concerned about the system of internal controlare most concerned about the system of internal controland that the financial statements are free of materialand that the financial statements are free of material

misstatement. The auditor should make sure the auditmisstatement. The auditor should make sure the auditcommittee understands the level of responsibility thatcommittee understands the level of responsibility thatthe auditor assumes for the system of internal controlthe auditor assumes for the system of internal controland the financial statements under generally acceptedand the financial statements under generally acceptedauditing standards (GAAS). It is also important that theauditing standards (GAAS). It is also important that the

auditor make sure that the audit committee understandsauditor make sure that the audit committee understandsthat an audit is designed to obtain reasonable rather thanthat an audit is designed to obtain reasonable rather thanabsolute assurance about the financial statements.absolute assurance about the financial statements.


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The following statistics about fraud and whiteThe following statistics about fraud and white--collar crime are from thecollar crime are from theAssociation of Certified Fraud Examiners (US) report:Association of Certified Fraud Examiners (US) report:

Fraud and abuse costs US organizations more than $Fraud and abuse costs US organizations more than $400400 billion annually.billion annually.The average organization loses more than $The average organization loses more than $99 per day per employee toper day per employee tofraud and abuse.fraud and abuse.

The average organizations lose aboutThe average organizations lose about 66%% of its total annual revenue toof its total annual revenue tofraud and abuse committed by its own employees.fraud and abuse committed by its own employees.The median loss caused by mails is about $The median loss caused by mails is about $185000185000; by females about; by females about$$4800048000 and thus men commit nearlyand thus men commit nearly 7575%% of the offenses.of the offenses.Losses caused by managers are four times those caused by employees.Losses caused by managers are four times those caused by employees.Median losses caused by executives areMedian losses caused by executives are 1616 times those of their employeestimes those of their employeesThe highest median losses occur in the real estate financing sector.The highest median losses occur in the real estate financing sector.

Occupational fraud and abuses fall into these main categories; assetOccupational fraud and abuses fall into these main categories; assetmisappropriation, fraudulent statements and bribery and corruption.misappropriation, fraudulent statements and bribery and corruption.


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Fraud effect in UKFraud effect in UK

It is estimated that fraud costIt is estimated that fraud cost 1313 billion inbillion in 20002000 oror230230 for every man, womanfor every man, womanand child in Britain (figures exclusive of money laundering)and child in Britain (figures exclusive of money laundering) (City of London Police,(City of London Police,20022002; National Economic Research Associates for the Home office,; National Economic Research Associates for the Home office, 20002000))

False motor and household claims cost the insurance industry and policy holdersFalse motor and household claims cost the insurance industry and policy holders2020 million per weekmillion per week(Association of British Insurers, April(Association of British Insurers, April 20032003))

5151% of British businesses have been the victims of fraud in the last two years% of British businesses have been the victims of fraud in the last two years

(PricewaterhouseCoopers, July(PricewaterhouseCoopers, July 20032003)) Benefit fraud costsBenefit fraud costs 22 billion a year,billion a year, 8080 for every family in the countryfor every family in the country

(Department of Work and Pensions, June(Department of Work and Pensions, June 20032003))

Plastic card fraud alone costPlastic card fraud alone cost 424424..66 million inmillion in 20022002 3030% up on the year before% up on the year before(Association for Payment Clearing Services, April(Association for Payment Clearing Services, April 20032003))

CardCard--notnot--present fraud is the largest type of card fraud in the UK. Inpresent fraud is the largest type of card fraud in the UK. In 20032003 losseslosseswerewere 116116..44 millionmillion (Association for Payment Clearing Services, April(Association for Payment Clearing Services, April 20042004))

Fraud wrecks ordinary lives by destroying jobs, savings and pensions.Fraud wrecks ordinary lives by destroying jobs, savings and pensions. 1616 investorsinvestorstook their own lives in the aftermath of the Barlow Clowes fraudtook their own lives in the aftermath of the Barlow Clowes fraud (The Serious(The SeriousFraud Office,Fraud Office, 20022002))


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Auditors under fireAuditors under fire

Andrew Ratcliffe Chairman of the ICAEW Audit and AssuranceAndrew Ratcliffe Chairman of the ICAEW Audit and AssuranceFaculty:Faculty:

Auditors are not, and indeed should not be, held responsibleAuditors are not, and indeed should not be, held responsiblefor detecting all fraud, but we must play our part to improvefor detecting all fraud, but we must play our part to improve

the overall detection rate to help maintain public trust inthe overall detection rate to help maintain public trust inpublished accounts following the recent spate of USpublished accounts following the recent spate of USaccounting scandals.accounting scandals.

We are also concerned about companies that adopt aggressiveWe are also concerned about companies that adopt aggressiveaccounting practices which might stop short of being clearlyaccounting practices which might stop short of being clearly

fraudulent. Faced with this risk, auditors will need to morefraudulent. Faced with this risk, auditors will need to moreactively search out aggressive accounting and help ensure thatactively search out aggressive accounting and help ensure thatthe right judgments are applied."the right judgments are applied."


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Introduction to Fraud DetectionIntroduction to Fraud DetectionThere are more advanced techniques on this site, butThere are more advanced techniques on this site, but

this is the place to start to get some idea whatthis is the place to start to get some idea what

techniques you can use for spotting funny numbers.techniques you can use for spotting funny numbers.

Examine cash flow.Examine cash flow.

Watch out for "capitalizing" of assets.Watch out for "capitalizing" of assets.

Watch for "channel stuffing.Watch for "channel stuffing.

Beware "Pro Forma.Beware "Pro Forma. Look for routine writeLook for routine write--offs.offs.

Understand the business.Understand the business.


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Frauds can also be categorized by the technique or activity used by the fraudster.Frauds can also be categorized by the technique or activity used by the fraudster.These include:These include:

Advance fee fraudsAdvance fee fraudsBogus invoicesBogus invoicesComputer hacking of information or propertyComputer hacking of information or propertyCorruption and briberyCorruption and briberyCounterfeiting, forgery, or copyright abuseCounterfeiting, forgery, or copyright abuseCredit Card fraudCredit Card fraudFalse AccountingFalse Accounting -- manipulation of accounts and accounting recordsmanipulation of accounts and accounting recordsFraudulent bankruptcyFraudulent bankruptcy -- exploitation of crossexploitation of cross--border corporate structuresborder corporate structuresInsurance fraudInsurance fraudInternet online scamsInternet online scams -- auctions, credit card purchases, investment scamsauctions, credit card purchases, investment scamsInvestment fraudInvestment fraudLong Firm fraudLong Firm fraudMisappropriation of assetsMisappropriation of assets

Money launderingMoney launderingMortgage FraudMortgage FraudPayroll fraudPayroll fraudPrincipal agentsPrincipal agents -- failure of systems to restrict key individualsfailure of systems to restrict key individualsPyramid schemesPyramid schemesUnsolicited letter frauds.Unsolicited letter frauds.


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Fraud Detection: Basic TechniquesFraud Detection: Basic Techniques Watch out for two or more businesses controlled byWatch out for two or more businesses controlled by

the same person.the same person.

Revenue and expenses can be arbitrarily shiftedRevenue and expenses can be arbitrarily shiftedbetween the two businesses. For example, if a personbetween the two businesses. For example, if a personcontrols a retail business and a real estate business, hecontrols a retail business and a real estate business, he

can shift revenue from the real estate business whencan shift revenue from the real estate business when

the retail business has a bad year. Public corporationsthe retail business has a bad year. Public corporations

frequently share board members and executives withfrequently share board members and executives with

other corporations.other corporations.


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Check their income tax expense and footnotes.Check their income tax expense and footnotes.Fraudulent corporations have an incentive to makeFraudulent corporations have an incentive to make

their profit number as big as possible for their annualtheir profit number as big as possible for their annualand quarterly reports, but they have an incentive toand quarterly reports, but they have an incentive tomake that number asmake that number assmallsmallas possible for the IRS,as possible for the IRS,because they have to pay income tax on it! So if thebecause they have to pay income tax on it! So if the

corporation is reporting large profits but is payingcorporation is reporting large profits but is payingnext to nothing on income tax, they might be lyingnext to nothing on income tax, they might be lyingeither to you, or to the IRS. NOTE: Unfortunately,either to you, or to the IRS. NOTE: Unfortunately,this doesn't prove fraud, as the tax code is so riddenthis doesn't prove fraud, as the tax code is so riddenwith loopholes that multiwith loopholes that multi--billionbillion--dollar corporationsdollar corporationslike General Electric routinely get away with payinglike General Electric routinely get away with payingno income tax at all!no income tax at all!


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Beware discontinuities that becomeBeware discontinuities that become

continuitiescontinuities

An extraordinary loss or gain should notAn extraordinary loss or gain should notbecome a regular feature of a business's incomebecome a regular feature of a business's income

statement. If a business is having majorstatement. If a business is having major

lawsuits, abandoning product lines, orlawsuits, abandoning product lines, orundergoing major restructuring, that's a signundergoing major restructuring, that's a sign

that management is either up to somethingthat management is either up to something

(fraud), or don't know what they are doing(fraud), or don't know what they are doing

(poor management).(poor management).


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Beware discontinuities that become opportunities toBeware discontinuities that become opportunities todump too many writedump too many write--downs and losses.downs and losses.

This is the "big bath" theory. The company may runThis is the "big bath" theory. The company may run

losses for years, without reporting them, and thenlosses for years, without reporting them, and thentake a "big bath" and write down the losses all attake a "big bath" and write down the losses all at

once. If the company has done this is the past, theyonce. If the company has done this is the past, they

might do it again, and as an investor you don't want tomight do it again, and as an investor you don't want to

get caught in the bath.get caught in the bath.


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Watch for high debtWatch for high debt

A company with too high debt is walking onA company with too high debt is walking onthe edge of a cliff. Any major problem, andthe edge of a cliff. Any major problem, and

they get pushed over. Note: Even an acidthey get pushed over. Note: Even an acid--testtest

ratio .ratio .

11--toto--11 may not be enough if you're dealingmay not be enough if you're dealingwith a type of business that depends heavily onwith a type of business that depends heavily onshortshort--term debt.term debt.


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Pay attention to the accounting methods. WhatPay attention to the accounting methods. Whatmethod are they using to determinemethod are they using to determine

inventory,inventory,

cost of goods sold, andcost of goods sold, and

depreciation of assets.depreciation of assets. Are they using "markAre they using "mark--toto--market" for accountingmarket" for accounting

their sales revenue? (Enron was.) Companies dotheir sales revenue? (Enron was.) Companies do

not have to report what their income would havenot have to report what their income would have

looked like if they were using different accountinglooked like if they were using different accounting

rules.rules.


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Beware "free cash flow"Beware "free cash flow"

Free cash flow hasFree cash flow has nono officially definedofficially definedmeaning determined by any authoritativemeaning determined by any authoritative

accounting ruleaccounting rule--making body.making body.


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L

ook for special gains and losses on the statementL

ook for special gains and losses on the statementof stockholders' equity.of stockholders' equity.

The general format of the statement ofThe general format of the statement ofstockholders' equity is to use a column for eachstockholders' equity is to use a column for eachclass of stock (common stock, preferred stock,class of stock (common stock, preferred stock,treasury stock, and so on), a column for retainedtreasury stock, and so on), a column for retainedearnings, and any other components ofearnings, and any other components ofstockholders' equity. Special gains and lossesstockholders' equity. Special gains and lossesshould be reported on the income statement,should be reported on the income statement,

underneath the net income line. They shouldunderneath the net income line. They should notnotbe here, on the statement of stockholders' equity.be here, on the statement of stockholders' equity.


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Look for "window dressing" on the balanceLook for "window dressing" on the balancesheet.sheet.

This is where numbers are nudged from oneThis is where numbers are nudged from oneaccount to another, without changing theaccount to another, without changing the

total amount. For example, money could betotal amount. For example, money could be

moved from accounts receivable to cash, tomoved from accounts receivable to cash, to

make the cash balance look better.make the cash balance look better.


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Watch out for profit smoothingWatch out for profit smoothing

A company that has large changes in revenue willA company that has large changes in revenue willusually use profit smoothing. This involvesusually use profit smoothing. This involvesmoving current income to the future. Formoving current income to the future. Forexample, suppose the company is a video gameexample, suppose the company is a video gamecompany, and they get massive revenue "spikes"company, and they get massive revenue "spikes"

when a game is released, but relatively low saleswhen a game is released, but relatively low salesthe rest of the time. The company will spread thethe rest of the time. The company will spread themoney from the "spikes" out over the year, so thatmoney from the "spikes" out over the year, so thattheir revenue shows a steady increase from yeartheir revenue shows a steady increase from year

to year. Using profitto year. Using profit smoothing is legal, but cansmoothing is legal, but canbe abused.be abused.


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Look for sales skimming.Look for sales skimming.

This is when the owners pocket sales moneyThis is when the owners pocket sales moneywithout reporting it. One way to spot this is towithout reporting it. One way to spot this is to

look at the gross profit and operating profitlook at the gross profit and operating profitratios.ratios.


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Look for unnecessary dilution of stock.Look for unnecessary dilution of stock. If a company is creating shares of stock for sale,If a company is creating shares of stock for sale,

but doesn't actually need the money, then theybut doesn't actually need the money, then theycould be doing something sneaky. Watch out forcould be doing something sneaky. Watch out formanagers that give themselves stock optionsmanagers that give themselves stock options(and create new shares in the process) and then(and create new shares in the process) and thenhave the company buy back the company stockhave the company buy back the company stockoff the market. By doing this, they increase theiroff the market. By doing this, they increase their

own share of ownership in the company, at theown share of ownership in the company, at theexpense of everybody else (including you).expense of everybody else (including you).


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Beware ofLLC'sBeware ofLLC's

Limited Liability Corporations, or LLC's, canLimited Liability Corporations, or LLC's, can

have extremely complicated ownershiphave extremely complicated ownershipstructures.structures.


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Examine how indirect costs are allocated.Examine how indirect costs are allocated.

Indirect costs are costs that cannot beIndirect costs are costs that cannot beobviously attributed to specific products,obviously attributed to specific products,organizational units, or activities. A bookorganizational units, or activities. A bookpublisher's phone bill is a cost of doingpublisher's phone bill is a cost of doing

business, but it can't be attributed to abusiness, but it can't be attributed to aparticular book, or a particular step in theparticular book, or a particular step in theprocess of producing books. Allocation ofprocess of producing books. Allocation ofindirect costs is ultimately arbitrary.indirect costs is ultimately arbitrary.Because it is arbitrary, it can be abused. ForBecause it is arbitrary, it can be abused. Forexample, misclassification of manufacturingexample, misclassification of manufacturingcosts as operational costs will make the costcosts as operational costs will make the costof producing a product look too low.of producing a product look too low.


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Watch out for products sold "on approval"Watch out for products sold "on approval"or with right of return. Revenues shouldor with right of return. Revenues should

only be booked after the sale is completeonly be booked after the sale is completeand the goods can no longer be returned.and the goods can no longer be returned.


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7171

Examine how indirect costs are allocated.Examine how indirect costs are allocated.Indirect costs are costs that cannot beIndirect costs are costs that cannot be

obviously attributed to specific products,obviously attributed to specific products,organizational units, or activities. A bookorganizational units, or activities. A bookpublisher's phone bill is a cost of doingpublisher's phone bill is a cost of doingbusiness, but it can't be attributed to abusiness, but it can't be attributed to a

particular book, or a particular step in theparticular book, or a particular step in theprocess of producing books. Allocation ofprocess of producing books. Allocation ofindirect costs is ultimately arbitrary.indirect costs is ultimately arbitrary.Because it is arbitrary, it can be abused. ForBecause it is arbitrary, it can be abused. For

example, misclassification of manufacturingexample, misclassification of manufacturingcosts as operational costs will make the costcosts as operational costs will make the costof producing a product look too low.of producing a product look too low.


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Watch out for products sold "on approval"Watch out for products sold "on approval"

or with right of return. Revenues shouldor with right of return. Revenues shouldonly be booked after the sale is completeonly be booked after the sale is completeand the goods can no longer be returned.and the goods can no longer be returned.


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Watch out for LIFO inventory.Watch out for LIFO inventory.

LIFO is usually the wrong accounting method forLIFO is usually the wrong accounting method forinventory, because:inventory, because:

most businesses don't raise prices as soon asmost businesses don't raise prices as soon asreplacement costs increase, or base their salesreplacement costs increase, or base their sales

pricepriceonon the most recent purchase costs,the most recent purchase costs, the inventory cost value can get seriously outthe inventory cost value can get seriously out

of date, especially if the business sells productsof date, especially if the business sells productsthat have long lives (an equipmentthat have long lives (an equipment

manufacturer, for example),manufacturer, for example), LIFO figures can be moreeasily manipulatedLIFO figures can be moreeasily manipulatedby unscrupulous management.by unscrupulous management.


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Make sure the company is using "Lower ofMake sure the company is using "Lower ofCost or Market" (LCM) to calculate theirCost or Market" (LCM) to calculate theirinventory.inventory.

Lower of Cost or Market gives a moreLower of Cost or Market gives a moreconservative inventory value. Someconservative inventory value. Somemanagers cheat and useLCM to report anmanagers cheat and useLCM to report anunusually low inventory for cheating onunusually low inventory for cheating onincome tax.income tax.


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Did the company change depreciationDid the company change depreciationrules? An unexplained change fromrules? An unexplained change from

accelerated depreciation to straightaccelerated depreciation to straight--linelinedepreciation, or to markdepreciation, or to mark--toto--marketmarketdepreciation should set off alarms.depreciation should set off alarms.Companies can make funny money byCompanies can make funny money by

playing with depreciation rules, eitherplaying with depreciation rules, eitherwriting off too little (and boosting theirwriting off too little (and boosting theirbalance sheet) or too much. If they write offbalance sheet) or too much. If they write offtoo much, it makes their current financialtoo much, it makes their current financialresults look bad, but gives them hidden cashresults look bad, but gives them hidden cashreserves. They can use these reserves toreserves. They can use these reserves toboost future sales or offset futureexpenses.boost future sales or offset futureexpenses.


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Compare profit ratios with past statements.Compare profit ratios with past statements. Calculate the gross margin (profit as aCalculate the gross margin (profit as a

percentage of sales) and see if it changes frompercentage of sales) and see if it changes from

quarter to quarter.N

ormally it will notquarter to quarter.N

ormally it will notchange suddenly. There are many other ratioschange suddenly. There are many other ratiosyou can look at.you can look at.


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Examineextraordinary losses.Examineextraordinary losses. Often an extraordinary loss is not the resultOften an extraordinary loss is not the result

of a oneof a one--timeevent, but the cumulativetimeevent, but the cumulative

result of years of bad accounting.result of years of bad accounting.


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See ifearnings per share kept up with profit.See ifearnings per share kept up with profit. If profit increased by a larger percentage thanIf profit increased by a larger percentage thanearnings per share, and there wasn't any stockearnings per share, and there wasn't any stocksplit, or stock offering (with a clearlysplit, or stock offering (with a clearlyexplained justification), then management isexplained justification), then management isdiluting the shares. While this doesn'tdiluting the shares. While this doesn'tnecessarily mean fraud, it is a red flag thatnecessarily mean fraud, it is a red flag thatmanagement doesn't care about shareholdermanagement doesn't care about shareholder

interests.interests.


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Compare profit increase with cash flow.Compare profit increase with cash flow.These should increase in lockstep. Usually ifThese should increase in lockstep. Usually ifcash flow is low (or negative) it's because allcash flow is low (or negative) it's because allthe profits are in accounts receivable andthe profits are in accounts receivable andhaven't been collected yet.haven't been collected yet.


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Check that increases in assets and liabilitiesCheck that increases in assets and liabilitiesare consistent with the business's growth.are consistent with the business's growth.

If the company is reporting profits quarterIf the company is reporting profits quarterafter quarter, but total assets is shrinking,after quarter, but total assets is shrinking,something is wrong. If most balance sheetsomething is wrong. If most balance sheetitems increase by a few percentageeachitems increase by a few percentageeachyear, but one item has a huge jumpyear, but one item has a huge jump

Positive or negativePositive or negative

Make sure you know the reason why.Make sure you know the reason why.


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Look for "other." Most balance sheets haveLook for "other." Most balance sheets havea catcha catch--all category called "Other assets."all category called "Other assets."Likewise, most income statements have aLikewise, most income statements have a

catchcatch--all category called "Other expenses."all category called "Other expenses."These "other" categories should be smallThese "other" categories should be smalland insignificant. If a significant amount ofand insignificant. If a significant amount ofassets is in the "other" category, beware!assets is in the "other" category, beware!


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1010 STEP ANTIFRAUD PLAN (PWC)STEP ANTIFRAUD PLAN (PWC)

11)) Anticipate Questions and Manage Expectations.Anticipate Questions and Manage Expectations.

22)) Assess existing antifraud programs and controls.Assess existing antifraud programs and controls.33)) Secure management and audit committee sponsorship.Secure management and audit committee sponsorship.

44)) Assemble fraud expertise within internal auditing.Assemble fraud expertise within internal auditing.

55)) Organize a fraud and reputation risk assessment.Organize a fraud and reputation risk assessment.

77)) Evaluate and test the design and operatingEvaluate and test the design and operatingeffectiveness of controls.effectiveness of controls.

88)) Refine the audit plan to address residual risk andRefine the audit plan to address residual risk andincorporate fraud auditing.incorporate fraud auditing.

99)) Establish a standard process for responding to fraudEstablish a standard process for responding to fraudallegations or suspicions.allegations or suspicions.

1010)) Remediate and prevent recurrenceRemediate and prevent recurrence


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What did the auditor say?What did the auditor say?

Just because the auditor says the books are cleanJust because the auditor says the books are cleandoesn't mean they are, of course. You shoulddoesn't mean they are, of course. You shouldnever trust the auditor. But if the auditor didnever trust the auditor. But if the auditor didraise a red flag, take it very, very seriously! Ifraise a red flag, take it very, very seriously! If

the auditor's opinion is qualified by anything,the auditor's opinion is qualified by anything,you should be more skeptical of the entireyou should be more skeptical of the entirefinancial statementfinancial statement ---- not just the item that thenot just the item that theauditor expressed concern about. If the auditorauditor expressed concern about. If the auditorexpresses concern about the company's ability toexpresses concern about the company's ability to

be a "going concern", the auditor is saying thebe a "going concern", the auditor is saying thebusiness is about to be forced into bankruptcy.business is about to be forced into bankruptcy.


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What Arthur Anderson SaidWhat Arthur Anderson Said

Bauer, the chief auditor of EnronBauer, the chief auditor of Enrons wholesale division,s wholesale division,

I did not know the company was using reserves toI did not know the company was using reserves to

meet earnings targets and would not have approved ifmeet earnings targets and would not have approved if

he had known, the Chicago Tribune reports.he had known, the Chicago Tribune reports. No oneNo onegave me this information,gave me this information, Bauer said.Bauer said. ThatThatss

earnings management; thatearnings management; thats never OK. . . . Enrons never OK. . . . Enron

had an obligation to me to provide all documents, allhad an obligation to me to provide all documents, all

agreements, oral or written and they didnagreements, oral or written and they didnt do that,t do that,..

AccountingWEB.comAccountingWEB.com -- MarMar--2424--20062006


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Is the auditor also doing consulting?Is the auditor also doing consulting?Consulting may be referred to asConsulting may be referred to as"corporate finance," "eBusiness," "human"corporate finance," "eBusiness," "humancapital," " legal services," "outsourcing,"capital," " legal services," "outsourcing,""risk management," "tax services", and so"risk management," "tax services", and soon. Doing audits and consulting is a deepon. Doing audits and consulting is a deepconflict of interest, as the Enron scandalconflict of interest, as the Enron scandalwell demonstrates.well demonstrates.

Consequences of FraudConsequences of Fraud


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Consequences of FraudConsequences of Fraud

Lost confidence in capital marketsLost confidence in capital markets

LawsuitsLawsuitsone company has overone company has over 33,,000000 Firms going out of businessFirms going out of businesshuge bankruptcieshuge bankruptcies Lost reputation and bad pressLost reputation and bad press Longer and more expensive audits, special inquiriesLonger and more expensive audits, special inquiries

Fines &Fines & investigationsinvestigations Damaged employees & reputationsDamaged employees & reputations Lost retirement and pension fundsLost retirement and pension fundsnow downnow down 4545%% Directors with personal liability, forced resignationsDirectors with personal liability, forced resignations Losses from fraudLosses from fraud Significant legislative activitySignificant legislative activity


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Financial Statement FraudsFinancial Statement Frauds

Revenue/Accounts Receivable Frauds (GlobalRevenue/Accounts Receivable Frauds (GlobalCrossing, Quest, ZZZZ Best)Crossing, Quest, ZZZZ Best)

Inventory/Cost ofGoods Sold FraudsInventory/Cost ofGoods Sold Frauds

(PharMor)(PharMor) Understating Liability/Expense Frauds (Enron)Understating Liability/Expense Frauds (Enron) Overstating Asset Frauds (WorldCom)Overstating Asset Frauds (WorldCom) Overall Misrepresentation (BreOverall Misrepresentation (Bre--X Minerals)X Minerals)

R R l t d T ti d F d


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Transaction Accounts Involved Fraud Schemes

1. E all

uncollectible accounts

Bad debt expense, allowance for

doubtful accounts

1. Understate allowance for doubtful accounts, thus

overstating receivables

2. Sell goods and/or

services to customers

Accounts receivable, revenues

(e.g. sales revenue) (Note: cost of

goods sold part of entryh is

included in Chapter 5)

2. Record fict itious sales (related part ies, sham sales,

sales with conditions, consignment sales, etc.)

3. Recognize revenues too early ( improper cuto ff,

percentage of completion, etc.)

4. Overstate real sales (alter cont racts, inflate

amounts, etc.)

3. Accept returned goods

from customers

Sales returns, accounts receivable 5.Not record returned goods from customers

6. Record returned goods after t he end of the period

4. Write off receivables as

uncol

Fraud & Corruption Final

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